Neil Hermon, fund manager of the Henderson Smaller Companies Investment Trust (LSE:HSL), names the shares he has held the longest and the drivers behind the trust’s consistently strong performance.
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Kyle Caldwell, head of collectives, interactive investor: Hello, joining me today is Neil Hermon, fund manager at the Henderson Smaller Companies Investment Trust which invests in UK companies. Neil, thank you for your time today.
Neil Hermon: No problem at all, Kyle. Good to speak to you.
Kyle Caldwell: You’ve outperformed the benchmark, the Numis Smaller Companies index in 15 out of the last 17 financial years for the trust. What would you say has been the main driver behind this consistent level of outperformance?
Neil Hermon: So, what's the special source or the USP. That’s a very interesting question actually. Look, I think we’ve got a very consistent process and philosophy in the way we do things, and it hasn’t changed the way we pick companies and construct our portfolios for the last 18 years. So, I think that’s really helped drive those long-term returns. And, ultimately, think about how we’ve delivered that return because it’s really been through stock selection. You know, the way we create value or create alpha is by picking the right companies that will do right, do well over the longer term. And I think that comes down to the quality of the people, so I think I’ve got a really good team.
So, to me, it’s about consistent delivery and application of our process, and also just picking the right stocks.
Kyle Caldwell: On average, you hold stocks for more than five years. What company have you held the longest? Are there any examples of companies that you've held for nearly two decades since taking over the management of the trust in 2002?
Neil Hermon: It's a really interesting question actually…I’ve looked back at the portfolio going back to 2002. When I started at Janus Henderson and took over running the trust, we needed to do quite a lot of reconstruction of the portfolio because we wanted to get it into the shape that you want going forward.
I look at the portfolio at the end of 2003 and where we are today, and there's a lot of change. I mean, obviously, understandably, like things move on, things you want to sell. A lot of companies have been taken over in that period as well, really, but there were five names that were still in the portfolio today from the end of 2003, so, you know, over 17 years and those were Bellway (LSE:BWY), it’s a UK housebuilder, and the total return on that stock since December 2003 is 720%.
Renishaw (LSE:RSW), which is a high-technology precision and calibration equipment manufacturer, total return 1,600%. Rotork (LSE:ROR), it’s a kind of a manufacturer of actuators for the processing oil and gas industries, total return’s been 1,440%. RWS (LSE:RWS), which is a patent translation and transition translation services business, total return 3,700%. And then lastly Victrex (LSE:VCT), which is a manufacturer specialist thermoplastic called PEEK, total return 1,000%. So, you can just see there the phenomenal returns you can get from taking a long-term perspective on very high-quality growth companies.
Kyle Caldwell: Around two-thirds of the trust is in mid-cap firms listed in the FTSE 250 index. Is part of the reason for this because you like to run your winners? And also, what causes you to sell a winner?
Neil Hermon: Yes, you look at the shape of the portfolio and, as you said, run the winners. That’s one of the reasons why we had that mid-cap bias. But if you include the AIM stocks that we own that probably would fit in the 250, it’s more like probably 70, 75% by size would be in that kind of mid-cap area.
I think there's a number of reasons why we have that weighting. First up is liquidity, I mean this, the fund itself has now just gone through a billion gross portfolio value. It's quite a large trust, and we've run other mandates alongside it. So, we run about £1.7 billion in our small-, mid-cap strategy. So naturally we just can't get involved in the very small companies in the UK market. So, we gravitate towards those larger small-cap and mid-cap companies.
Second, it kind of mirrors our benchmark. You know, we’re not benchmark slavish, we’re benchmark aware, so the Numis Smaller Companies index, which is our benchmark, is quite heavily mid-cap biased.
The third point I think is one you mentioned, about running the winners. We don’t invest in anything which is large-cap, we invest in small and mid-cap, the original point. However, if those companies do well, and I think I mentioned in the last answer some of the companies that we’ve held over the last 17 years, if they do well and grow and be successful, then naturally we are going to end up with a higher portion of mid-caps if we’re making the right decisions.
And lastly, I think you know, the relative quality and growth. We don’t really care where we find our ideas. Ultimately, it’s kind of find the best companies that can deliver returns for investors over the medium to longer term, and if that’s in the mid-cap, that’s in the mid-cap, but we’re not kind of slavish to that.
And what makes us sell stocks? Well, I think one of the things about running the winners, there’s a natural point we dispose of things, so when it gets to the FTSE 100 index, that’s a point when we cut the position, so clearly, we’re not here to run a portfolio of FTSE 100 companies. So, for example, just unfortunately, Renishaw, which is one of those five I mentioned in the previous answer, it actually went to the FTSE just last month. So, we’ll be disposing of that unfortunately in the next few months, but that’s the natural way of things.
And other disposals come down to things around changing our investment thesis, potentially valuation, changing the manager or strategy, so natural evolution of investment ideas,
Kyle Caldwell: Part of your investment process takes into account environmental, social, and governance (ESG) factors. So, what sorts of qualities do you look for in this respect?
Neil Hermon: I think it’s exactly as you said, ESG’s become an increasingly important factor in investing in the last few years, certainly when compared to a number of years ago. You know, we're not in ethical funds. We haven’t got exclusion lists regarding things that we don’t invest in, but we do think ESG’s very important. And because we’re a large investor and also long-term, we do have quite a significant influence on the management teams of the companies we invest in, because they do listen to us.
We do think that companies that employee strong ESG, environment, social, and governance criteria tend to be those long-term winners. We are looking for those criteria to be met by the companies we invest in. And, you know, I think that kind of what we're looking for is a journey on ESG. The companies that are going to try and deploy the right policies, going to move in the right direction, and improve their ratings. So, I think they’re essentially companies that have the right ESG criteria ultimately will deliver evaluation premium over time.
Kyle Caldwell: And could you name an example or two of a company in which you're using your shareholder influence to drive positive change?
Neil Hermon: I think a really good example of that is we actually recently wrote to every company in our investment portfolio, and we set out the ESG criteria which we felt was important for them to be applying. And those were around their plans to reduce carbon emissions, and to go carbon neutral at some point in the future. Things around the diversity both from gender and ethnicity of the board members, issues around diversity and inclusion and the gender pay gap, management shareholdings in the business, and also critically for us in terms of the short-term was we said we would not support any company paying a divided while they were receiving furlough payments.
Now I think that letter’s been well received, I think we’ve clearly set out what our criteria are of things we think are important in the short-term, and I think certainly from the furlough perspective we’ve had – there’s been significant kind of advancement on that perspective. We’ve certainly been engaging with a number of companies regarding their dividend policy. And a number of companies through our prompting have certainly been looking to repay furlough money to the government before they start paying dividends. So, I think essentially, we’re having some positive impact there on some of our portfolio companies.
Kyle Caldwell: Neil, thank you very much for your time today.
Neil Hermon: Thank you, Kyle. Thanks for your time, too.
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