Henderson Smaller Companies Investment Trust — Valuation opportunities in quality UK small caps

Henderson Smaller Companies Investment Trust (LSE: HSL)

Last close As at 17/07/2024

678.00

0.00 (0.00%)

Market capitalisation

GBP506m

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Research: Investment Companies

Henderson Smaller Companies Investment Trust — Valuation opportunities in quality UK small caps

Henderson Smaller Companies Investment Trust (HSL) is managed by Neil Hermon, who has been at the helm for more than 20 years. While FY23, ending 31 May, was a difficult year as growth stocks derated in an environment of rising interest rates and bond yields, this should be put into context as the manager has outperformed the trust’s benchmark in 16 of the last 20 years. Hermon believes that there is a disconnect between portfolio companies’ valuations and the strength of their operations as, faced with higher input costs, businesses have adapted to protect their margins. The manager has taken the opportunity of share price weakness to add some new high-quality names to the portfolio, which would have previously been disregarded on valuation grounds. HSL is now one of just 20 funds designated as an AIC dividend hero.

Melanie Jenner

Written by

Mel Jenner

Director, Investment Trusts

Investment Companies

Henderson Smaller Companies Investment Trust

Valuation opportunities in quality UK small caps

Investment trusts
UK smaller companies

22 August 2023

Price

706.0p

Market cap

£527m

Total assets

£716m

NAV*

828.7p

Discount to NAV

14.8%

*Including income. At 18 August 2023.

Yield

3.7%

Ordinary shares in issue

74.7m

Code/ISIN

HSL/GB0009065060

Primary exchange

LSE

Association of Inv Cos (AIC) sector

UK Smaller Companies

Financial year end

31 May

52-week high/low

902.0p

680.0p

NAV* high/low

1,025.5p

781.3p

*Including income

Net gearing*

12.0%

*At 31 July 2023.

Fund objective

Henderson Smaller Companies Investment Trust (HSL) aims to maximise shareholders’ total returns (capital and income) by investing in smaller companies that are quoted in the United Kingdom. The fund’s benchmark is the Numis Smaller Companies (ex-investment companies) Index, which is the bottom 10% of the UK stock market by market cap (up to c £1.5bn market cap). In addition, the fund invests in the Alternative Investment Market (AIM).

Bull points

UK equities, and small-cap businesses in particular look very attractively valued.

Operational strength of portfolio companies supports rising dividend.

Experienced team with long-term disciplined process and philosophy.

Bear points

Smaller companies can be more volatile, less liquid and more cyclical than larger businesses.

Small-cap stocks are currently out of favour with investors and UK fund flows remain challenging.

Gearing can amplify losses in a falling market.

Analyst

Mel Jenner

+44 (0)20 3077 5700

Henderson Smaller Companies Investment Trust is a research client of Edison Investment Research Limited

Henderson Smaller Companies Investment Trust (HSL) is managed by Neil Hermon, who has been at the helm for more than 20 years. While FY23, ending 31 May, was a difficult year as growth stocks derated in an environment of rising interest rates and bond yields, this should be put into context as the manager has outperformed the trust’s benchmark in 16 of the last 20 years. Hermon believes that there is a disconnect between portfolio companies’ valuations and the strength of their operations as, faced with higher input costs, businesses have adapted to protect their margins. The manager has taken the opportunity of share price weakness to add some new high-quality names to the portfolio, which would have previously been disregarded on valuation grounds. HSL is now one of just 20 funds designated as an AIC dividend hero.

NAV outperformance record vs the benchmark under pressure since Q321

Source: Refinitiv, Edison Investment Research

Why consider HSL?

HSL has a long-term record of outperformance versus its benchmark and has recently been classified as an AIC dividend hero, following its delivery of 20 years of consecutive dividend growth. The portfolio is (adjusted for gearing) split between: the UK 250 index (62.5%); the UK small-cap index (12.7%); and the UK AIM index (24.8%). These UK smaller companies have demonstrated outperformance over the long term, although have lagged larger-cap businesses in recent quarters during a period of heightened investor risk-aversion due to an uncertain macroeconomic environment. Given HSL is trading at a wider discount than many of its sector peers and its own historical averages, now could be an opportune time to consider this high-quality UK small-cap fund.

Hermon and his team employ a solid, repeatable investment process based on four M’s: a company’s business model, the quality of its management team, its financial strength (money) and momentum in terms of a firm’s recent and longerterm news flow. ESG considerations are an integral part of the thorough fundamental approach. The manager is closely supported by two colleagues, both of whom are also qualified accountants, which is a particular benefit in the analysis of a smaller company’s financial strength. Hermon is also able to draw on the broad resources of Janus Henderson Investors’ wider investment team, which has both UK and global specialists, including other small- and mid-cap focused managers.

HSL: looking forward to a better market environment

Recent quarters have proved challenging for investors due to a range of macroeconomic issues. Rapid increases in interest rates have put pressure on economies and stock markets and, as inflation has proved to be stickier than expected, further interest rate hikes are possible. With this as a backdrop, a focus on quality companies with strong balance sheets that can successfully navigate the current choppy waters seems to be a sensible approach.

High-quality, GARP portfolio

HSL has a bias towards growth stocks; it could be described as a growth at a reasonable price (GARP) fund, rather than a portfolio that is invested in growth companies without regard as to how expensive they are. Higher interest rates have put pressure on growth company valuations as they decrease the present value of their long-term earnings streams. However, while growth stocks have de-rated, Hermon reports that at an operational level, portfolio companies are performing well and on average are generating year-on-year earnings growth of around 20%, which is supporting the trust’s rising revenue stream and covered dividend.

HSL’s investee companies have very strong balance sheets; half of the portfolio has net cash. Firms have been increasing their prices to cover higher input costs to protect their margins and now cost pressures are moderating, which should mean a less challenging operating environment. When economic conditions improve, the trust appears well positioned with more than 55% of the fund invested in industrial and consumer discretionary stocks.

HSL has a relatively high level of gearing compared with the average in the AIC Smaller Companies sector (Exhibit 1) and is towards the higher end of its own historical range. This reflects Hermon’s bullish outlook and should amplify capital gains in a rising market.

Exhibit 1: Net gearing, HSL vs the AIC UK Smaller Companies sector average

Source: Morningstar, Edison Investment Research

HSL is delivering strong dividend growth and, having achieved 20 consecutive years of higher dividends, has joined the ranks of the AIC’s dividend heroes. This is a select group of just 20 funds and it is interesting to note that the latest three to join are all UK smaller company funds. Typically, UK smaller-cap businesses were considered in terms of their growth rather than income potential.

Despite HSL’s high-quality attributes and long-term record of outperformance, the trust is trading at a double-digit discount that is wider than the majority of most of its peers. This could provide a good opportunity for investors seeking an attractively priced asset class with strong long-term capital appreciation and, increasingly, income growth prospects. For more information about HSL’s dividends and valuation, please see the relevant sections on page 7.

Growth stock price weakness has provided new opportunities

Hermon describes the UK small and mid-cap market as ‘vibrant and exciting’ and as growth names de-rated this opened up more portfolio opportunities. New holdings include:

Ergomed – a specialist pharmaceutical services business, both as a clinical research organisation and providing pharmacovigilance services. It is a global operation with 24 offices servicing customers in 140 countries. Ergomed’s business model is capital light enabling the company to generate high returns. It has net cash on its balance sheet, which can be used to acquire companies to augment the firm’s robust organic growth.

GlobalData – provides high-level data intelligence, analytics and insights across a wide range of industries primarily to executive-level customers at major organisations. The company’s important product differentiator is a focus on live and real-time updated datasets and analysis rather than large reference reports. Strong topline growth and cost control offer margin expansion potential.

Morgan Advanced Materials – a thermal and ceramic products company, which has a wide range of end markets, customers and applications producing extreme precision materials or those required to perform in very harsh environments. Morgan’s management has upgraded the firm’s product portfolio in recent years and organic growth has exceeded investors’ expectations. Net cash on the balance sheet provides inorganic growth opportunities.

Wilmington – a training, events and education business operating out of two units. Intelligence provides a combination of risk and compliance data to insurance, pension and healthcare customers across the world. Training & Education offers bespoke technical support for customers across the financial services and healthcare sectors. Wilmington generates high margins and sells into defensive areas of corporate spend with attractive growth opportunities. It also has potential to make accretive acquisitions.

HSL’s portfolio structure

The trust’s sector exposure is shown in Exhibit 2. In the six months to end-July 2023, the largest changes were a higher allocation to industrial stocks (+2.7pp) and a lower weighting in basic materials (-1.2pp).

Looking at a Morningstar analysis of HSL’s portfolio in terms of its sector weightings, there are a broad range of industrial businesses represented in its largest sector; some of the biggest holdings are top 10 name Balfour Beatty (an international contractor), Alpha Financial Markets Consulting (an investment management consultancy, classified as a business service), Volution (a producer of ventilation products), Serco (a provider of outsourcing services) and Bodycote (an engineering group). Within the second ranked sector, the largest consumer discretionary stocks include top 10 names Bellway (a housebuilder), Mitchells & Butlers (a hospitality operator) and Watches of Switzerland (a luxury watch retailer).

Exhibit 2: Portfolio sector exposure

Portfolio end-July 2023

Portfolio end-January 2023

Change (pp)

Industrials

35.0

32.3

2.7

Consumer discretionary

22.0

22.6

(0.6)

Financials

16.2

17.0

(0.8)

Technology

12.3

12.2

0.1

Real estate

5.6

5.2

0.4

Energy

3.3

4.0

(0.7)

Basic materials

2.1

3.3

(1.2)

Telecoms

2.1

2.0

0.1

Healthcare

1.5

1.3

0.2

Total

100.0

100.0

Source: HSL, Edison Investment Research. Note: Numbers subject to rounding.

As shown in Exhibit 3, at the end of June 2023, HSL’s top 10 holdings made up around a quarter of the portfolio, which was broadly in line with 25.5% a year before; eight positions were common to both periods.

Exhibit 3: Top 10 holdings (at 31 July 2023)

Company

Industry

Portfolio weight %

31 Jul 2023

31 Jan 2023*

Oxford Instruments

Advanced instrumentation equipment

3.1

3.0

Bellway

Housebuilder

2.9

2.4

Balfour Beatty

International contractor

2.7

2.6

Mitchells & Butlers

Hospitality operator

2.6

N/A

Paragon Banking Group

Buy-to-let mortgage provider

2.5

2.7

Vesuvius

Ceramic engineering

2.5

N/A

Impax Asset Management Group

ESG-focused investment manager

2.4

3.0

Watches of Switzerland Group

Luxury watch retailer

2.1

2.4

Future

Specialist internet, website and magazine co

1.9

2.5

OSB Group

Buy-to-let mortgage provider

1.8

2.6

Top 10 (% of portfolio)

24.5

25.5

Source: HSL, Edison Investment Research. Note: *N/A where not in end-January 2023 top 10.

The modest year-on-year sector changes shown above are unsurprising as the manager and his team take a long-term investment perspective. HSL’s portfolio turnover is generally below the AIC sector average (Exhibit 4); an annual turnover of less than 20% equates to a holding period of more than five years.

Exhibit 4: Annual portfolio turnover, HSL vs the AIC UK Smaller Companies sector average

Source: Morningstar, Edison Investment Research

The UK valuation backdrop

UK equities have been out of favour with global investors over a multi-year period due to concerns about Brexit, the UK’s relatively low economic growth, political turmoil, and a perception that the country lacks significant exposure to higher-growth sectors such as technology. This has resulted in UK valuations looking very attractive in both absolute and relative terms, which may lead to an acceleration in M&A that could be very supportive for UK stock prices.

Looking at the valuation of the UK stock market, the Datastream UK Index is trading on a 10.5x forward P/E multiple, which is a 22.2% discount to its 13.6x 10-year average. In relative terms, this index is currently at a 26.3% discount to the Datastream World Index, which is considerably wider than the 12.4% average discount over the last decade.

The manager points to the wide valuation gap in the UK market that favours smaller UK companies and given that stock markets are cyclical and tend to discount economic conditions by around six to nine months, he anticipates that market conditions will be brighter in the coming year.

Performance: Looking to a return to form

There are 24 funds in the AIC UK Smaller Companies sector and Exhibit 5 includes the largest 13 with market caps above £100m. HSL’s underperformance since Q321 has had a negative impact on its standing within the selected peer group. The trust’s NAV total returns are below average over the periods shown, ranking 13th over the last one and five years, 11th over the last three years and 10th out of 11 funds over the last decade. HSL’s discount is wider than average, in a group where no funds are trading at a premium. The trust has the lowest ongoing charges ratio in the selected peer group and is 50bp below the mean, although it is one of four funds that can earn a performance fee. HSL has an above-average level of gearing, ranking fourth and a dividend yield that is 120bp above the mean.

Exhibit 5: Selected peer group at 21 August 2023*

% unless stated

Market
cap £m

NAV TR
1 year

NAV TR
3 year

NAV TR
5 year

NAV TR
10 year

Discount
(cum-fair)

Ongoing charge

Perf.
fee

Net gearing

Dividend yield

Henderson Smaller Companies

527.4

(18.4)

(4.3)

(13.1)

70.7

(13.6)

0.4

Yes

112

3.7

Aberforth Smaller Companies

1,023.1

(0.4)

50.5

2.7

74.4

(13.3)

0.8

No

104

3.9

Aberforth Split Level Income

132.8

(0.3)

64.4

(6.3)

(2.2)

1.3

No

142

7.2

abrdn UK Smaller Cos Growth

353.7

(17.2)

(15.1)

(10.0)

82.0

(13.0)

0.8

No

103

2.0

BlackRock Smaller Companies

608.3

(13.7)

1.7

(5.5)

104.3

(12.5)

0.7

No

112

3.2

BlackRock Throgmorton Trust

541.0

(7.2)

1.5

4.5

127.6

(7.3)

0.5

Yes

117

2.0

Invesco Perpetual UK Smaller

137.0

(16.0)

3.3

(1.5)

92.0

(9.6)

1.0

No

100

0.0

JPMorgan UK Smaller Companies

202.2

(10.0)

9.2

13.7

101.2

(12.9)

1.0

No

115

2.7

Montanaro UK Smaller Companies

167.4

(9.7)

(8.7)

(7.6)

33.4

(7.8)

0.9

No

107

4.5

Odyssean Investment Trust

178.7

(6.9)

50.7

58.4

(1.3)

1.5

Yes

100

0.0

Oryx International Growth

147.0

6.5

29.0

64.6

283.0

(33.6)

1.4

No

100

0.0

Rights & Issues Investment Trust

109.7

(7.3)

20.5

(3.0)

159.6

(15.7)

0.5

No

100

2.1

Strategic Equity Capital

152.4

6.1

42.8

33.5

155.7

(10.0)

1.1

Yes

100

0.7

Simple average (13 funds)

329.3

(7.3)

18.9

10.0

116.7

(11.7)

0.9

109

2.5

HSL rank

4

13

11

13

10

11

1

4

4

Source: Morningstar, Edison Investment Research. Note: *Performance to 21 August 2023. Based on ex-par NAV. TR, total return. Net gearing is total assets less cash and equivalents as a percentage of net assets.

Exhibit 6: Investment trust performance to 31 July 2023

Price, NAV and benchmark total return performance, one-year rebased

Price, NAV and benchmark total return performance (%)

Source: Refinitiv, Edison Investment Research. Morningstar. Note: Three-, five- and 10-year performance figures annualised.

In FY23, HSL’s NAV and share price total returns of -13.8% and -12.0% respectively lagged the benchmark’s -7.4% total return. The largest positive contributors to the trust’s relative performance were: Balfour Beatty (+0.9pp), a new management team has transformed the business in recent years, increasing margins in its UK, US and Hong Kong operations, while maintaining the value of its infrastructure investment portfolio. Improved cash flow has facilitated higher returns to shareholders via share repurchases and larger dividends; National Express (now Mobico, not owned, +0.6pp) its business has struggled post-COVID-19 due to weaker demand and higher wage costs, along with high levels of debt; and Oxford Instruments (+0.6pp) a manufacturer of advanced instrumentation equipment selling to a range of high-growth industries. The company also has a business improvement programme, which is bearing fruit.

On the other side of the ledger, the largest detractors to HSL’s performance were its holdings in: Future (-1.3pp), a global business-to-business specialised media company, which suffered from both earnings downgrades and a de-rating. Apart from operational issues, the firm’s highly regarded CEO retired. The manager is confident that Future’s business conditions will improve, and a new CEO is in place; Synthomer (-0.9pp) was a COVID-19 beneficiary due to high demand for its nitrile latex that is used to manufacture surgical gloves, and there was a cyclical downturn in some of its other product segments. A new management team is working to strengthen the company’s debtladen balance sheet and Hermon is anticipating a recovery in the nitrile latex market; and GB Group (-0.7pp), a data identity, fraud prevention and address verification business, where some of its customers experienced weaker trading conditions. Also, the company’s shares were negatively affected by the general de-rating of growth stocks.

Exhibit 7: Share price and NAV total return performance, relative to indices (%)

 

One month

Three months

Six months

One year

Three years

Five years

10 years

Price relative to Numis Smaller Cos ex-ICs

(1.5)

(8.7)

(11.4)

(16.6)

(16.5)

(13.9)

14.9

NAV relative to Numis Smaller Cos ex-ICs

(1.4)

(7.0)

(9.0)

(15.3)

(16.6)

(12.3)

10.7

Price relative to Numis Smaller Cos plus AIM ex-ICs

(0.2)

(6.4)

(7.8)

(10.2)

(7.5)

(8.5)

23.2

NAV relative to Numis Smaller Cos plus AIM ex-ICs

(0.0)

(4.6)

(5.3)

(8.8)

(7.7)

(6.8)

18.7

Price relative to CBOE UK All Companies

0.1

(6.6)

(12.3)

(19.5)

(21.9)

(20.8)

16.0

NAV relative to CBOE UK All Companies

0.3

(4.9)

(10.0)

(18.2)

(22.1)

(19.3)

11.7

Source: Refinitiv, Edison Investment Research. Note: Data to end-July 2023. Geometric calculation.

As shown in Exhibit 7, a difficult period of relative performance due to the de-rating of growth stocks and cyclical weakness in some of the trust’s more cyclical businesses over the last few quarters has hurt HSL’s medium term performance. Despite this, the trust remains comfortably ahead of its benchmark over the last decade in both NAV and share price terms.

Exhibit 8: Five-year discrete performance data

12 months ending

Total share price return (%)

Total NAV
return (%)

Numis Smaller Cos ex-ICs (%)

Numis Smaller Cos plus AIM ex-ICs (%)

CBOE UK All Companies (%)

31/07/19

(6.2)

(6.8)

(6.1)

(7.4)

1.1

31/07/20

(10.9)

(8.4)

(13.6)

(8.7)

(18.5)

31/07/21

79.4

66.5

49.4

50.3

26.4

31/07/22

(27.4)

(23.2)

(13.0)

(16.0)

6.1

31/07/23

(14.3)

(13.0)

2.7

(4.6)

6.4

Source: Refinitiv. Note: All % on a total return basis in pounds sterling.

Exhibit 9: HSL’s upside/downside capture over the last decade

Source: Refinitiv, Edison Investment Research. Note: Cumulative upside (downside) capture calculated as the geometric average NAV TR of the fund during months with positive (negative) benchmark total returns, divided by the geometric average benchmark total return during these months. A 100% upside (downside) indicates that the fund’s TR was in line with the benchmark’s during months with positive (negative) returns.

Exhibit 9 shows how HSL has performed in months when the benchmark rose and fell. Over the last decade, the trust’s cumulative upside and downside capture were both 119%. As they are above 100%, it suggests that HSL outperforms on the upside but loses more on the downside. The increase in the trust’s downside capture since Q321 coincides with HSL’s underperformance as growth stock valuations have come under pressure and gearing has exacerbated the trust’s capital losses during periods of market weakness.

Dividends: HSL is now an AIC dividend hero

HSL has increased its annual distribution for the last 20 consecutive years, which means the trust qualifies as an AIC dividend hero; one of just 20 funds that has achieved this status. Hermon expects the underlying earnings and dividend strength of HSL’s portfolio companies will continue.

Exhibit 10: HSL dividend history since FY13

Source: HSL, Edison Investment Research

In FY23, HSL’s revenue per share increased by 19.6% to 29.38p. The board has proposed a 19.0p final dividend bringing the total annual distribution to 26.0p (c 1.1x covered), which is an 8.3% increase compared with 24.0p in FY22. At end-FY23, HSL had c £17.2m in revenue reserves, which have been rebuilt following lower dividend receipts during the pandemic, and is equivalent to c 0.9x the FY23 payment. Dividends may also be paid out of capital reserves when required. Over the last decade, the trust’s annual distributions have compounded at a rate of 14.9%.

Valuation: Scope for a narrower discount

Exhibit 11: Discount over three years (%)

Source: Refinitiv, Edison Investment Research

HSL’s latest 14.8% share price discount to cum-income NAV is towards the wider end of the 8.2% to 17.3% range of average discounts over the last 12 months. It is also wider than the 9.4% to 12.3% range of average discounts over the last one, three, five and 10 years.

There is scope for the trust to be afforded a higher valuation given its long-term record of outperformance generated using a well-articulated, repeatable investment process. The board regularly monitors HSL’s discount and discusses the merits of share repurchases; however, it does not currently believe that share buybacks are the most effective way to generate long-term shareholder value.

Fund profile: Smaller-cap UK equity specialist

HSL was launched in December 1887 and is quoted on the Main Market of the London Stock Exchange. Manager Neil Hermon (with effect from November 2002) and deputy fund manager Indriatti van Hien (with effect from June 2016) aim to maximise shareholders’ total returns (capital and income) by investing in smaller UK-quoted companies. These are defined as any company outside of the largest 100 UK company index; if a portfolio holding enters this index, in normal circumstances, it will be sold within six months. The manager and his team tend to avoid companies with a market cap less than £150m to mitigate liquidity risk.

HSL’s performance is measured against the Numis Smaller Companies (ex-investment companies) Index, which is the bottom 10% of the UK stock market by market cap (up to c £1.5bn market cap). The manager’s team receives a proportion of any performance fee paid by HSL, part of which is deferred into the company’s shares.

There are a series of investment parameters in place: equities are 80–100% of total gross assets, fixed income and cash are 0–20%, a maximum 5% in a single holding and a maximum 10% of an investee company’s equity (at the time of initial or additional investment). In exceptional circumstances and with board approval, limits can be exceeded to 10% in a single holding and 20% in an investee company’s equity. Derivatives are permitted for efficient portfolio management. Net gearing is limited to 30% of shareholders’ funds. In practice, individual positions are limited to ±4% versus the benchmark with sector exposures ±10%.

Investment process: Quality growth at the right price

HSL’s managers employ a three-step investment process to construct a portfolio of quality growth stocks: idea generation; research/debate; and implementation. The investible universe of more than 1,000 companies is screened for liquidity and market cap (minimum of £100m) to reduce the number to around 500 names. This potential investible universe is considered using financial statement analysis, sell-side research, along with deep market knowledge, to reduce the opportunity set to around 200 firms. These businesses form the focused investible universe and undergo thorough fundamental research including company meetings and the managers’ proprietary 4M approach to evaluating companies:

Model – focuses on a company’s competitive advantage, and barriers to entry, such as an enduring franchise. While a business may not score highly in this area, it could still be favoured for medium-term growth potential and valuation support. An unexpected change in a company’s strategy could provide a sell signal.

Management – an assessment of the quality of a company’s leadership team including its past record and entrepreneurial vision, and whether its interests are aligned with those of minority shareholders. Management changes or insider selling could be a red flag.

Money – an analysis of a company’s financial position, balance sheet, cash flow and debt profile. Deteriorating fundamentals, especially cash outflows are a cause for concern.

Momentum – a consideration of near- and longer-term news flow that can influence a company’s share price. A firm that can deliver persistent positive earnings surprises could benefit from a rerating. Conversely, negative earnings surprises or earnings downgrades is generally bad news.

Different valuations measures are taken into account, depending on which are the most appropriate and include P/E and EV/EBITDA multiples, free cash flow yield and dividend yield, along with ESG factors and a consideration of the macroeconomic backdrop.

The resulting portfolio is a fund of around 100 names. HSL’s managers employ a long-term view, so portfolio turnover is low. Investee companies with deteriorating 4M scores are reevaluated and may be sold. Stocks may exit the portfolio on valuation grounds, if there is a deterioration in its risk profile or if a company has become too large; as noted in the Fund profile section, any business entering the UK 100 large-cap index will be sold within six months.

HSL’s approach to ESG

ESG analysis is an integral part of HSL’s 4M investment process. The managers believe that companies that score well on ESG factors and sustainability deserve a premium valuation over time. They seek to determine what is/is not a fair premium for these businesses rather than exclude stocks on ESG ratings alone.

The managers have found attractive growth opportunities in companies that provide goods and services that address aging populations, urbanisation and the savings gap, for example. They actively engage with companies to promote positive change and can draw on the specialist resources of Janus Henderson’s governance and stewardship (G&S) team. The G&S team screens portfolios for major ESG issues and highlights important engagement topics ahead of company meetings. The managers will consider selling a portfolio company if its management team does not address shareholders’ concerns.

During FY23, of the c 300 meetings the HSL team undertook, 126 were ESG interactions or engagements with investee companies, during which environmental issues were raised at 60 of the meetings, social issues at 48 and governance issues at 57 of the meetings. The team also discussed thematic ESG matters with portfolio companies including carbon-reduction targets for industrial companies, employee welfare during the cost-of-living crisis and efforts to promote a circular economy.

Gearing

HSL has a combination of debt facilities: a £30m 3.33% 20-year unsecured loan note (issued in 2016); a £20m 2.77% 30-year unsecured loan note (issued in February 2022); £85m of short-term bank borrowings; and a small number (4,257 of £1 each) of preference shares. Gearing of up to 15% of net assets is permitted and, while detrimental in FY23, the use of leverage has made a meaningful positive contribution to the trust’s investment performance during Hermon’s tenure.

Fees & charges

HSL’s management fee is a modest 0.35% of net assets per year, 0.0875% is payable quarterly in advance based on net assets, excluding any funds managed by Janus Henderson Investors (none), at the end of the prior quarter. Broadly, a performance fee is payable calculated as 15% of any outperformance versus the benchmark on a total return basis over HSL’s financial year (further details are shown in the company’s annual report, including how relative underperformance must be made good before a performance fee is paid). The annual combination of management and performance fees is limited to 0.9% of the average monthly value of the trust’s net assets during the year. Both the management and performance fees are charged 70% and 30% to the capital and revenue accounts respectively. In FY23, HSL’s ongoing charges ratio was 0.44%, which was 2bp higher year-on-year (no performance fee was payable).

Capital structure

HSL is a conventional investment trust with one class of share; there are currently 74.7m ordinary shares in issue. Over the last 12 months, HSL’s average daily trading volume was c 91k shares. The trust’s two largest holders are retail platforms Interactive Investor and Hargreaves Lansdown, which together make up around 23% of the share base.

Exhibit 12: Major shareholders and platforms

Exhibit 13: Average daily volume

Source: Bloomberg. Note: At 3 August 2023.

Source: Refinitiv. Note: 12 months to 21 August 2023.

Exhibit 12: Major shareholders and platforms

Source: Bloomberg. Note: At 3 August 2023.

Exhibit 13: Average daily volume

Source: Refinitiv. Note: 12 months to 21 August 2023.

HSL is subject to a three-year continuation vote, with the next due at the September 2025 AGM.

The board

Following nine years on HSL’s board, David Lamb retired on 30 September 2022. The trust’s newest non-executive director, effective from 3 April 2023, is Yen Mei Lim, who is managing director, CFO and head of corporate development at Anthemis Group. She is also a director of NASDAQ-listed Anthemis Digital Acquisitions I Corp.

Exhibit 14: HSL’s board of directors

Board member

Date of appointment

Remuneration in FY23 (£)

Shareholdings at 2 August 2023

Penny Freer (chair since 1 October 2021)

14 September 2018

41,500

3,400

Victoria Sant

23 September 2016

28,500

1,670

Alexandra Mackesy

14 September 2018

33,200

2,200

Michael Warren

1 March 2021

28,500

6,000

Kevin Carter

1 May 2021

28,500

12,000

Yen Mei Lim

3 April 2023

4,750

0

Source: HSL

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London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

General disclaimer and copyright

This report has been commissioned by Henderson Smaller Companies Investment Trust and prepared and issued by Edison, in consideration of a fee payable by Henderson Smaller Companies Investment Trust. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2023 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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