Smithson fund switch: will it pay off, and who are its rivals?

Smithson fund manager Simon Barnard.

When popular asset manager Fundsmith brought the Smithson Investment Trust Ord (LSE:SSON) to market in October 2018 it broke the record for the most successful investment trust launch ever. The IPO raised £834 million as investors piled into the global small and mid-cap trust run by Simon Barnard, with star manager Terry Smith providing oversight.

But despite compelling returns in its first three years, the trust’s performance began trailing its benchmark in 2022 in the face of soaring interest rates and inflation.

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The trust’s share price subsequently took a beating, hovering at around a -10% discount to net asset value (NAV), despite the board spending almost £1 billion in share buybacks in just over three years.

Enter activist US hedge fund Saba Capital, who have built a 16% position in Smithson, ahead of a possible continuation vote next year. Grasping the nettle, the Smithson board announced plans to convert the £1.6 billion trust into a new open-ended investment company in early 2026 in a bid to restore value for shareholders, with Barnard set to remain at the helm.

Shareholders will now have the choice to withdraw their money at close to NAV, or switch into the fund structure.

As things stand, the restructure looks to be a shoo-in: Saba is backing the relaunch, Smith has said he will invest his 2.3% stake in the restructured fund, and Fundsmith has pledged to contribute to the cost of the overhaul to avoid diluting the remaining investors’ holdings.

With the trust’s discount narrowing since the plans were announced on 12 November (standing at -3.4% on 8 December), Matt Ennion, head of investment fund research at Quilter Cheviot, says shareholders may well use the opportunity to take the cash exit.

“It’s hard to determine whether the fund will retain a large amount of assets post the transition,” he said.

Samir Shah, senior research analyst, collectives, at JM Finn, says Smithson could face a similar situation to the Mobius Investment Trust Ord (LSE:MMIT) – an emerging markets smaller companies fund – which operated a three-year redemption facility.

“We estimate there to be an additional 5%-10% of shares held by value-focused investors in addition to Saba,” he says.

“Given the fund’s weak track record of late, we suspect up to 50% of shareholders could elect for a cash exit. We have recently seen such an event when 48% of shareholders in the Mobius investment trust elected for a cash exit earlier this month.”

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Ben Yearsley, director at Fairview Investing, is in no doubt Smithson will lose assets.

“There could be a rush for the exit once the fund has converted as investors take the opportunity to exit at NAV,” he says.

“Investors have suffered five years of average performance, and they may have put up with a bit more, but with the discount now narrowed to under 5% is there any point in waiting?

“If I was an investor, I would use the current opportunity to exit,” he adds.

Conversely, Smithson could end up with more assets if larger wealth managers seize the chance to pile in, Wealth Club investment manager Nicholas Hyett suggests.

The liquidity constraints of investment trusts often deter larger investors, so the flexibility of an open-ended structure could prove alluring for wealth managers who need to be able to buy and sell large slugs of equity.

“For larger investors, the ability to invest in Fundsmith’s small and mid-cap strategy through an open-ended structure might be very appealing,” Hyett says.

“Whether inflows or outflows win out is impossible to say from the outside, but it wouldn’t be at all surprising to see Smithson with more assets rather than less in a few years’ time.”

Due to the size of the companies it invests in – mid-caps and small-caps – it is expected that Smithson will be able to replicate the trust’s investment process in a fund structure.  

In a recent interview with interactive investor, Barnard said that one of the reasons for choosing the investment trust structure was “because we intended to invest in smaller mid-cap companies where we had concerns that perhaps the liquidity wouldn’t be sufficient to be able to invest with an open-ended daily dealing fund”.

However, he added that liquidity – the ability to buy and sell easily – has not been an issue.

Barnard said: “Actually, as time has gone on over the last seven years, it hasn’t been as bad as we thought. So, liquidity has been fine.”

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With investment trusts, a set number of shares are issued, raising a fixed amount of money for the manager to invest in a portfolio of assets. Those shares are traded on a stock exchange and their price fluctuates according to demand and supply. But the fund manager does not have to sell or buy shares depending on whether they are attracting or losing investors.

In contrast, funds must invest when they receive inflows of cash, or sell investments held in the fund when there are more sellers than buyers asking for their money back at the same time.

Smithson investors wanting to reinvest in a like-for-like investment trust may struggle to find a similar strategy, given that the trust is a concentrated portfolio of 30 stocks investing in a handful of sectors.

While not directly comparable, investors could consider spreading their capital across a selection of funds and investment trusts that are smaller company specialists in their particular region. A possible combination from interactive investor’s Super 60 list of investment ideas could be Diverse Income Trust Ord (LSE:DIVI), The European Smaller Companies Trust PLC (LSE:ESCT) and Artemis US Smaller Companies I Acc GBP.

Wealth Club’s Hyett highlights Herald Ord (LSE:HRI) and Edinburgh Worldwide Ord (LSE:EWI) as Smithson’s current peers, albeit with different remits.

Both were part of the original seven investment trusts that Saba targeted a year ago. The activist still has big stakes in the duo, with Edinburgh Worldwide remaining firmly in its sights with it recently saying it intended to requisition a meeting to oust the entire board.

In response to this, a proposal was put on the table to merge Baillie Gifford trusts Edinburgh Worldwide and Baillie Gifford US Growth Ord (LSE:USA). However, Saba has reportedly rejected the idea.

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“These funds are the only global small-cap investment trusts of any real size, but both have important differences to Smithson,” Hyett says. “Herald focuses exclusively on technology, media and communications companies, while the Baillie Gifford-managed Edinburgh Worldwide is far more focused on growth companies and includes a mixture of public and private companies.”

Both Shah and Yearsley name Columbia Threadneedle’s The Global Smaller Companies Trust Ord (LSE:GSCT) as a potential alternative, with Shah noting that the trust has outperformed Smithson over the past five years.

Yearsley points out: “If you’re an investment trust fan, that’s probably the obvious choice. But there is a dearth of good options, probably as it’s so difficult being an expert in small cap in multiple countries and regions.

“Investors may be better off buying US, Asian and European small-cap funds with experts in each area, which is basically what Global Smaller Companies does, tapping into group resources as well as outsourcing some of Japan, Asian and emerging market smaller companies to external managers.”

In its new iteration as an open-ended fund, Smithson will be up against another well-known fund, abrdn Global Smaller Companies, headed up by small-cap guru Harry Nimmo until 2022 and now managed by Kirsty Desson.

“Kirsty Desson has now been running the fund, either alongside Nimmo or independently, for six years and has her feet firmly under the table,” Hyett explains.

“The fund has a bias towards industrials, with a slight overweight to Europe – not unlike Smithson. With £680 million invested across the strategy, the fund is of a decent size, but crucially not so large that it runs into capacity problems.”

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Another option is to simply own the market. Hyett highlights the Vanguard Global Small-Cap Index £ Acc fund as a rival to Smithson. This is one of interactive investor’s Super 60 ideas.

“Although it lacks the focus on quality companies you get in Smithson, it provides exposure to nearly 4,000 underlying companies, so plenty of diversification in what can be quite a high-risk part of the market,” he says.

Shah seconds the Vanguard fund and suggests Liontrust Global Smaller Companies could also compete with Smithson for assets on the active side, describing it as “slightly more on the growthier side and managed by well-regarded portfolio managers Alex Wedge and Bobby Powar”.

However, for shareholders who decide to stick with Smithson, Ennion says the restructure will be advantageous.

“We view the restructure as positive for those who remain convinced by the portfolio manager and aren’t concerned by the recent period of underperformance, given that the change will simply allow investors to access the strategy in a vehicle with more pricing predictability and potentially better liquidity.”