Small and medium sized companies for growth and incomeContributor Ian Cowie
Small and medium-sized companies for growth and income
Many small and medium-sized companies have delivered growth and income to shareholders over the medium to long-term, despite recent stock market shocks. The coronavirus crisis killed the longest bull market – or period of rising share prices – on record but many smaller businesses are less dependent on global trade than their larger rivals. Companies with smaller or medium stock market capitalisations might not be household names today but could have the greatest scope for growth in future.
It is important to remember that not every acorn grows into an oak. Smaller and mid-cap companies often lack the capital reserves of larger rivals and are less likely to have long-established, widely-diversified businesses. These characteristics can make them more vulnerable to unexpected setbacks. So it makes sense to consider exposure to the smaller and medium-sized end of the stock market through investment trusts over the medium to long-term; that is, five years or more.
This type of pooled fund can diminish risk by diversification, spreading your money over many different companies. It also enables everyone to share the cost of professional stock selection and fund management.
British smaller businesses
Because many of British smaller businesses are more dependent on the domestic economy than exports, valuations had been depressed by uncertainty about Brexit and a potential change of government.
Those political doubts specific to Britain were eased or dispelled by the result of the General Election last December before the coronavirus crisis presented a global threat to health and wealth. Even in the midst of the worst public health crisis for decades and after sharp declines in share prices, many investment trusts focussed on smaller and medium-sized companies have rewarded long-term investors.
Income and value from smaller and mid-cap investment trusts
Because investment trust’s share prices are determined by the interaction of supply and demand on the stock market, many are priced at less than their net asset value (NAV); that is, the net value of all their underlying assets, less any liabilities such as debt or gearing. When a trust’s NAV is greater than its share price, it is said to be trading at a discount.
At the time of writing, you can buy £1 of NAV in the average UK Smaller Companies investment trust for less than 92p because the average discount in this sector is over 8%. It is important to beware that discounts can widen, as well as narrow, but buying shares for less than their NAV may appeal to bargain-seekers.
For example, JPMorgan Smaller Companies’ (stock market ticker: JMI) share price is 3% lower than its net asset value (NAV) and so investors obtain £1 of assets for every 97p they invest. The shares yield 3.1%.1
Mercantile (ticker: MRC) is another JPMorgan investment trust which aims to achieve long-term capital growth from medium and smaller companies with a dividend at least in line with inflation. Mercantile shares are priced at a 1.9% premium to NAV and yield 3.9%.2
JPMorgan MidCap (JMF) seeks capital growth from investing in medium-sized UK listed companies and aims to achieve this by outperformance of the FTSE Mid 250 Index. Its shares trade at a 4.2% discount and also yield 3.9%.3
Smaller companies in the states
Some of the biggest opportunities for smaller and medium-sized companies exist in the world’s largest economy; the United States of America. Tax cuts and other forms of fiscal stimulus introduced by President Donald Trump boosted demand for goods and services before the coronavirus crisis hit economic activity hard.
JPMorgan US Smaller Companies (JUSC) aims to provide investors with capital growth by investing in US smaller companies that have a sustainable competitive advantage.
European smaller companies for diversity
The coronavirus crisis has dramatically displaced Brexit as a hot topic but the United Kingdom’s departure from the European Union will still have economic consequences, which remain unclear.
Whatever you think of Brexit, there’s no need to shun opportunities elsewhere in Europe. The continent boasts many first class businesses and assets denominated in foreign currencies - such as the euro, Danish krone or Swiss franc - can diminish your exposure to the ups and downs of the pound.
JPMorgan European Smaller Companies (JESC) aims achieve capital growth through a diversified portfolio of smaller companies in Europe, excluding the UK. Its shares are priced at a 23% discount to its NAV and yield 2.7%.4
Maximising returns and minimising risks
Medium-sized and smaller companies can offer greater scope for capital growth than businesses that are already very large and may have their best days behind them. But higher risks may accompany the potential for higher rewards when seeking the corporate winners of tomorrow.
Diversification is a tried-and-tested way to manage risk. The principle is the same as not putting too many eggs in too few baskets. Pooled funds, such as investment trusts, automatically put this into effect by spreading individual investors’ money over dozens of different companies’ shares to reduce their exposure to the danger of setbacks or failure at any company. However, diversification does not guarantee investment returns and does not eliminate the risk of loss.
A big advantage of investment trusts
Investment trust shareholders enjoy an important advantage over investors in other forms of pooled funds – such as unit trusts or open-ended investment companies – because investment trusts are closed-end funds. This means their managers are never forced to sell underlying assets to raise cash to meet redemptions if sentiment changes, as it often does at different stages in the economic cycle. By contrast, open-ended fund managers may be forced to dispose of whichever assets can be sold when confidence falls, share prices decline and short-term speculators wish to get back into cash.
The closed-end structure of investment trusts may help medium to long-term investors withstand fluctuations and volatility in stock market sentiment and valuations during the economic cycle. For example, JPMorgan Mercantile Investment Trust has survived two world wars and several economic crises since being launched in 1884. It now manages nearly £1.6bn on behalf of its shareholders.
Past performance is not a reliable indicator of current and future results
Source: All share prices and performance figures sourced from Morningstar via the Association of Investment Companies on April 2, 2020.
1Quarterly rolling performance (%) as at 31/12/2019: 2014/15: 26.03%, 2015/16: -6.69%, 2016/17:36.41%, 2017/18: -9.04%, 2018/19: 67.53. Benchmark: Numis Smaller Companies plus AIM Index (exl investment companies)
2 Quarterly rolling performance (%) as at 31/12/2019: 2014/15: 30.00%, 2015/16: -3.67%, 2016/17:30.22%, 2017/18: -17.08%, 2018/19: 53.93%. Benchmark: FTSE All-Share (ex FTSE 100, ex Inv Companies)
3 Quarterly rolling performance (%) as at 31/12/2019: 2014/15: 42.45%, 2015/16: -11.30%, 2016/17:30.58%, 2017/18: -16.90%, 2018/19: 43.80%. Benchmark: FTSE 250 Index (ex. Investment Trusts)
4 Quarterly rolling performance (%) as at 31/12/2019: 2014/15: 44.05%, 2015/16: 1.86%, 2016/17:45.10%, 2017/18: -20.61%, 2018/19: 18.62%. Benchmark: MSCI Europe ex UK Small Cap Index (Net)
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