Sizing up small-cap funds, Photo by patricia serna on Unsplash

Sizing Up UK Small-Cap Funds

We seem to be having more of a Santa Rout than a Santa Rally, so it’s a brave investor that’s looking to put money in small-cap funds right now. But I think it’s a great time to size up what’s on offer.

In an earlier piece, I looked what we actually mean by small caps (in short, pretty much anything outside the FTSE 100 in the UK) and why they seem to produce better returns than larger companies.

In a subsequent piece, I plan to look at small-cap investment trusts that invest outside the UK as there are a few that cover the globe (4 in total), Europe (4), North America (3), and Japan (4).

Small-caps begin at home

Here, I’m going to concentrate on UK-focused small-cap investment trusts. There are 23 funds in total if we include a handful classed outside the UK Smaller Companies sector and ignore sector specialist funds and venture capital trusts.

As the FTSE 250, the UK mid-cap index, seems to perform similarly to the small-cap index, I’ve included JPMorgan MidCap and Schroder UK Mid Cap even though the AIC classes them under UK All Companies. I’ve also added Acorn Income and Aberdeen Smaller Companies Income from the UK Equity & Bond Income sector.

I’ve listed the funds in descending order of size with a selection of additional data points. The performance figures are in net asset terms rather than share prices.

UK small-cap funds

NameTickerLaunchedAssets (£m)Discount (%)Gearing (%)1y (%)3y (%)5y (%)10y (%)Yield (%)
Aberforth SmallerASL19901,165-120-1312262992.5
BlackRock SmallerBRSC1906696-117-935605722.4
Henderson SmallerHSL1887657-114-1224505452.8
Standard Life UK SmallerSLS1993477-90-826524581.7
BlackRock ThrogmortonTHRG1962453-1217-836635462.1
JPMorgan MidCapJMF1972266-56-166443362.9
Montanaro UK SmallerMTU1995218-910-147162575.3
Schroder UK Mid CapSCP1983206-174-1311253062.9
JPMorgan SmallerJMI1990205-1511-131023308*14.4
Aberforth Split Level IncomeASIT2017202-534-185.3
Rights & IssuesRIII1962171-40-952855971.5
Strategic Equity CapitalSEC2005154-180-1315515200.5
Invesco Perpetual UK SmallerIPU1988154-70-930603444.9
Acorn IncomeAIF199992-739-1612335755.5
Miton UK MicrocapMINI201588-30-11120.6
River & Mercantile UK Micro CapRMMC201484-90-456
Odyssean Investment TrustOIT20188450
Aberdeen Smaller Companies IncomeASCI199270-198-1324404123.1
Downing Strategic Micro-CapDSM201744-20-15
Gresham House StrategicGHS201543-2508271.0
SVM UK EmergingSVM2000640-82147152
Chelverton GrowthCGW2001350-36-126185

* see the dividend section below

The old and the new

There’s quite a mix of established funds and young upstarts here. Six funds have been launched in the last five years, so are yet to be battle-tested in a proper bear market. Most of the rest have been around for at least 20 years.

In the interests of disclosure, I currently own BlackRock Smaller and Henderson Smaller, the two oldest funds in the sector, and Acorn Income.

In terms of individual fund managers, some of the more famous names include Mike Prentis at BlackRock Smaller (since 2002), Neil Hermon at Henderson Smaller (also 2002), Gervais Williams at Miton (2015), and Standard Life’s Harry Nimmo (2003). Prentis also used to run Throgmorton but handed that over to Dan Whitestone earlier in 2018.

I believe the longest-tenured manager is Simon Knott at Rights & Issues (1984). This is a trust I’ll probably look at more closely at a later date as it boasts an excellent long-term record (note: here’s that closer look).

From 1984 to 2017, Rights & Issues rose eighty fold compared to seven times for the UK market. It has a very concentrated portfolio, though, with just two dozen holdings. Some 70% of its assets are in its top seven positions.

Can a small-cap fund be too big?

By necessity, the biggest small-cap funds tend to be a lot more diversified than the likes of Rights & Issues, otherwise they would end up with very large positions in the smallest companies. In such cases, it would be hard for them to buy into a company without increasing its share price significantly or sell out without causing it to crater.

Aberforth Smaller, which is by some distance the largest in the sector, aims for around 80 positions. Henderson Smaller and BlackRock Smaller have just over a hundred apiece.

These larger funds often have material positions in FTSE 250 companies. Aberforth has around 40% in the FTSE 250 while Henderson has 55%. BlackRock has just 20%, however, with around 50% of its money in AIM shares. The slightly different target areas are why I have holdings in both Henderson and BlackRock.

While I am hoping to hold both Henderson and BlackRock for a long time, I’ll be watching out for any change of manager and how position sizes change as the fund becomes larger over time (although that doesn’t seem to be much of a concern with the markets as they are right now!)

Letting go at River & Mercantile

On the subject of not getting too big, River & Mercantile UK Micro Cap has an interesting share redemption programme designed to keep it around the £100m market cap level. It’s had three redemptions since launching in 2014, courtesy of its good returns to date, and it looks like a leading contender to top the 5-year performance tables once it qualifies to be included around this time next year.

River & Mercantile has 40% of its assets in companies valued at more than £100m, which is odd for a micro-cap fund you might think. It’s notable both for being an early backer of Blue Prism, one of the best-performing shares of recent years, and for selling it before the company’s share price slump of the last few months. (This highlights a strange dilemma that a small-cap fund manager can end up facing: if a company ‘multi bags’ and is no longer considered a small cap should you hold on or let it go?)

It’s been an eventful year for River & Mercantile as it sacked its manager, Philip Rodrigs, in February of this year for a professional misconduct issue. His replacement, George Ensor, made the call to ditch Blue Prism because its market cap soared over the £1bn mark. Not much seems to be known about Ensor, but this seems like a fund worth researching in more detail.

Some funds can be too small

In most cases, I’m reluctant to invest in trusts with a market cap of £30m or below, as their small size means charges can be quite high and their shares tend to be illiquid with wide bid-offer spreads.

The UK small-cap sector has three trusts with assets of less than £10m, making them pretty much uninvestable as far as I am concerned. That said, Athelney and Chelverton are of note, albeit not necessarily in a good way.

Athelney’s well-regarded fund manager of 24 years, Robin Boyle, resigned in a tweet at the end of September. In terms of Twitter drama, it’s certainly no Elon Musk/Tesla moment, but it’s fairly radical for the sleepy world of investment trusts!

Athelney has just announced plans for a tender offer, for those who wish to follow Boyle out of the door, plus a new issue to increase the size of the trust. Details are sketchy, so we’ll have to see what happens next.

Chelverton Growth, the smallest fund in the sector, has had a torrid year with its shares down nearly 40%. Last month, it said it was looking at winding itself up although it expects the process to take a couple of years due to the illiquid nature of many of its holdings.

This trust is also notable for its share price trebling in Autumn 2016 when it was apparently being ramped by a couple of websites. After Chelverton’s management highlighted the illogical nature of its 108% premium to net asset value, gravity soon reasserted itself.

Discounts are the norm

Athelney and Chelverton are two of only three small-cap funds to trade at a premium. The other is Odyssean, a new fund run by Stuart Widdowson, who was in charge of Strategic Equity Capital up until February 2017. Strategic Equity Capital, a sector star up until that point, seems to have struggled a little since and has cut its charges to appease investors.

Odyssean is another fund I’m keeping a watchful eye on, given Widdowson’s track record. It launched in May 2018 but still had 55% of its assets in cash in September. I suspect Widdowson has been out shopping since. He appeared on a recent Investors Chronicle podcast if you want to get a feel for his style.

It’s another trust that illustrates the recent trend of managers setting up on their own (Neil Woodford and Terry Smith being the most famous) to run more concentrated portfolios. Odyssean is aiming for around 25 holdings with the majority of its assets in the largest ten. Concentrated portfolios can be great for long-term outperformance but expect them to be more volatile.

Across the rest of the sector, discounts are typically in the region of 10%, so greater than the average investment trust. In the financial crisis, discounts widened considerably, in a few cases exceeding 40%.

Gresham House Strategic, which has the largest current discount at 25%, is another so-called conviction portfolio. It’s a relatively new fund having been created from the ashes of a company called SPARK Ventures in 2015.

At one stage it had nearly half its assets in one company — a software company called IMImobile, which was a legacy holding from the SPARK days. The IMImobile stake is now down to around 25% and this trust also has a 25% cash position, but the big discount appears stubbornly persistent!

Dividends are low (but can grow quickly)

Smaller companies tend to pay lower dividends than blue chips, so it’s no surprise that small-cap investment trusts pay out less than mainstream funds. 2.0% to 2.5% is fairly standard right now although there are some notable exceptions.

Acorn Income, for example, juices its payouts by investing in some fixed-interest securities and having the highest level of gearing in the sector due to a dual capital structure with zero dividend preference shares (ZDPs). In total, £36m of ZDPs are due to be redeemed in February 2022, making this perhaps my riskiest personal holding.

Invesco Perpetual UK Smaller is one of a few investment trusts that now make dividend payments from capital as well as income. It made this change in 2015 and targets a 4% yield. 2018’s stock market drop means its yield is now nearly 5%, so the final payment for the year (usually announced in March or April) could be trimmed to bring the yield back down to 4%.

Last and not least, JPMorgan Smaller’s dividend yield is not actually 14.4% as per my table. This trust did a 5 for 1 share division at the end of November and the data at the AIC website obviously hasn’t been updated to reflect this yet. I left this number unchanged to remind myself that you can never 100% rely on data sources without checking the original figures!

What small-cap funds lack in overall yield, they can make up for in terms of dividend growth. Many funds have seen growth in the region of 15% a year over the last five years. If you’re planning to hold small-cap funds for a decade or more, they could have the potential to morph into substantial dividend payers.

Performance figures are flattering

The 10-year performance figures across the sector look amazing right now.

Out of 17 funds with a 10-year history, 13 have quadrupled your money or better in term of net asset return. However, both the FTSE 250 and FTSE SmallCap indices are also up 300% over the last 10 years, so arguably this is the minimum you should expect a decent UK small-cap trust to have produced.

I’d say that the 5-year performance stats are probably more indicative of what you might expect to see over the very long term. But this is definitely a sector of feast and famine, so expect returns to vary wildly from year to year.

2018 demonstrates this in spades, with pretty much every single trust down over the last 12 months (kudos to Gresham Strategic for being the lone positive performer).

Active management through an investment trust can be a great way to generate additional returns from specialised niche sectors like small caps. But it’s really hard for any fund to buck short-term downward moves like the one we’ve seen in recent months.



Please note that I may own some of the investments mentioned above -- you can see my current holdings on my portfolio page.

Nothing on this website should be regarded as a buy or sell recommendation as I'm just a random person writing a blog in his spare time and I am not authorised to give financial advice. Always do your own research and seek financial advice if necessary!

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