Aberforth on ‘the trouble with value investors’

A value approach to investing has been defended by small-cap specialist Aberforth against wider aversion to the style.

 Aberforth on ‘the trouble with value investors’

‘For several years now,’ the firm reported, ‘the market has run scared of practically everything that the Aberforth Smaller Companies Trust has to offer: the low volatility of bonds has been preferred to equities; the perceived certainty of the growth style has been preferred to value; more liquid ‘larger small’ companies have been preferred to ‘smaller small’ companies; private equity models have been preferred to quoted companies; and exciting emerging markets have been preferred to the UK.’

Despite Aberforth’s anxiety, the investment trust performed well in 2012. Last year, it delivered a total return of 40 per cent, compared with the average of 27 per cent for both the sector and the benchmark.

The fund nevertheless trades at a discount of 11 per cent, in contrast to the premia for growth-focused trusts such as Dunedin Smaller Companies and Standard Life UK Smaller Companies.

‘The trouble with value investors is that they can almost always present a set of numbers that demonstrates how much cheaper their portfolio is than the market,’ explained Aberforth of the apathy for its fund.

But it maintained that regardless of fleeting investor sentiment, value strategies would outperform over the long term.

Aberforth attributed this in part to the compounding effect from the dividends typically paid by value stocks. To highlight this, Aberforth calculated that while the Numis Smaller Companies Index (Excluding Investment Companies) – the bottom tenth of the UK stock market by market capitalisation – entered the new year 19 per cent above its mid-2007 peak in total-return terms, it had only risen by 1 per cent in capital terms.

‘In today’s income-starved world,’ Aberforth commented, ‘it can be frustrating when the search for yield within the UK equity market tends to begin and end with the FTSE 100.’

Although the average yield in the small-cap universe is 2.8 per cent, lower than the FTSE All-Share’s 3.6 per cent, Aberforth noted that this was artificially depressed by the number of companies not paying a dividend. Stripping these out, Aberforth arrived at an average yield of 3.4 per cent for the dividend-paying small-caps.

And Aberforth added one further advantage of small-cap income: ‘The small-company universe also comprises many more stocks than the large-cap world and income is considerably less concentrated, a point highlighted by BP’s problems two years ago.’

The fund managers observed too that investors had prioritised mid-caps of late. ‘The craving for certainty that has characterised financial markets in recent years has driven many investors to overlook the less liquid ‘smaller small’ companies,’ they remarked.

‘With its closed-end status, the Aberforth Smaller Companies Trust is well placed to exploit the consequent discount for illiquidity,’ they continued. ‘This discount is unusually large at present and does not accurately reflect the business fundamentals of many ‘smaller small’ companies.’

One final complaint Aberforth voiced about current investment trends regarded the vogue for keeping surplus cash on balance sheets. Instead, it called for businesses ‘to utilise their financial strength on organic investment or modestly priced acquisitions’.

Aberforth concluded: ‘In the absence of these, mounting cash piles are of little help to anyone and represent an opportunity cost to investors.’

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