UK small caps are ‘cheap’ - we back these stocks

Abby Glennie, manager of the abrdn UK Smaller Companies Growth Ord (LSE:AUSC) Trust, sits down with Sam Benstead to discuss the opportunities and risks in the UK small-cap sector. 

She explains the strong run for shares, but argues that smaller UK companies are still cheap. Glennie gives examples of her favourite companies and explains how she picks winners.  

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Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Abby Glennie, manager of abrdn UK Small Companies Growth Trust. Abby, thank you very much for coming into the studio.

Abby Glennie, manager of abrdn UK Small Companies Growth Trust: Thank you for having me.

Sam Benstead: UK small companies have been on a fantastic run. What's been behind this?

Abby Glennie: It's been a tough few years for smaller companies as an asset class and probably particularly the UK small cap. I think we're seeing a few things now. The last year or so has been pretty good for the asset class and I think that ties in with what we see in broader markets, which is that equities are much more in favour again.

We're [at] that point in a cycle where we're seeing a bit more of a risk-on attitude again, after having gone through that period [where] everyone was worried about economic data, and recession. And so we've really passed that point of inflection, it feels like. I think the UK particularly suffered a blow ever since Brexit in terms of sentiment.

What was frustrating for us as managers is that when we looked at the underlying companies, they weren't really impacted and we continued to see really strong growth. But sentiment against the UK as a region has been quite tough, and it's been tough on flows.

I think the other thing we've seen is headwinds in terms of people's attitude to investing in the UK and we've seen people look more globally.

What's really turned around is two things. I think for the UK, we've seen a strong period now of good economic growth, more political certainty, good employment data, and high savings ratio. So there's a lot of health for the economy, and particularly when you compare that to other regions. 

I think we're also seeing - and my team also run European and global small-cap products - that strength in small cap relative to large really start to come back and investor appetite definitely pick up.

Sam Benstead: And because of the rise in share prices, have they become more expensive, these UK shares, or are investors still getting a good deal?

Abby Glennie: I think that's an important point because people look at the strength they've seen and think, have I missed this inflection? And we would look at the rating and say, absolutely not. As an asset class, UK small cap is cheaper than it was six months ago, whereas actually UK large cap, I think, is more expensive than six months ago.

And small cap does trade at a premium typically to large cap. We think that's right because of the better gross prospects that you're seeing. But if you look at the premium of small cap verses large cap in the UK space, it's about 50% less than the long term, the 10-year average premium. So, we think that's a pretty attractive entry point.

On a global basis, I think UK small cap trades on around 15 times, and world small cap on 20 times. And we have to think that, actually, 50% of the revenue generated by the UK smaller companies universe is generated overseas as well. So, I think there is a reasonably fair comparison there.

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Sam Benstead: So, lots of opportunities out there. What is your process then for picking companies? How do you find winners in the UK small-cap space?

Abby Glennie: So we have an investment process for the trust and all the products we run within our small-cap team, which is very consistent and we've run that for over 25 years in the UK space now and that is around quality growth and momentum.

We also have a stock-screening tool called the Matrix. That was in-house developed 25 years ago and is a really good way that we can focus our research efforts on to the stocks that are more likely quality-growth momentum companies.

So, we're using that as a screening tool for new ideas, but we're also using that in terms of portfolio construction and judging the existing holdings. Really, we are bottom-up stock pickers. You absolutely have to think about the macro environment, and we try and do that in terms of looking at how the risk factors are directly impacting those companies. But we're seeing lots of new ideas being thrown up across a range of sectors as well, which is very healthy.

The other thing that we do a lot is meet companies. So, myself and my colleague Amanda Yeaman, who I run the trust with, we spend a large part of our days meeting companies. I think that's one of the most valuable uses of our time, that interaction.

Sam Benstead: And what have been the big winners recently, and have you made any portfolio changes this year?

Abby Glennie: We tend to have portfolio holdings, some of them have been held for a large number of years and some of those have been the best contributors to performance over the past year or so. So, we're still seeing that the oldies, but goodies are really coming through in this environment. We also have a wealth of new ideas coming into the portfolio.

The Matrix has been throwing out lots of ideas for us. How the Matrix works is it is essentially showing us what it thinks is quality-growth momentum. And then it's about our fundamental analysis in terms of judging that.

But the thing I see in the portfolio at the moment is that sometimes we go through periods where we would say there's real themes, but I think at the moment, there's a real diversity across the portfolio.

If we look at some of the new ideas we've put in, so for instance, Hunting (LSE:HTG), which is an oil services company. Chemring Group (LSE:CHG), in the defence space, and ME Group International (LSE:MEGP). We've put in an IPO of Raspberry Pi Holdings (LSE:RPI), which some people might have heard about, and Clarkson (LSE:CKN), the global shipbroking business. Every company there is very diverse in what it does. We've really seen some of these things be good contributors.

So, while I talked about the things we've held for a long time having done well, so, for instance, in recent periods we've had real share price strength from [firms] like Cranswick (LSE:CWK), the food producing company, Gamma Communications (LSE:GAMA), a business-to-business communications company, and Morgan Sindall Group (LSE:MGNS) in the construction space, a real quality play there.

We've also had new ideas really contribute. For instance, Cairn Homes (LSE:CRN), which is an Irish housebuilder, and an XPS Pensions Group (LSE:XPS), which is in pensions administration and consultancy. So, it's been good to see these new stocks contribute.

But also I think it's been really supportive how well some of our longer-term holdings have done. Particularly because one of the key parts of our investment process is what we call 'run your winners'. So, as long as that investment case is still stacking up, we continue to believe in those companies.

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Sam Benstead: You said you like to go out and meet company management. How often are you on the road and what kind of characteristics are you looking for in a good company leader?

Abby Glennie: We definitely try and do some site visits. I think there's two interesting things often. One is that sometimes you can see a company be brought to life depending on what it does. So, it's nice to see that in reality.

The other thing is just seeing companies on their own turf and particularly meeting the next level down of management is a really valuable thing for us.

Maybe Amanda and I manage to do a site visit once every couple of months. We say we meet all our company management teams twice a year, but I would say there's vast chunks of the portfolio that we will easily meet four times a year or more. And that’s for various reasons.

I'm going to conference this week, for instance, and I'll see some of the companies there. Sometimes companies will do something proactive throughout the year as well. So, maybe they'll be doing an acquisition and they're looking to raise money for it. So, yes, we spend a lot of time meeting and engaging with them.

One of the things we focus on is management quality. Now, that is very hard to judge. It's definitely something that the more you do, and the more you interact, hopefully the better you get at it.

We look for different things in management teams. One thing I do look for is, for instance, a CEO [who] surrounds [themselves with] the right people. Often a good CEO knows their own skill set and knows what their competencies are, and they build a team around them that complements that. I've certainly seen that in companies as they've developed and matured, they've hired and delegated in the right way.

A CEO doesn't have to have a certain fit, and I think that makes sense because if we look at the types of companies we invest in, these companies do completely different things. So, it's important that it's more about what they understand about their business, what sort of a strategy fits that. Importantly, what sort of internal business model fits. People who are open to advice is a really valuable thing.

Sam Benstead: Gearing is one of the tools an investment trust can use to increase returns. So, borrowing on behalf of investors. Do you use that to make more money in your fund?

Abby Glennie: Yes. So, the trust typically has some level of gearing in it, that has been lower over recent years given our view of the challenges that markets have seen. But we increased that again at the back end of last year. So, the trust is about 5% or 6% geared at the moment, which is a level that we feel quite comfortable with. That's probably in line with the long-term gearing that we've held in the trust.

I think it's definitely a positive, and, if you're an investor, [who] can take a slightly longer-term time horizon, this is where the investment trust becomes a really attractive opportunity in terms of returns. You can look at the asset class returns, but you also have the benefit of gearing and, we would hope, some discount narrowing as well.

Sam Benstead: Abby, thanks very much for coming in.

Abby Glennie: Thank you for having me.

Sam Benstead: And that's all we've got time for. You can check out more Insider Interviews on our YouTube channel, where you can like, comment and subscribe. See you next time.