Neil Hermon, Fund Manager for Henderson Smaller Companies Trust, discusses how the trust has performed so far in 2019 and delivers the latest portfolio activity, explaining why the team have chosen to reduce the number of holdings. Neil also discusses the Trust’s income growth and how his strategy has led to a very impressive income growth record.

Transcript

Q: Hello and welcome to this latest video update for the Henson Smaller Companies Investment Trust. I'm delighted to be joined by the fund manager Neil Hermon. Neil thank you very much for joining me today. Now we're not far off the halfway point for 2019. So how has the U.K. smaller company sector fared so far this year?

A: It's been quite good. Double-digit returns from UK small cap in the first five-and-a-half months of 2019. Q4 2018 was very tough indeed, and there were a number of reasons for that, really around concerns of Brexit, escalating tensions between US and China trade wars, the Fed rates rise in December and likely to rise in 2019, and a potential global economic slowdown. So, Q1 saw a lot of those things come to a slightly better conclusion, Brexit made progress, or stumbling progress; US and China seem to be getting on a bit better regarding their trade negotiations and the Fed moved from raising rates in 2019 to actually maybe even see none or even a decrease in rates. So markets have rallied, only back to where they were in September 2018, but they've made reasonable progress. So in that context small caps have done quite well and have made double digit returns.

Q: Okay now looking at the smaller companies portfolio, the number of names has come down from about one 105 five to roughly a 102. Perhaps you could shed some light on why you've sold some of those positions.

A: It's quite a small change 105 to 102 is hardly a material change, we're around 100 holdings usually so we're quite consistent to where we have been previously. We've disposed of the few things this year; a few names have gone from the portfolio. This would include, for example Elementis, they’re a chemicals company, where we're concerned about the outlook for earnings and a poorly judged acquisition last year which raised leverage.

We sold of our position in Faroe Petroleum after we received an agreed bid from DNO, a Norwegian company. We sold our position in Equinity, increasingly frustrated by lack of progress regarding the Wells Fargo US acquisition integration.

Also the NCC, a kind of cyber security business, because they had a pretty poor set of earnings in January. Concerns regarding the escrow business and also then the ability for them to retain and recruit staff, which means seeing margin pressure in their computer consultancy business.

So a number of holdings, it's always the way, there's a bit of turnover in the portfolio. We don't see much material change in the number of holdings, around 100 is what we try to aim towards.

Q: Now one little talked about aspect of the trust is that it has a very impressive income growth record since you took the job back in 2002. Now assuming dividends are reinvested, the income story is 28 percent growth annually, which is not bad for a trust that focuses on growth primarily. Now obviously past performance is not a guide to future results but perhaps you can tell us about how you got to that record and what's your philosophy?

A: We don't target income we target total return. If you think about the returns we've generated over the last 16 years, most have come from capital. However, the style we do is we are very much total return focused, but we are very much on quality companies.

Therefore, we want companies that are profitable, cash generative, growing and generally pay a dividend. Over 90 percent of the companies that we own pay a dividend and basically whilst we're investing in those growth companies the dividends they pay generally are growing quite quickly.

So ultimately, although our starting yield in a portfolio isn't particularly high, it's about 2.5 percent as we stand today, it’s growing at a pretty rapid rate. And over the last 16 years our dividends are growing 28 percent compound, albeit from a pretty low base. So if you put that in context, if you put one hundred pounds into HSL back in 2003 you'd be initially getting about six pound of income; your income would now be worth 270 pounds a year. So that just shows the power of growth and compounding leads to a pretty good dividend and return story.

Q: Neil Hermon, as always, it's been a pleasure. Thank you very much for joining me.