Smaller firms provide range from may of Magnificent Seven

The manager of the Global Smaller Companies Trust (GSCT) is convinced good times are around the corner for the asset class he has been investing in professionally for the past 19 years.

Nish Patel, lead manager of the £772 million investment trust, says the 14-year bear market in smaller companies – relative to the performance of larger companies – is coming to an end. And if history is an indicator, a bull market could ensue over the next decade.

‘The relative performance of smaller and large companies is cyclical, and the dominance of the larger stocks is drawing to an end,’ he says. ‘Now is an opportune time to be investing in smaller companies. They are a perfect portfolio diversifier, especially if the move away from the Magnificent Seven stocks continues.’

Patel says the outlook looks as rosy as it did in 1974 when smaller companies went on to enjoy nine years of outperformance against large cap stocks – and in 2000, post the bursting of the dot-com bubble, smaller companies had 11 golden years before the seeds of the Magnificent Seven were sown.

GSCT draws upon a vast pool of investment experts at asset manager Columbia Threadneedle for the construction of its portfolio.

Apart from Patel, two investment managers scour markets for buying opportunities in four areas: Europe, Japan, North America, and the UK.

‘On average, we each have 20 years of investing in smaller companies,’ he says. ‘We have a good idea of which companies will succeed and those likely to fail.’

The result is a 192-stock portfolio, including funds with a focus on smaller companies in Asia and emerging markets. These are chosen following both ‘data intensive and rigorous research’ conducted by Columbia’s multi-manager investment team.

By including smaller companies in emerging countries, the idea is to provide investors with a one-stop shop embracing all global smaller firms.

‘Our overall approach is conservative,’ explains Patel. ‘We identify high quality companies, but we only buy when they are out of favour and their share prices are sitting at a discount. In buying cheap, we build a margin of safety into the portfolio.’

Although GSCT has underperformed its benchmark in recent years – a mix of smaller companies’ indices for the UK and the world – it stands up well against its peer group. Its five-year return of 38 per cent is by far the best, with the closest being Herald (14.2 per cent).

Recent portfolio additions include PriceSmart, a US operator of membership warehouse clubs across Central America, the Caribbean and South America.

‘It span out of Costco,’ says Patel, ‘and it’s gaining market share as customers, who pay an annual membership fee, are attracted to its keenly priced products. It’s a virtual circle. As more people sign up, the more scope it has to drive down prices.’

Among portfolio disposals is US company Molina Healthcare, which Patel says has been impacted adversely by the cuts in federal Medicaid funding.

‘The investment thesis for holding the stock no longer stands as its profit margins narrow,’ he says.

While income delivery to shareholders is not a priority, GSCT has grown its dividend annually for the past 55 years, a record surpassed by only four others. Income is paid half-yearly and equivalent to an annual yield of 1.64 per cent.

Annual charges are 0.62 per cent and, due to the board’s active share buyback policy, shares stand at a relatively small discount (7 per cent) to the value of underlying assets.