Important: This article is not a recommendation to buy or sell shares in Aberforth Smaller Companies Trust. I am a private investor, storing and sharing my notes. Please read my disclaimer.

Name: Aberforth Smaller Companies Trust
Ticker: ASL
Business: Investment trust
More: Trustnet / Google Finance
Official site: Aberforth Smaller Companies

Many active stock pickers spend their days trawling in the lower reaches of the index, searching for small cap bargains to boost their returns.

As we’ve written many times on Monevator, most of these would-be Mini Buffetts will fail to beat the index. Stock picking is immensely hard (although that doesn’t stop me trying it). Most readers will be better off with index funds.

However UK investors looking to hang up their small cap Geiger counters face a stiffer challenge than mere self-awareness.

Whereas lucky US investors can choose from small cap index funds and value-based ETFs galore, here in Britain it’s like shopping for bread in Soviet Moscow during a farmer’s strike. Blindfolded.

Recent developments haven’t really helped matters. My co-blogger The Accumulator rejected Credit Suisse’s CUKS ETF as an expensive-ish mid cap tracker disguised as a small company affair, and the RBS Hoare Govett Smaller Company tracker got the thumbs down for being a synthetic exchange traded note (ETN) that suffers from a lack of transparency.

So whether you’re a small cap sniffer-outer tired of the game or a passive investor looking to bolt-on value via the little companies, what are you to do?

Enter the Aberforth Smaller Companies Trust

I’ve several times suggested that readers, friends – and The Accumulator for that matter – do some research into the Aberforth Smaller Companies Trust (ASCoT), to see if it can plug this gap in their portfolios.

As Aberforth reported its full-year results to December 31 this week, I thought I’d offer a quick summary here, too.

Now let me be very clear – this is no index fund. It’s a managed investment trust, and while the TER of 0.85% isn’t too bad compared to the worst of those beasts, this is no low cost vehicle scooping off market returns like an elegant crane dipping its beak into an unruffled lake to skim a sliver of water.

But it’s no hippo executing a belly flop, either.

Investing in smaller companies is always more expensive than buying liquid large caps, so you’d expect the TER to be larger than, say, the blue chip buying income investment trusts.

A TER of 0.85% is much less too than what the average small stock picker pays in dealing fees and spreads to execute their own trades – though buying either the trust or the companies it buys on your behalf will cost you the same initial 0.5% in stamp duty.

That TER doesn’t include the cost of interest. ASCoT’s portfolio was on average geared to the tune of 10% throughout 2011, and it’s currently running at 13%.1.

It also doesn’t include the underlying transaction costs paid by the fund manager in turning over the portfolio as it dives in and out of positions.

While the manager talks a good long-term game, the trust turned over 29% of its portfolio in 2011, so these costs will not be inconsequential.

They will ultimately be paid from out of your returns, either by reducing the underlying NAV, or through shareholders being paid a lower annual dividend yield if the costs are met out of income.

Enter the Hoare-Govett Smaller Companies Index

Costs are a drag on a trust’s performance, which means managers need to offset them through some winning picks if they’re not to fall behind their benchmark.

ASCoT’s chosen benchmark is that already-mentioned RBS Hoare Govett Smaller Companies Index (HGSC) (excluding investment companies).

Encouragingly (unless you’re a conspiracy theorist) the trust’s chairman Paul Marsh is one of the two professors who spend much of their working days monitoring this index. He should certainly know his small caps, as well as his benchmark!

Indeed, Marsh and his colleague Elroy Dimson spend a lot of time delving into past returns from Britain’s little companies. They tracked returns from the HGSC index back to 1955 and found that:

… if you’d put £1,000 into the HGSC index in 1955 and then reinvested your dividends thereafter, by the end of 2010 you’d have a pot worth £3.25 million.

That smashed the returns from the wider FTSE All-Share by 3.4% a year; playing safe and investing £1,000 then reinvesting dividends into the All-Share instead would have delivered just £620,000.

Nice returns if you can get them, although past performance isn’t a guarantee of future returns. And given the paucity of small trackers in the UK, unless you fancy that synthetic ETN mentioned I cited earlier there’s no way to easily capture them anyway.

In some ways then, we’re not even asking for ASCoT to beat the index in return for gobbling up some of our return as fees, like you’d normally demand (/hope!) for from a managed fund. Just matching the HGSC index would be nice.

So how’s it done?

On a total return2 basis:

Period	ASCoT NAV	HGSC Index
1 year to 31st December 2011	-13.5%	-9.1%
3 years (C.A.G.R)	+16.5%	+23.3%
5 years (C.A.G.R)	-3.1%	+0.4%
10 years (C.A.G.R)	+8.0%	+8.2%
15 years (C.A.G.R)	+9.6%	+7.9%

Note: C.A.G.R. is Compound Annual Growth Rate.

For my money, Aberforth has made a pretty good fist of at least tracking the index over the long-term.

In recent years though it’s clearly struggled, which is reflected in growing investor disenchantment with the trust.

The discount to NAV has widened to nearly 17%, and on a share price return basis, that’s meant an investment made at the start of 2011 had fallen even more than NAV in cash terms by year-end – you’d have been down some 18.5% on your initial stake.

Value shares out of favour

The managers claim their recent run of under-performance is due to the trust’s value investing style.

Over the long-term, they say, analysis by Paul Marsh’s London Business School points to value shares in the HGSC beating its growth shares by a thumping 5% per year since 1955.

Sometimes value stops working, however – one reason why people find it hard to stick with for the long-term.

During the dotcom boom, ASCoT did poorly as investors bought companies that weren’t even making profits, but then rebounded when those companies failed, for example. The managers claim that for whatever reason, the past five years have been similar, with their research showing HGSC growth shares have beaten value shares by 10% per annum.

Clearly that’s a big headwind to performance. But if you believe in mean reversion in markets then the trust should turnaround when the wind changes.

Cheap small cap value shares

We won’t run through all 89 companies that Aberforth Smaller Companies had invested in at the last count, but I will state I like its style.

The trust is currently particularly weighted towards the smallest small companies, where I agree valuations look most compelling.

What’s more these shares don’t look particularly imperiled. Some 43% of the companies ASCoT has bought have net cash, meaning that at the very least they’re unlikely to go bust any time soon.

You may think it’s bizarre that lowly-rated cash-rich companies are among the cheapest you can buy currently, given all the dire headlines about the economy.

The managers agree, stating in their annual report:

…during the bear market of the second half of the year, the correlation between balance sheet strength and share price performance within the benchmark was remarkably low – the relationship between the two was effectively random. This frustrating lack of discernment can probably be attributed to the prevailing climate of extreme risk aversion, which has, so far, out-weighed other considerations.

I concur, having seen various small cap shares pummeled in late 2011, and liquidity so constrained that I’ve had to buy or sell some investments in blocks of £1,000 or less to avoid moving the price. Bearishness still reigns in this stock market.

ASCoT’s holdings also look cheap on other measures. As of December 31st:

• Their average P/E rating was just 9.0, compared to 11.8 a year ago and 10.5 for the HGSC index.

• The companies’ dividend yield was 3.4%, compared to 3.2% for the index. This yield was 3.3x covered by profits.

• On an EV/EBIDTA basis, the trust’s portfolio is valued at 6.9x, compared to 8.9x for the HGSC as a whole.

The trust was yielding 4% in December (thanks to the amplifying affect of the discount), and it’s still yielding 3.6% after a strong run in the share price in January.

Equally, the discount remains elevated at 15.3%.

The managers believe that the trust’s fortunes will reverse in time (and I agree) stating:

The present gulf between the valuations of value and growth stocks is exaggerated. History suggests that the relationship between the two groups will not stay at such stretched levels. The process of normalisation will be advantageous to the value investment style.

Investors who are prepared to wait can enjoy a decent dividend income, which in recent years has grown much faster than inflation:

Why I hold Aberforth Smaller Companies Trust

I’ve almost always held Aberforth Smaller Companies Trust shares in the past 4-5 years, although residing in my active portfolio the position is liable to be trimmed and expanded as I see fit.

My current holding is the largest I’ve ever had, representing around 5% of my total net worth.

As with Caledonia Investments, I like the underlying companies, and the long-term record and approach of the managers. I think they’ll do well eventually. Both trusts are on large discounts, and I think in time they’ll close, which will amplify returns.

Passive investors looking for a straight proxy for the HGSC index shouldn’t be interested in such speculation, of course, and will rightly be wary of investing in ASCoT given its relatively high costs.

But I think one shouldn’t let perfect be the enemy of the good.

In the absence of a cheap small cap value tracker, I think a small deviation from the righteous passive way to invest say 5% of your portfolio in this small cap trust is likely to prove more rewarding than skipping past the small cap segment of the market altogether.

Note: As with all our specific share write-ups, I can take no responsibility for the accuracy of this post. Please do your own research on Aberforth Smaller Companies Trust and read my disclaimer.

1. Using debt to buy shares will boost returns when the markets do well, but exacerbate losses in a downturn [↩]
2. Total return is underlying net asset value growth plus dividends paid. [↩]

If you find the range of index funds aimed at UK investors about as appealing as snacks on a train’s buffet trolley, then take a look at the BlackRock family of trackers known as the BlackRock Collective Investment Funds (CIF).

Nestling within this series of index-hugging Unit Trusts is:

• A highly competitive emerging markets fund.

• The first property index fund for UK passive investors.

• Some dirt cheap total expense ratios (TERs) that are not all they seem.

The best picks from this Blackrock range offer a useful alternative to the tasty TER troika of Vanguard, HSBC, and L&G. They also offer the prospect of fee-dodging salvation for some Hargreaves Lansdown investors.

Until their adoption by the major fund platforms, coherent information on the BlackRock CIF index funds was shrouded in financial fog.

And there are still plenty of wisps obscuring the view even now.

Glimpses of ludicrously cheap TERs on MorningStar dissolve into the ether on the discount broker sites, while BlackRock’s homepage reveals nary a trace of these fabled funds… Just what exactly is going on?

The family BlackRock

Here’s the full rundown of index funds available from the BlackRock CIF range:

Fund name	Class A TER	Class D TER
Continental European Equity Tracker	0.58%	0.23%
Corporate Bond 1-10 Year	0.47%	0.22%
Corporate Bond Tracker	0.47%	0.22%
Emerging Markets Equity Tracker	0.6%	0.24%
Global Property Securities Equity Tracker	0.61%	0.24%
Japan Equity Tracker	0.57%	0.23%
North American Equity Tracker	0.57%	0.21%
Overseas Corporate Bond Tracker	0.52%	0.22%
Overseas Government Bond Tracker	0.52%	0.22%
Pacific ex Japan Equity Tracker	0.59%	0.24%
UK Equity Tracker	0.57%	0.21%
UK Gilts All Stocks Tracker	0.46%	0.21%

Note: Stated TERs for the Class A funds can vary by platform.

The funds appear in two guises: Class A and D.

Obviously – given the lower TERs – Class D is the good stuff, but sadly it’s reserved for institutional investors. i.e. Pension fund type financial behemoths. However, it’s possible to join in the party, if you know where to look. More below.

Financial fleas like you and me are normally offered Class A. As ever in the world of finance, the less you can afford something, the more you have to pay for it.

Other points of intrigue:

• Published TERs are all over the place for the Class A funds. I’ve never seen such swings – anything up to 0.28% – and almost every platform plus MorningStar and BlackRock seems to have its own ‘exclusive’ number. The funds are relatively new and the TERs are still settling down, so ask for the latest information before you invest.

• You can shave 0.2% off the Class A TERs – see the Cavendish Online trick below.

• There’s an initial charge of 5%. But there’s no need to pay it as any decent online platform will discount it to zero.

• Only the UK gilts fund distributes income. The other funds offer accumulation units only.

• As the funds are newish, the performance data is short-term and fund sizes are pretty small. That’s hardly an issue that’s unique to BlackRock but it’s worth checking during your research.

• There’s a spread to pay every time you trade. BlackRock have published spread estimates on page 10 of the simplified prospectus.

• ISA eligibility is patchy – it depends on the platform.

Let’s make this interesting… the Cavendish Online trick

Yes, sorry. Where this does really get interesting (and you have to take your thrills where you can in this game) is:

Discount brokers Cavendish Online will rebate 100% of their trail commission on all BlackRock funds!

I’ve not seen any platform rebate trail commission on index funds before, and it means you can knock 0.2% off the TER of every Class A BlackRock fund you buy through Cavendish.

If you react to trading fees like Dracula to sunlight, then the rebate makes the Class A emerging market fund and the corporate bond funds well worth a second look.

The other funds are either unavailable through Cavendish, or else can all be beaten by Britain’s cheapest tracker alternatives – at least for now.

It’s also worth checking if your preferred platform is refunding any BlackRock commission along the Cavendish model.

Let’s make this interesting… emerging markets

The BlackRock Emerging Market Equity Tracker Fund is a good option for investors who can’t afford Vanguard or ETF trading fees.

Its published TER of 0.6% trounces its nearest competitor – the 0.99% of the L&G Global Emerging Markets Index Fund – even when you take into account the spread.

It can even beat the Vanguard Emerging Markets Stock Index Fund, if you buy through Cavendish Online and pay an effective TER of 0.4%.

Research is crucial with this fund, however. Its benchmark is the FTSE All World Emerging index (same as the L&G fund) but BlackRock’s interim report shows that the fund has a 20% allocation to North America.

What gives?

As it turns out, the North American allocation is chock full of emerging market companies that are listed in the US.

Performance-wise it’s not wildly out of sync with its L&G equivalent, but you need to be comfortable with what you’re getting into.

Let’s make this interesting… global property

The BlackRock Global Property Securities Equity Tracker is the only property index fund available in the UK.

It invests in developed world commercial property, with a massive bias towards the US.

The TER of 0.61% plus spread compares well with the equivalent iShares ETF – IWDP – (on which you’ll incur trading fees) although HSBC have recently launched a global property ETF – HPRD – with a TER of 0.4%.

Cavendish doesn’t list the property tracker online (a fair few brokers seem to skip this one) but it’s worth a phone call. The fund is new enough that websites may well still be playing catch up with the latest developments.

Class D – out there somewhere?

The holy grail when it comes to BlackRock index funds would be to somehow masquerade as a pension fund and access those juicy Class D TERs.

Many platforms do list the Class D funds but the £250,000 minimum investment is a hurdle I personally find hard to clear.

However, as reader Gadgetmind reveals in the comments below, most Class D BlackRock funds can be bought by mere mortals, if you’re prepared to use the Skandia fund supermarket.

Skandia normally requires investors to use an IFA go-between, but a few discount brokers such as Clubfinance enable you to  go it alone.

Here’s the SP:

• Initial charge: 0
• Annual charge: £68.50
• Minimum investment: £2500 lump sum or £99 monthly contribution.

Clubfinance take trail commission from BlackRock but so does every other platform, so don’t worry about that.

Using the Skandia/discount broker combo, the Class D TERs become super-competitive, but only if your portfolio and contributions are large enough to reduce the annual charge and bid-offer spreads to atoms.

Even then the differences are marginal in comparison to the equivalent HSBC and Vanguard funds. Again, it’s the property and emerging market funds where the gain is most impressive.

Want to know more?

BlackRock jealously guards its CIF Investment Fund secrets on its intermediaries’ site. Admit to being an enthusiastic amateur and you’ll never find what ye seek:

• Factsheets

• Prices and performance

• The simplified prospectus

One day the financial services industry will work out how to make things easy for UK investors and empower more people to take charge of their finances. In the meantime, I’m hanging up my deerstalker for another week but hopefully I’ve clued you in to some useful index tracker ideas.

Take it steady,

The Accumulator

Good reads from around the web.

I have feared inflation ever since the credit crisis began. Interest rates at multi-century lows, quantitative easing, and the UK government taking on the liabilities of RBS and Lloyds only added to my desire to guard against the erosion of my wealth.

Unlike most inflation paranoiacs, however, who cover their windows in the silver foil and bury gold bars in their basement, I’m pretty optimistic about the global economy and stock market, at least in nominal terms.

This means I’ve been able to meet my fears by being extremely long equities and very light on bonds, together with buying NS&I index-linked certs when available. I am usually a fan of private investors holding a big slug of cash, but outside of the cash-equivalent linkers, my cash allocation is near its all-time low of March 2009.

This stance has been a reasonable one overall – who a decade ago would have thought we’d see inflation breach 5%, yet the Bank of England keep rates at 0.5%? – yet there have definitely been hiccups along the way.

Last year, for instance, was a terrible year to not hold any government bonds. They were the best performing asset class, yet I have long considered over-valued in light of my inflation concerns.

Oops!

Those of you with pure passively managed portfolios that include a good slug of gilts probably beat the majority of active traders in 2011. Not unusual, and why passive approaches are our central recommendation here at Monevator, not my off-piste active shenanigans!

As The Accumulator has reported, gilts saved most of our Slow & Steady Portfolio’s bacon in 2011.

Currency debasement is a long-term game, however – it happens over decades, not quarters. The UK government has every reason to be happy seeing the real value of its debt watered down, provided creditors don’t get the willies. So I’m not running up the white flag just yet!

If you’re not familiar with why massive government debt and inflation so often goes hand in hand, you might want to read How Sneaky Governments Steal Your Money, on The Psy-Fi blog this week.

As author Timmar states, eroding debt through stealthy inflation:

“…relies on the sleight of hand that lies behind money illusion – the idea that people focus on nominal interest rates rather than real ones. Unfortunately, this seems to be hardwired into people.

Of course, if financial repression was on the cards then we might expect to see abnormally low interest rates, stubbornly high inflation rates and governments imposing all sorts of new capital holding requirements on banks and pension funds.

We’d better keep an eye open for those, then…”

For more evidence that inflation is the likely endgame, see this PDF from the Bank of International Settlements on The Liquidation of Government Debt.

I don’t expect we’ll see hyperinflation, or small boys pushing SIM cards around in wheelbarrows in lieu of pocket money.

But I do suspect real interest rates will continue to be low for years.

[continue reading…]