Investment trusts’ average discount to net asset value (NAV) is 6%. But there are plenty of trusts with double-digit discounts. Often, this is the result of persistent poor performance. Sometimes the sector is out of fashion. But occasionally it is because professional investors struggle to pigeon-hole it. The Henderson Opportunities Trust (LSE: HOT), of which I was a director until March, is one of these. With net assets of £80m, it is the smallest of three trusts managed by James Henderson and Laura Foll.
It invests right across the UK market and is benchmarked against the All-Share index. When smaller companies are doing well, it outperforms but when they lag, as they had last year , this tends to get left behind. For most professional investors, this characteristic, and the trust’s small size, are off-putting – but it should appeal to opportunists.
The obvious answer to the ebb and flow of smaller companies’ performance would be for the managers to switch out when small caps are riding high and jump back in when they are depressed, but this is easier said than done: small caps rarely look expensive even at the top of their cycle. More importantly, Henderson and Foll have a firm bias towards value in large-cap stocks but this has been a dismal place to invest for 20 years.
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The stars align
Four factors now make HOT attractive. Firstly, its shares trade on a generous discount of 18% while yielding over 3%. Secondly, UK large and mid-cap value stocks are looking appealing. Thirdly, sustained underperformance makes smaller companies look cheap, especially those on Aim. Finally, the team combines Henderson’s well-deserved reputation as a contrarian happy to buy out-of-favour stocks with Foll’s diligent analysis and discipline in cutting poor performers.
“We have a value bias,” she says, “but we don’t buy just anything on a low valuation, and avoid companies with flat or falling sales.” Many investors conflate value with income but “there is very little overlap. The best value opportunities are now in the companies that have suspended their dividends.”
While their share prices have fallen sharply, the long-term prospects of many larger companies that have been forced to restructure have improved, providing contrarian opportunities for the fearless.
Meanwhile, UK small caps offer “exciting opportunities, notably in technology, to which there is little exposure among large caps.” Portfolio examples include Blue Prism, a pioneer in robotic process automation, RWS, a leader in providing translation and localisation services, Learning Technologies, an e-learning provider, and Ceres, a pioneer in fuel-cell technology.
Serica, responsible for 5% of the UK’s gas production, has been a good long-term investment. In the mining sector, large cap is preferred, notably Rio Tinto with “low-cost mines, good cash-flow generation and a strong balance sheet.”
Britain is due a quick rebound
Foll and Henderson are optimistic about both the UK economy – “we are positioned for a relatively quick recovery” – and the market but a trust such as this depends far more on their skill than on a rising tide. Though allocation between size segments held performance back last financial year, “stock selection was a positive contributor in each segment; large caps, mid caps, small caps and Aim.”
Moreover, “the greatest opportunity lies in the smallest companies and Aim stocks, currently held back by liquidity concerns which have caused open-ended funds to sell…we expect a catch-up.” The pandemic may have delayed this by six months but with small caps down 25% this year and large caps only 15%, the potential is greater than ever.Such is their conviction that the trust is geared with borrowings of 15% of net assets to finance extra investment. Given their focus and their record, that confidence looks justified.
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