Trustnet Magazine Issue 34 November 2017 | Page 8

/ JANUS HENDERSON / DISCRETE PERFORMANCE Performance Jun 2016 - Jun 2017 Jun 2015 - Jun 2016 Jun 2014 - Jun 2015 Jun 2013 - Jun 2014 Jun 2012 - Jun 2013 Nav 14.50% 3.10% 6.40% 14.80% 23.90% Price 16.60% 0.30% 7.20% 15.10% 21.50% Source: © Morningstar 2017. Annual Return to 30/06/2017 WOULD YOU LIKE THAT IN A SMALL, MEDIUM OR LARGE, SIR? Janus Henderson’s Neil Hermon offers three “pretty compelling reasons” why it can be more lucrative to invest in smaller firms than their larger counterparts U K-BASED INVESTORS HAVE TENDED TO FILL THEIR PORTFOLIOS with funds investing in the large, liquid firms of the FTSE 100. They are easy to buy in large amounts, generally well established in their sectors, and tend to have strong governance and long histories of creating shareholder value. But history lends us evidence of investments with even stronger returns: the UK’s smaller companies. These are firms in the bottom 30% of the UK stock market by market capitalisation – so the FTSE 250 and smaller, or less than around £4bn. The volatility for investors likely contributes greatly to small-cap reluctance – their share prices tend to swing more wildly, setting nerves affray, and they’ve been known to disappear from time-to-time on account of poor management. But the long-term numbers – 6 where investors should be focused – speak for themselves: if you’d put £100 in the FTSE All-Share in 1955, by 2016 you would have received £96,792; for the FTSE-Small-Cap it would have been £597,433. The latter is quite remarkable at six times the former. WHY IS SMALL MIGHTY? Professors Elroy Dimson and Paul Marsh of London Business School developed the theory behind why small-cap firms outperform larger ones. 1) Organic growth – The growth potential tends to be greater because it’s much easier for small, more ambitious companies, with profits in the millions rather than billions of pounds to double their business. It’s partly a law of numbers: a firm earning £1 million one year could feasibly double that over the course of the following year, but one that earned £1 billion would have to generate an additional billion pounds over that time to achieve the same growth rate. Small companies also have more options for increasing business. They are inherently more nimble, dynamic and innovative, and so are more able to expand into new parts of the country, launch new products or services, or venture overseas – and make a huge difference to the bottom line. In contrast, new initiatives for giant multinationals are likely to affect only one of their many subsidiaries or product lines. And it’s a self-fulfilling prophecy – a company that repeatedly delivers on its earnings increasingly satisfies investors who then place a higher value on the business. This is known as momentum. 2) Lack of research – The stock market is a pricing mechanism that takes into account all of the trustnetdirect.com publicly available information there is regarding a firm’s finances and its operations. The price is informed by the work of analysts. Big companies tend to be followed by lots of analysts: it averages 24 per firm for those over £10bn. Because their operations are so extensively scrutinised it’s very unlikely any great corporate initiatives or managerial shake- ups will pass under the radar, so the share price tends to reflect the business realities fairly accurately, making it harder for fund managers to find pricing anomalies. In contrast, smaller firms have fewer analysts following them, with those under £500m averaging only two. It means there’s more opportunity to spot mispricing. Academics call this the ‘neglected effect’. to major investments in such an uncertain environment – but as economic confidence has recovered, they’ve been spending. According to Dealogic, records were broken in 2015, with $4.7trn of deals. 2016 still proved high at $3.8trn. 3) Mergers & acquisitions – One of the big a ttractions of investing in smaller companies is the likelihood of a corporate action, usually when a larger firm snaps them up. For large, slow-growing companies, taking over an attractive small firm is probably the easiest way to expand the business in a lucrative new direction. M&A deals are viewed as good news for shareholders in the acquired company because as owners of the business they will receive payment, usually in the form of cash or shares in the acquiring company, or a mixture. Many companies had built up a war-chest of cash in the years following the financial crisis, having been reluctant to commit as the Trustees Executors and Securities Insurance Corporation, aiming to beat UK government bonds. Its original Chairman branched out into accountancy services and eventually formed Touche Ross, now a key part of Deloitte – one of the biggest accountancy firms in the world. It was not until 1992 that it started investing in smaller companies and in 2000 only in those from the UK. This makes it one of the oldest investment trusts there is: surviving, adapting and evolving over many years. In 2002, in the wake if the dotcom crash, I became the Trust’s fund manager. Much has happened since: four prime ministers, various A RICH HISTORY The Henderson Smaller Companies Investment Trust has not always been in the business of smaller companies. It was founded in 1887 “Small companies are inherently more nimble, dynamic and innovative, and so are more able to expand” The information should not be construed as investment advice. Before entering into an investment agreement please consult a professional investment adviser. Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Issued in the UK by Janus Henderson Investors. Janus Henderson Investors is the name under which Henderson Global Investors Limited (reg. no. 906355), Henderson Fund Management Limited trustnetdirect.com polarising US presidents, oil prices bucking between $30 and $140 a barrel, Harry Potter and his famous scar, a Middle Eastern melt-down, a searing global financial crisis, and the explosion of social media, smartphones and apps. Throughout these twists and turns markets have gyrated, yet we have delivered an average annual return of 17.9%, outperforming the benchmark in 13 of the last 14 years. We know the past doesn’t predict the future, but this would have transformed £1,000 of your cash into over £12,000. We’ve done it through consistency, consistency… you get the idea – the method has never changed. Now supported by Indriatti van Hien, our focus is on finding exceptional management teams and good-quality businesses, buying them at prices we think are value for money (other small-cap managers care less about firms priced expensively against history or otherwise, but we think this is a key mistake). With Brexit-this and interest rate-that, the UK market seems on a more cautious footing: now has probably never been a better time for stock picking.  (reg. no. 2607112), Henderson Investment Funds Limited (reg. no. 2678531), Henderson Investment Management Limited (reg. no. 1795354), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), Gartmore Investment Limited (reg. no. 1508030), (each incorporated and registered in England and Wales with registered office at 201 Bishopsgate, London EC2M 3AE) are authorised and regulated by the Financial Conduct Authority to provide investment products and services. 7