Henderson Smaller Companies Trust – finding gems in the UK market
While economic uncertainty and jittery markets make for a challenging investment environment, for the discerning investor, they also create fantastic opportunities. Amid the turmoil, there are hidden gems, companies that are not only surviving but have become undervalued and are thriving. In such a market, stock picking is more important than ever.
6 minute read
- The current market backdrop is ripe for stock pickers looking for hidden gems that have been caught in the recent sell-off and are being overlooked by the wider market.
- We look for companies that produce quality products, have a sustainable competitive advantage, a strong balance sheet, and ambitious and capable management that can navigate the business through challenging times.
- While there are many economic risks and challenges, not all companies are equally exposed, and some are extremely well-placed to thrive and take market share from their competitors.
The economic outlook, both globally and in the UK, remains deeply uncertain. The war in Ukraine grinds on, tensions between the West and China remain elevated, inflation remains stubbornly high and central banks around the world continue to raise interest rates.
Domestically, inflation in the UK has dropped back from its peak of more than 11% in August 2022, but it has not fallen as fast as many had hoped. As a result, the Bank of England has signalled that it will continue to raise interest rates, leading many to forecast a recession for the UK economy. This has sparked volatility in all corners of the market, making uncertainty the new normal.
In such an environment, being selective about your investments is key. At the Henderson Smaller Companies Investment Trust, we believe that true active management will navigate you through challenging periods. Yes, there are many economic risks and challenges, but not all companies are equally exposed, and some are extremely well-placed to thrive in current environment. Active management is all about selective discernment, shutting out the noise and finding the hidden gems amongst the volatility.
It is a strategy that has served us well. Total share price returns over the last 10 years are 142% , well above our benchmark and the FTSE All-Share Index.
Selecting for excellence
The current economic and market environment is ripe for stock pickers looking for hidden gems that have been caught in the indiscriminate sell-off we have experienced over the last few years and are being overlooked by the wider market. And there are certain qualities we look for in these businesses.
We look for strong franchises – quality products, loyal customers and a valuable brand are all essential if a company is to weather tough economic conditions and grow while other businesses struggle. A sustainable competitive advantage is also key – a company with a dominate or fast-growing market share, a strong unique proposition, patented intellectual property or some other factor that gives them an edge over rivals
Within these strong franchises, we also look for skilled management teams that can grow the business and can navigate challenging market environments. A strong management team will ensure that its goals and objectives are aligned with its long-term growth and can generate sustainable revenues.
Another crucial factor is a healthy balance sheet or strong financials. Interest rates may soon peak and begin to fall once again, but they are still likely to settle at a level far above the historic lows that have been typical for the last decade or more. Companies that have depended on cheap borrowing and have high debt levels will be at risk. Those with low levels of borrowing, cash deposits or valuable tangible assets are not only less exposed to higher interest rates, but they also have the financial firepower to invest for growth.
These criteria are the starting point. Detailed analysis and research are then essential to pick out those individual businesses that not only meet these core criteria, but which have that extra factor that makes them a hidden gem of value.
The pick of the crop
Our most successful investments in recent years include Watches of Switzerland, a leading retailer of luxury watches and jewellery in the UK and US. The group has a 40% share of the UK luxury watch market and 10%+ share of the US luxury watch market. Over 50% of revenues are generated from the sale of Rolex watches. In addition to driving sales densities across existing stores through improved marketing and stock availability, management’s growth strategy is centred around expansion in the US and Europe where there is significant potential for market share gains.
Another success has been Oxford Instruments, a manufacturer of scientific and technical equipment with significant sales in the healthcare and medical sectors. Oxford Instruments’ prominence in the Henderson Smaller Companies’ portfolio has grown steadily over the years and in recent months has become a top contributor to performance.
Over the last year, we have added several investments we see as undervalued opportunities including GlobalData, a data analytics and consulting company that provides unique data, expert analysis, and innovative solutions to companies in the world’s largest industries. Another addition has been Ergomed, a company dedicated to the provision of specialized services to the pharmaceutical industry and the development of new drugs. It has provided clinical development, trial management, and pharmacovigilance services for 300+ clients, from top 10 pharmaceutical and generics organizations to small and mid-sized drug development companies. Meanwhile, we have also added Morgan Advanced Materials, a manufacturer of advanced ceramic and composite products used in industries from steel to electronics.
In the current uncertain economic environment, stock picking is the key to maintaining a successful portfolio. Quality products, strong market positions, strong balance sheets and ambitious and capable management – these are the characteristics that deliver for investors. At Henderson Smaller Companies Investment Trust, we have been following this approach for years and have outperformed the market as a result. Today, in the wake of recent crises, many high-quality smaller UK companies are significantly undervalued. It is an opportunity we do not intend to miss.
Past performance does not predict future returns.
Balance sheet – A financial statement that summarises a company’s assets, liabilities and shareholders’ equity at a particular point in time. Each segment gives investors an idea as to what the company owns and owes, as well as the amount invested by shareholders. It is called a balance sheet because of the accounting equation: assets = liabilities + shareholders’ equity.
Volatility – The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. Higher volatility means the higher the risk of the investment.
References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.
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Please read the following important information regarding funds related to this article.
- If a Company's portfolio is concentrated towards a particular country or geographical region, the investment carries greater risk than a portfolio that is diversified across more countries.
- Most of the investments in this portfolio are in smaller companies shares. They may be more difficult to buy and sell, and their share prices may fluctuate more than those of larger companies.
- This Company is suitable to be used as one component of several within a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested in this Company.
- Active management techniques that have worked well in normal market conditions could prove ineffective or negative for performance at other times.
- The Company could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Company.
- Shares can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
- The return on your investment is directly related to the prevailing market price of the Company's shares, which will trade at a varying discount (or premium) relative to the value of the underlying assets of the Company. As a result, losses (or gains) may be higher or lower than those of the Company's assets.
- The Company may use gearing (borrowing to invest) as part of its investment strategy. If the Company utilises its ability to gear, the profits and losses incurred by the Company can be greater than those of a Company that does not use gearing.
- Using derivatives exposes the Company to risks different from - and potentially greater than - the risks associated with investing directly in securities. It may therefore result in additional loss, which could be significantly greater than the cost of the derivative.