Shares we’ve been buying during the dip

Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today I have with me Abby Glennie, fund manager of the abrdn UK Smaller Companies Growth (LSE:AUSC) Investment Trust. Abby, thanks for coming in today.

Abby Glennie, fund manager of the abrdn UK Smaller Companies Growth Investment Trust: Hi, thanks for having me.

Kyle Caldwell: Year-to-date in 2022, it's been a very tough period to be a UK smaller companies’ investor. What are your thoughts on the sell-off? Do you think it's been overdone?

Abby Glennie: We don’t really think the sell-off is overdone if we look at some of the historic sell-offs we've seen in markets over long-term periods. I think that we've seen definitely risk-off trade, which obviously hit small and mid-caps more typically than large-caps.

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I think particularly in the UK we’ve seen some of the sectors which dominate in the UK large-cap space, such as resources, which have been doing particularly well for various macro reasons, has made that disparity even broader.

Why we don't think that the sell-off has been overdone to date is that we’ve seen larger sell-offs than this historically, and also we think that we are still in the early stages of recession, and typically what we would see is that markets don’t start to recover until you get to the worst point of pain. And the macro environment seems to suggest that we're probably still a little way off that. We do have optimism about recovery overall and certain style aspects starting to rotate again. But, overall, the market doesn’t feel like it’s about to go on a big recovery mode to us.

Kyle Caldwell: The market rotation to value shares has also been a headwind for your strategy, given you focus on growth, quality and momentum. If that market rotation continues, how much of a headwind will it be for the trust?

Abby Glennie: This year, particularly in the early stages of the year, value was very much the dominant drivers of the market, and you know quality and growth feel out of favour. Now for us, if we look over the long term, we do believe that quality growth will continue to perform well. Typically, periods of value outperformance aren’t long-lived.

And when we look at some of the valuations that we’re seeing for quality-growth businesses now, we think that they offer really good value and almost sit in some of the value buckets that people would make looking at P/E multiples. Some of that as well we've seen from some of the sectors which are doing well happen to sit in those value spaces as well. So, we always think it's difficult as well comparing like for like in different periods.

Now, if we continue to see value in vogue, that does become more difficult for us. But you know, what we've seen signs of, and I think what's been difficult about this year, is we've seen maybe a month where we've seen something change in the market, but we haven't seen those trends sustained yet.

We believe, though, that as we go into a recession and slower economic growth, that quality becomes increasingly important, and that's what we haven't seen quite in the market yet. And if I'm honest, I think we would have expected to have seen that by now. And that's because investors really start to look for companies that, for instance, have balance sheet strength, have resilient revenue streams, have recurring revenue, all those aspects which make their survivability and ability to thrive better. And also, when growth becomes scarcer, I think if we can still identify companies that are delivering consistent earnings growth in that environment, that also becomes more valuable. So, in a typical recession, on a relative basis, we tend to do quite well because of that quality focus. But we are still to see that environment emerge this year.

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Kyle Caldwell: And given the sell-off that's taking place in markets this year, have you been using the volatility as an opportunity to pick up some potential bargains?

Abby Glennie: Yeah, so I think if we look across the trust, we probably have a slightly lower number of holdings now. And we've had a couple of new holdings we've added in, but I would say more of the activity in the trading has been on top-ups and reducing positions. Now, I think overall turnover actually is probably very much in line with the long-term average, but I think where we've been taking opportunities is in, somewhat of it is driven by what we've seen with share price moves, in terms of just portfolio construction, and also part of our process is always looking at, we want to be adding to companies and investment cases which are improving and reducing, where we're seeing distractions as such, and we use the matrix, our stock-screening tool, to help with that. So, a good example, for instance, retail has obviously been a tougher environment, so that's something that for several months we've been continuing to reduce.

Kyle Caldwell: Could you give a couple of stock examples of companies that you've been adding to this year?

Abby Glennie: Yeah, sure. So, a couple of things that we've been topping up a lot I would say would be companies such as 4imprint Group (LSE:FOUR), which is a heavily US-focused business, which does promotional product materials. So, this really has been recovering out of Covid. But this has a potential to be a good dividend yielder, it's trading incredibly well, and importantly, they're seeing a high return on their increased marketing spend that they're making. So, we've been topping up that.

We've been topping up companies like Marlowe (LSE:MRL), which is business services, very critical in nature, very recurring, and things like Alpha Financial Markets Consulting (LSE:AFM). This is a business that does consultancy for the asset management business, and increasingly as well life insurance, and it's trading well across the UK and has expanded into the US, so that's sort of a growth into an adjacency that's helping the overall investment case. And, with them we see [that] any disruption in market, any regulation, any consolidation in the industry, tends to be a positive for them and that's what they continue to see.

Kyle Caldwell: And to fund those additions, has gearing being increased in the trust? And if not, what would it take for gearing levels to go up?

Abby Glennie: Yes, so typically we have gearing as more of a structural aspect. So, the gearing hasn't really changed a lot. We have the flex if we wanted to increase gearing. We typically aren't big market timers and we always want shareholders to take more of a long-term strategic view in terms of having some of their asset allocation in smaller companies. I think if we had a bullish view on a market recovery, then we do have the optionality to use gearing a bit more.

Kyle Caldwell: Inflation is a big concern now. Have you been adding inflation protection to the portfolio, such as focusing more on pricing power among the companies that you hold?

Abby Glennie: Yes, so I think inflation is a good example of how we think about macro things that we're seeing, which is that we very much take those on a stock-specific level. So, we're thinking about for each stock-specific investment case, what is their inflationary pressures and what can they do to offset that? And typically, having pricing power in any environment is something we look for in our businesses. So, we're seeing, I'm not saying it's not a headwind and an issue for businesses, but we do think we have quite a lot of holdings where they can pass that on and protect margins, and maybe some examples would be things like Watches of Switzerland Group (LSE:WOSG).

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They really are a beneficiary of inflation. So, where they are seeing Rolex have now, having not actually increased prices for many years, have put through a pricing rise earlier this year and then another one this week, another 5%. And that is a benefit to Watches of Switzerland.

I mentioned Marlowe before. I think that the business-critical nature of their type of services really helps them in terms of passing on those inflationary pressures. We've also got things like global data in the tech space. So, very much these are recurring revenue streams. We don't really see customers cancel even in a slightly tougher environment. And the inflationary pressure they've already been going through, a sort of pricing mix because of the history of the business, so I think they also have the opportunity that, you know, it's done within that, but because they can offer lots of additional services, inflationary pressures can almost be bundled up in terms of offering more, as well with given price rises.

You touched on it earlier, it's likely that the UK is going to enter a recession before the end of the year. How much of an influence does something like a recession have on your stock picking?

Yeah, so I think the key for us is that we stick to the same investment process and we've run that for so many years now, we think this is the sort of fifth economic cycle that we're seeing. So, we absolutely will not veer away from that. But recession does have an impact, and I think that's the way that I was saying that we take all those macro views and we look at them on a company-specific, bottom-up level. So, for every company, we're thinking about things like inflationary pressures, interest rate pressures, what's a positive, what's a negative. So, I think you can absolutely see shifts. I think we've been moving, as I said, away from, for instance, consumer exposure generally. And I think we've been adding to things where we really believe in the quality aspects of the business and the recurring and visible nature of the sort of revenue streams, and where they have that pricing power that they're able to protect margins. We really want to focus on businesses where we're getting earnings growth and dividend growth.

Kyle Caldwell: And finally, do you personally invest in the trust?

Abby Glennie: Absolutely. So, a big part of my personal savings are in all sorts of funds run by our team so, our UK small-cap trusts, our mid-cap funds, and our European and global funds as well within the team.

Kyle Caldwell: Abby, thank you for your time today.

Abby Glennie: Thanks very much.

Kyle Caldwell: That's all we have time for today. You can check out the rest of our Insider Interviews on our YouTube channel, where you can like and subscribe. See you next time.