Small fry with big potential

Barely a week goes by without news of an investment trust arranging a new loan or debenture at incredibly low rates, says David C Stevenson. But some fund managers are using even more exotic instruments to raise funding.


Britain is in better shape than the headlines suggest
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The flipside of the scramble for yield is that many firms, especially investment trusts and funds, are now looking to refinance their long-term debts to lock in low interest rates. Barely a week goes by without news of an investment trust arranging a new loan or debenture at incredibly low rates. But some fund managers are using even more exotic instruments to raise funding.

Asset manager Chelverton has announced that its Small Companies Dividend Trust (LSE: SDV) wants to raise up to £30m of new funding using an instrument called a zero-dividend preference share, or ZDP. This is a cross between equity (it is ranked below loans and debt in terms of security) and a bond (it pays out a fixed return at maturity). But rather than pay out the income regularly, it rolls it up until the end.

Chelverton is looking to issue these ZDPs for a term of 7.3 years, with a gross redemption yield of 4.0%. Although these instruments can be tax-efficient for many investors (as the income is rolled up as a capital payment), I'm not especially excited about a rate of just 4% (the last set of ZDPs paid out 6% a year). The rate is better than most, but investors might be better off just buying into the fund itself.

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Over the last five years, the net asset value (NAV the value of the underlying portfolio) for this small fund is up 189%, versus 101% for the Numis Smaller Companies (excl. Investment Companies) index, with a current dividend yield of 3.1%, not far off that ZDP yield. Over the last one, three and five years, the fund has been the top-performing UK equity income trust. So it's little wonder that the managers are looking to raise up to £75m through a C-share issue (these are later converted to ordinary shares, so that the cost of fundraising isn't borne by existing shareholders).

The Chelverton fund is a play on two interrelated themes equity income and smaller companies. The managers look to identify "dull but worthy" companies, where the dividend of 4% is well backed by solid cashflow. The team screens all small- and mid-caps on a regular basis to identify potential investments and meets about 250 companies each year. Once the yield falls below 2%, the management starts exiting the investment.

As you'd expect from a small- to mid-cap specialist, top holdings include relatively new names such as Diversified Gas & Oil, retail group McColl's and Jarvis Securities, as well as more established companies such as software provider StatPro Group and housebuilder Galliford Try. In sector terms, across the 50- to 70-strong portfolio, financials account for 15%, and support services 13%.

More than 70% of the portfolio's businesses are UK-focused, and so should benefit from a domestic economy that is, in my opinion, in better shape than is currently being depicted by gloomy newspaper articles. Finally, valuations aren't high the average 2017 price/earnings multiple of the portfolio companies was 12.9, while the historical dividend yield of the portfolio was 4.16%, according to brokers StockdaleSecurities.

There are some very obvious risks with a fund like this. In a recession, smaller caps get hit badly, and during the global financial crisis the fund certainly had its challenges net assets fell by 44% between April 2007 and April 2008. So if Brexit does derail the UK economy, this fund might underperform. But overall, it is an excellent core investment for anyone looking for income from small- to mid-caps. Buy into the placing.

Activist watch

"Iconic" German steelmaker ThyssenKrupp has rejected calls from Swiss activist investor Cevian for it to split up, reports Handelsblatt. As a result, the steelmaker's CEO and board chairman are "likely to have an awkward meeting" this week with Cevian founder Lars Frberg, who is "growing impatient with [CEO Heinrich Hiesinger's] seven-year-long efforts to turn around the company".

The Swiss activist, which is ThyssenKrupp's second-largest shareholder, has not demanded that Hiesinger be replaced, but Frberg "avoided a clear commitment to him" in an interview with Handelsblatt. ThyssenKrupp is currently trying to manage a spinoff and merger of its steel division with the UK subsidiary of Tata Steel.

In the news this week

The Financial Conduct Authority (FCA) is investigating four asset managers over concerns they broke competition law by colluding on share prices, says Greig Cameron in The Times. The FCA alleges that Artemis, Hargreave Hale, River & Mercantile and Newton shared information on what price they were planning to pay in two initial public offerings and one share placing from a company that was already listed, an action which could have disadvantaged other investors who did not have the same information.

The £240m float of online holiday company On The Beach is one of the cases involved, according to The Sunday Times. If an asset manager is found to have broken the law, it can be fined the equivalent of up to 10% of worldwide revenue, and could face damage claims, though victims might struggle to quantify their losses. Newton has apparently dismissed one of its most senior fund managers over the investigation.

Shares in Provident Financial fell 16% on the news that the regulator is looking into its subsidiary Moneybarn, which provides car loans to customers with an impaired credit history, reports FTAdviser. The FCA is investigating Moneybarn's "treatment of customers in financial difficulties" and its affordability tests. Provident Financial, whose shares are down 73% this year, accounts for 2.2% (£176m) of Neil Woodford's £8.2bn equity income fund.

David C. Stevenson

David Stevenson has been writing the Financial Times Adventurous Investor column for nearly 15 years and is also a regular columnist for Citywire. He writes his own widely read Adventurous Investor SubStack newsletter at

David has also had a successful career as a media entrepreneur setting up the big European fintech news and event outfit as well as in the asset management space. 

Before that, he was a founding partner in the Rocket Science Group, a successful corporate comms business. 

David has also written a number of books on investing, funds, ETFs, and stock picking and is currently a non-executive director on a number of stockmarket-listed funds including Gresham House Energy Storage and the Aurora Investment Trust. 

In what remains of his spare time he is a presiding justice on the Southampton magistrates bench.