UK smaller companies yielding more than FTSE 100

Abby Glennie, co-fund manager of the Aberdeen UK Smaller Companies Growth Trust plc (LSE:AUSC), explains why UK smaller companies are offering higher yields than larger companies for the first time in 20 years, and how as a growth investor she’s approaching this trend.

Glennie also runs through how she’s responded to the pick-up in stock market volatility amid the conflict in the Middle East, gives her take on interest rates, and explains that the portfolio has very little exposure to UK consumer.

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello, and welcome to our latest Insider Interview. Today in the studio, I have with me Abby Glennie, co-fund manager of the Aberdeen UK Smaller Companies Growth Trust. Abby, thanks for coming in today.

Abby Glennie, co-fund manager of the Aberdeen UK Smaller Companies Growth Trust: Thanks for having me.

Kyle Caldwell: At the time of this recording, the conflict in the Middle East is ongoing. How, as a fund manager, do you approach what’s unfolding and the pick-up in stock market volatility that we’ve seen?

Abby Glennie:First, it’s very sad to see the conflict that’s evolving and the people who are caught up in that. As fund managers, I think that we have to be cautious of this in that the market is being very short-term focused at the moment, but these things can turn quite quickly. So, you don’t want to be too drawn into that.

I think we went actually into this crisis with quite a lot of balance in the portfolio and we’ve been using risk tools to help do that. So, I think we were quite well positioned for that even before this kicked off, and we continue to look at quality always as part of our investment process. In times of difficulty and volatility, that tends to stand up quite well.

We are looking at areas of opportunity as well though. For instance, we’ve been continuing to build up a newer holding, which is Plus500 Ltd (LSE:PLUS), an online trading platform. That tends to do well in times of market volatility.

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Kyle Caldwell:Interest rate cuts could aid a further recovery for UK smaller companies. How much of a problem for the portfolio is the prospect of rate pauses or even rate hikes following the conflict in the Middle East?

Abby Glennie: You’re right, decreasing interest rates tend to be a real catalyst for smaller companies and for flows into that space. As we sit here today (in mid-March prior to the Bank of England interest-rate decision), actually, I think the probability of a March cut has really gone away.

But most strategists, economists, are still thinking that we will probably get two interest rate cuts in the UK this year. But it does feel like the risk has increased on that not happening.

The thing that we should remind ourselves of though is that if we look at 2024, 2025, actually, this asset class delivered quite strong returns in a higher interest-rate environment. So, while we view cuts as being positive, we don’t think that’s the only driver of returns.

Kyle Caldwell: With an energy shock and the possibility of higher interest rates, what’s your current stance on the UK consumer? How heavily is the investment trust focused on the consumer and the UK economy?

Abby Glennie: Yes, so stagflation is definitely one of the things that fund managers need to consider as an outlook now.

The portfolio actually has very little exposure to the UK consumer. We’ve been reasonably cautious on that for a while because even though a lot of the stats have been quite supportive of the consumer and of savings rate and employment, actually the sentiment has been quite tough, whether that’s been media-driven or about true household income.

There’s been quite a few inputs into that. So, where we do have consumer exposure, we really try to pick what we think are the best leaders in categories and where they have many levers to operationally drive their business.

For instance, things like Dunelm Group (LSE:DNLM) in retail. Wickes Group (LSE:WIX) we also have a bit of exposure to, and Jet2 Ordinary Shares (LSE:JET2) in travel. That’s definitely been the tougher one lately.

Kyle Caldwell:UK smaller companies are offering a higher yield than UK larger companies. That’s the first time that’s happened in over 20 years. First, why has that happened?

Abby Glennie:Well, one of the challenges of that is that it’s been driven by returns. So, the yield becomes a somewhat calculation, so the underperformance of small cap is part of that. The other thing though is the real capital discipline that we see in businesses, and particularly the increase in that through smaller companies.

We’re now seeing more and more smaller companies make sure that they actually are returning to shareholders. So, we’re seeing higher dividend payments, but also particularly share buybacks. We’ve seen a real return to share buybacks in the market.

Kyle Caldwell:Second, how as a growth-focused investor are you approaching this particular trend? Is there a potential downside to this trend that companies are over-prioritising dividends and share buybacks at the expense of growth?

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Abby Glennie: In terms of portfolio companies that we’re investing in, absolutely we have a lot of companies now which are doing share buybacks. They’re showing the market the value that they see in their own business. So therefore, you’re looking at the valuation of their company and saying, this is a great investment return for me. 

Longer term, if we see companies continue to just return all their capital and not be doing proactive growth investing, I think that’s a concern. But I think as markets evolve, we’ll see companies get more of that confidence to then go and invest, whether it be organically or inorganically through acquisitions.

The other thing is the valuation of a company somewhat is their currency to do deals quite often. As we can see valuations improve, that allows companies to be more proactive about deals. And if we see some interest rate cuts, that also makes debt funding a bit cheaper. So, those things will all help the accretion of deals and help companies to probably be more positive about doing that.

Kyle Caldwell:The investment trust has a yield of 2.7%. How much of a focus is dividends for the investment trust?

Abby Glennie: Yes, so we aren’t an income trust, but the board are very aware of how important dividends are to many of our shareholders. It doesn’t constrain us as managers at all, so we’re pleased to pay out an attractive yield. What we’d really love, though, is to see the dividend yield shrink if that was driven by share price return.

Kyle Caldwell:I next want to ask you about gearing levels. The latest figures that I can see, which are to the end of January, show the gearing percentage at around 12%. That’s nearly double what the level was last summer. How are you now approaching gearing, particularly in light of the conflict in the Middle East?

Abby Glennie:Yes, so we believe in having long-term structural gearing in the portfolio. It’s one of the great benefits of an investment trust in that if you believe markets are rising over the long term, you can more than benefit from that. We have, though, been reducing the gearing somewhat, so very conscious about short-term market headwinds.

Kyle Caldwell: Finally, Abby, a question we ask all fund managers we interview, do you have skin in the game?

Abby Glennie:Yes, absolutely. Co-manager Amanda Yeaman and myself both have significant holdings in the investment trust.

Kyle Caldwell:Abby, thanks for your time today.

Abby Glennie: Thank you.

Kyle Caldwell: So, that’s it for our latest Insider Interview, I hope you’ve enjoyed it. For more videos in the series, do hit the subscribe button and hopefully I’ll see you again next time.