Henderson Opportunities Trust — Is a bird in the hand really worth two in the bush?

Henderson Opportunities Trust (LSE: HOT)

Last close As at 22/06/2024

GBP10.10

10.00 (1.00%)

Market capitalisation

GBP80m

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Research: Investment Companies

Henderson Opportunities Trust — Is a bird in the hand really worth two in the bush?

Henderson Opportunities Trust (HOT) seeks to identify the best investment opportunities across the breadth of the UK market. It has a strong bias towards smaller and early-stage companies with significant potential to grow into tomorrow’s leading British businesses, and a value-driven style that invests in out-of-favour or under-researched companies. In the past two years, UK market performance has been driven by the largest companies, with a broad sell-off in smaller companies, especially those listed on AIM. Many smaller companies, with strong earnings growth potential, are now trading at very low valuations and the managers see exciting opportunities for a recovery.

Martyn King

Written by

Martyn King

Director, Financials

Investment Companies

Henderson Opportunities Trust

Is a bird in the hand really worth two in the bush?

Investment trusts
UK all-cap equities

19 July 2023

Price

942p

Market cap

£74.4m

AUM

£105.8m

NAV*

1,118.8p

Discount to NAV

15.8%

*Including income. As at 17 July 2023.

Yield

3.6%

Ordinary shares in issue

7.9m

Code/ISIN

HOT/GB0008536574

Primary exchange

LSE

AIC sector

UK All Companies

52-week high/low

1,602.5p

1,040.0p

NAV* high/low

1,676.3p

1,203.0p

*Including income

Net gearing*

15%

*As at 31 May 2023.

Fund objective

Henderson Opportunities Trust aims to achieve capital growth in excess of the broad UK stock market from a portfolio of UK investments. Stock selection is not constrained by the benchmark and there are no limits by sector or market capitalisation. Therefore, the portfolio will differ materially from the index.

Bull points

Opportunities across all market segments and market capitalisation.

Disciplined approach to stock selection, valuation and portfolio diversification.

Experienced and stable management team with consistent long-term strategy.

Bear points

Relatively small size means HOT could be overlooked by some investors.

High portfolio weighting in smaller and earlier-stage companies, where liquidity can be thin and returns can be volatile.

The discount to NAV could drift wider if market conditions become more difficult.

Analyst

Martyn King

+44 (0)20 3077 5700

Henderson Opportunities Trust is a research client of Edison Investment Research Limited

Henderson Opportunities Trust (HOT) seeks to identify the best investment opportunities across the breadth of the UK market. It has a strong bias towards smaller and early-stage companies with significant potential to grow into tomorrow’s leading British businesses, and a value-driven style that invests in out-of-favour or under-researched companies. In the past two years, UK market performance has been driven by the largest companies, with a broad sell-off in smaller companies, especially those listed on AIM. Many smaller companies, with strong earnings growth potential, are now trading at very low valuations and the managers see exciting opportunities for a recovery.

Seeking tomorrow’s leaders

Source: Janus Henderson Investors.

Will the early bird catch the worm?

In an unconstrained, all-market portfolio, faster-growing, smaller and early-stage stocks have added significant long-term value to the HOT portfolio. Many have been identified on the AIM market (c 50% of the portfolio) where carefully selected stocks such as Serica Energy and Blue Prism have contributed greatly. However, when investor confidence is lower, smaller company and growth stock prices tend to be weaker, especially compared with large global stocks. This has been the case in the past two years, generating significant under-performance against HOT’s broad market benchmark.

As they have observed in previous cycles, the managers expect market leadership to broaden as confidence grows. They note that the de-rating of smaller companies leaves valuations at low levels, relative to larger companies and historically, already discounting a severe recession. While this alone should mitigate further weakness, the managers say that the operational performance of many portfolio companies is driven by their own efforts to penetrate large end-markets, with a limited impact from economic conditions. Stubbornly high inflation is yet to signal the peak in interest rates, making the timing of a small company recovery difficult to predict, but we believe the potential for strong returns makes HOT an attractive complement to more mainstream trusts, which should more closely track broader market developments. HOT’s permanent capital base supports a patient approach. While gearing (15%) has contributed to recent NAV weakness, it would positively affect a recovery. A narrowing of the discount (15.8%) would enhance shareholder returns.

Targeting growth with stability

HOT has been managed consistently for many years by two experienced investment managers, James Henderson (since 2007) and Laura Foll (since 2018) of Janus Henderson Investors (JHI). In turn, they are supported by the broader resources of the JHI equity team (see page 13). The trust aims to achieve capital growth in excess of the broad UK market from a portfolio of primarily UK investments, with a secondary objective of delivering dividend growth over time. The trust’s all-cap focus gives it the flexibility to seek growth opportunities from across the market, including those listed on AIM, underpinned by a value-driven style that invests in out-of-favour or under-researched companies. At its core, the HOT portfolio is a blend of what could be tomorrow’s leading British companies, across a wide range of activities and market caps, at different stages of their life cycle, from promising early-stage businesses to established businesses reinventing themselves. ‘Tomorrow’s leaders’ are complemented in the portfolio by investment in ‘stabilisers’. These are often larger, mature but still growing businesses, with more predictable cash flows, as well as natural resources companies that provide a hedge against unexpected developments in commodity markets.

Exhibit 1: HOT versus market by segment

Exhibit 2: HOT versus market by capitalisation

Source: Henderson Opportunities Trust, 30 April 2023 (last available data). Note: *Other includes unlisted equities.

Source: Henderson Opportunities Trust, 30 April 2023 (last available data)

Exhibit 1: HOT versus market by segment

Source: Henderson Opportunities Trust, 30 April 2023 (last available data). Note: *Other includes unlisted equities.

Exhibit 2: HOT versus market by capitalisation

Source: Henderson Opportunities Trust, 30 April 2023 (last available data)

Smaller companies have delivered long-term outperformance but with shorter-term volatility

Faster-growing smaller companies have outperformed their large-cap counterparts over the long term and this is reflected in HOT’s outperformance of its broad UK equity market benchmark over the past 10 years. Over shorter periods, smaller companies are more volatile but have tended to rebound strongly from market setbacks, typically led by larger caps.

Exhibit 3 shows how the Numis Smaller Companies Index excluding investment trusts (NSCIEXT)1 has outperformed the broad market over the past 10 years. We also show the same index but including AIM shares (NSCIAEX), which modestly underperformed the broader market. The main purpose of the AIM market is to encourage younger, smaller, more entrepreneurial businesses, some of which will succeed – often spectacularly – and many others will fail. While this has limited the long-term performance of the AIM index, it remains the case that selective, long-term investing in AIM-listed companies can be highly rewarding so long as the risks are well managed. We discuss below how this has been the experience of HOT and its managers at Janus Henderson, creating long-term value despite the sharp sell-off of AIM stocks in the past two years.

  1 The NSCI is the main index used as a smaller company benchmark. It targets the bottom 10% of the main UK market by value. The NSCIAEX includes all the constituents of the NSCI and all companies listed on AIM that fall below the NSCI size cut-off.

Exhibit 3: Long-term small-cap outperformance

Exhibit 4: Small-cap volatility versus broad market

Source: Refinitiv. Note: NSCIEXT is Numis Smaller Companies Index excluding Investment Companies. The NSCIAEX includes AIM.

Source: Refinitiv. Note: NSCIEXT is Numis Smaller Companies Index excluding Investment Companies. The NSCIAEX includes AIM.

Exhibit 3: Long-term small-cap outperformance

Source: Refinitiv. Note: NSCIEXT is Numis Smaller Companies Index excluding Investment Companies. The NSCIAEX includes AIM.

Exhibit 4: Small-cap volatility versus broad market

Source: Refinitiv. Note: NSCIEXT is Numis Smaller Companies Index excluding Investment Companies. The NSCIAEX includes AIM.

Small-cap weakness has negatively affected HOT’s recent performance

Given HOT’s significantly greater focus on smaller companies compared with its all-market benchmark (Exhibit 1), marked divergence in net asset value (NAV) total return performance over shorter time periods is inevitable.2 Resulting primarily from small-cap weakness over the past two years, and especially among AIM-listed companies, HOT’s NAV total return performance relative to the benchmark is negative over one, three and five years, but remains positive over 10 years. Portfolio ‘stabilisers’, including larger company and commodity exposures and stock selection, have provided positive offsets, with NAV total return performance ahead of the NSCIAEX over three, five and 10 years.

  2 At 31 May 2023, predicted volatility (including gearing) was 12.5% with a beta of 1.34%.

Exhibit 5: HOT performance versus Indices

Cumulative returns to 30 June 2023

1m

3m

6m

1y

2y

3y

5y

10y

Share price total return

-11.9%

-9.7%

-10.0%

-10.0%

-29.2%

22.6%

-5.2%

87.8%

NAV total return

-3.4%

-5.7%

-7.7%

-9.0%

-29.5%

22.0%

5.4%

85.0%

Benchmark total return

1.0%

-0.5%

2.6%

9.6%

9.6%

33.0%

16.3%

77.4%

Numis Smaller Companies + AIM ex-investment companies*

-1.0%

-1.6%

-2.2%

-21.3%

-21.3%

19.9%

-0.7%

67.7%

AIM

-3.4%

-6.3%

-8.5%

-37.9%

-37.9%

-11.5%

-25.9%

23.8%

Source: Refinitiv, Edison Investment Research. Note: *NSCIAEX.

The greater volatility of smaller company performance can better be seen in HOT’s returns on a discrete calendar year basis. HOT has tended to outperform the index when the market is rising, and this was clearly the case in 2020 as the market recovered strongly from the pandemic low point.

Exhibit 6: HOT’s calendar year performance relative to its broad market benchmark

H123

2022

2021

2020

2019

2018

2017

2016

2015

2014

2013

2012

HOT NAV total return

-7.7%

-21.5%

17.8%

14.0%

18.0%

-14.1%

24.8%

11.1%

4.0%

1.9%

45.5%

35.0%

Broad UK market total return

2.6%

0.4%

18.3%

-9.8%

19.2%

-9.5%

13.1%

16.8%

1.0%

1.2%

20.8%

12.3%

Source: Henderson Opportunities Trust

The investment managers see a strong opportunity to benefit from a small-cap performance recovery

Three key issues have negatively affected the recent performance of smaller companies:

Rising interest rates, which have reduced the value attached by investors to expected future earnings growth.

Uncertainty about the UK economy, to which smaller companies are typically more exposed than larger, more international companies.

A flight towards companies with greater share trading liquidity. To a large extent, this reflects ‘normal’ investor behaviour during a period of uncertainty but also structural, fiduciary issues, particularly, but not exclusively, in relation to the open-ended fund sector.

The investment managers firmly believe that there is a strong opportunity to benefit from a recovery in smaller stocks. This is based on several observations and expectations, including:

UK equities trade at low valuations (Janus Henderson estimates the lowest in three decades), and smaller stocks lower still. Despite market uncertainty limiting market-wide M&A activity, low valuations have been reflected in takeover activity (most recently for HOT, this includes Devro and Numis).

The UK economy has remained more robust than had been generally expected. With inflation stubbornly high and yet to signal a peak in interest rates, this may change, but valuations already appear to be signalling a very significant economic downturn.

Small-cap weakness has been broadly based. The investment managers note that for many economically sensitive companies, earnings performance has outstripped low expectations. More generally, for many smaller companies, growth is driven by capturing market share within large end-markets or creating new markets, mitigating any impact from general economic conditions.

Equity market performance has been led by larger-cap stocks and the investment managers anticipate this should eventually broaden out, as has typically been the case in previous market cycles.

As negative investor sentiment turns, the same liquidity constraints that are currently working against smaller company valuations will work in their favour. While the timing of this is difficult to predict, HOT’s permanent capital base allows it to take a patient, long-term view.

Although focused on capital growth, the trust has increased dividends by 62% in the past five years and its 3.6% dividend yield is the highest in its AIC sector. Shareholder returns would be enhanced by any closing of the 15.8% discount to NAV.

Recent performance leaves smaller companies on low valuations

Looking at price to sales ratios (P/sales) rather than using earnings, a less reliable indicator of underlying value, the small-cap index trades at a lower level than larger companies. While this is not unusual, at c 0.5x on a trailing basis it is at the lower end of its historical range. This is equally the case relative to larger companies.

Exhibit 7: Small-cap P/sales at low end of range

Exhibit 8: Small-cap P/sales low versus large cap

Source: Refinitiv

Source: Refinitiv

Exhibit 7: Small-cap P/sales at low end of range

Source: Refinitiv

Exhibit 8: Small-cap P/sales low versus large cap

Source: Refinitiv

HOT’s portfolio includes a number of early-stage companies (7% of the total), typically with a high P/sales ratio, reflecting valuations that anticipate very strong future sales growth from a low base. Nonetheless, on a blended basis, including its larger company exposure, HOT calculates its end-H123 P/sales ratio at c 0.6x, a five-year low, and well below the long-term average of little under 1x.

Exhibit 9: HOT portfolio long-term P/sales

Source: Henderson Opportunities Trust

Investors have taken AIM

Although AIM-listed companies cover a wide range of market caps (several companies have market caps of more than £1bn and up to c £2bn), it is within the AIM market that HOT’s investment managers expect to find most of what they hope will be tomorrow’s leading businesses. Correspondingly, the bulk of HOT’s small and early-stage company investments are AIM-listed. Over the longer term, HOT’s investments in AIM stocks have created significant value, driven by a combination of stock selection and risk mitigation. For example, during the past 10 years,3 HOT’s investments in AIM-listed Serica Energy, Blue Prism Group and Keywords Studios have provided exceptional returns of c 1,400%, 1,500% and 1,200% respectively.4 In aggregate, the top 10 AIM performers have contributed more than 50% to performance, more than offsetting a negative aggregate return of c 18% from the bottom 10 AIM contributors. While liquidity can often be restricted in smaller AIM stocks, risk exposure is highly diversified and actively guided by a strict valuation approach under which strongly performing investments are incrementally reduced.

  3 To 31 May 2023.

  4 To 31 May 2023.

HOT’s strong returns from AIM investments come despite the sluggish long-term performance of the AIM index (Exhibit 10), which in part reflects considerable ‘churn’ among its listed constituents. More than 4,000 companies have joined AIM since it launched in 1995 compared with c 800 listed today. Promotion to the Main Market or acquisitions account for much of the churn, but so too does company failure. Over shorter periods, AIM performance has been anything but sluggish (Exhibit 11). When investors are confident, the market has performed strongly, but, with risk aversion currently high, the sell-off has been sharp and broadly based, giving up most of the strong gains generated following the peak of pandemic uncertainty in early 2020. While taking a long-term approach to investment, the managers do take an active approach to the portfolio and during 2021, taking advantage of rising prices, and where valuations were becoming elevated, the portfolio was tilted away from growth stocks (‘tomorrow’s leaders’) and more towards portfolio ‘stabilisers’. While directionally this was a positive move, the benefits to performance were tempered, first by the impact of petroleum revenue tax on oil and gas producers, and subsequently by the emergence of investor concerns over the banking sector following several failures in the United States and Credit Suisse.

Exhibit 10: Long-term AIM performance

Exhibit 11: AIM has given up pandemic recovery gains

Source: Refinitiv

Source: Refinitiv

Exhibit 10: Long-term AIM performance

Source: Refinitiv

Exhibit 11: AIM has given up pandemic recovery gains

Source: Refinitiv

Investor enthusiasm for AIM companies remains low, to a large extent reflecting the greater exposure of companies to the domestic economy. While international investors have been buyers of UK equities, driven by relatively low valuations, this has been focused on large, global companies and does not extend to smaller companies or AIM. International investment has been met by UK institutional sales while domestic funds continue to see outflows. Within open funds, exposures to less liquid investments have been reduced to protect investors in periods of stress. Morningstar data show consistent monthly outflows from UK small-cap funds since the beginning of 2022, representing 13% of total UK equity fund outflows, well above the small-cap index weighting. We believe that retail investor sentiment is an important driver of AIM performance. Although somewhat dated, the Office for National Statistics estimated that in 2020, retail investors owned 24% of AIM and unit trusts a further 9%.5 While this current lack of investor enthusiasm for AIM investment may sound negative, for the contrarian investor, as is the case with the investment managers, this is just the sort of environment that throws up opportunities at attractive valuations.

Exhibit 12: Five-year UK fund flows (£bn)*

Exhibit 13: Five-year small-cap fund flows (£bn)*

Source: Morningstar. Note: *Aggregate UK Income, flex-cap, large-cap, mid-cap and small-cap funds.

Source: Morningstar. Note: *UK Small-Cap Equity funds only.

Exhibit 12: Five-year UK fund flows (£bn)*

Source: Morningstar. Note: *Aggregate UK Income, flex-cap, large-cap, mid-cap and small-cap funds.

Exhibit 13: Five-year small-cap fund flows (£bn)*

Source: Morningstar. Note: *UK Small-Cap Equity funds only.

Investment process is bottom up, with a strong underlying valuation discipline

The portfolio managers are focused on long-term returns, with investment decisions driven by a selective, bottom-up approach. They are looking for the best capital growth opportunities, with no specific sector or size remits, although these are most often found among smaller companies, particularly those at an early stage. Their experience is that by staying close to companies, they can invest with conviction and better add value than would be the case by relying on top-down macroeconomic forecasting. As a result, there is no common theme to stock selection other than that the managers are seeking to identify the next generation of leading companies across a wide range of activities. Interactions with companies are a key part of the stock selection process, with the managers undertaking several hundred meetings and site visits each year. They firmly believe that company management is one of the most important factors in identifying possible investments, noting that a good management team can navigate a difficult economic backdrop, while poor management can get it wrong even in the good times. Although the managers do not use specific quantitative screens to whittle down the large number of stocks in their investment universe, their focus on buying good companies at attractive prices means they employ a range of valuation criteria, such as P/E ratios, price/book value and enterprise value to sales. By way of example, they note that the small-cap end of the spectrum often offers superior earnings growth whilst trading at an attractive P/E discount to the wider market, albeit with the risk of lower liquidity and greater volatility of returns. Diversification is key to managing smaller company risk. As we have shown above, successful smaller companies can deliver exceptional growth and investment returns, but others will struggle or even fail, while liquidity constraints limit the opportunity to react. The managers take an active but measured approach to topping up and reducing holdings, to lock in gains and mitigate the possibility of future losses.

Portfolio positioning

At 31 May 2023 there were 98 holdings in HOT’s portfolio, towards the top of the 70–100 stock range. Six of the top 10 names were AIM stocks, with three banks (Barclays, Standard Chartered and HSBC) and the miner, Rio Tinto, accounting for the balance. Together, the top 10 holdings accounted for a little over a quarter of the total portfolio.

The managers expect banking stocks to continue to benefit from rising interest rates which benefit interest margins. Meanwhile, balance sheet and lending profiles are much healthier than they were ahead of the global financial crisis, providing protection against lending risk. Share prices have begun to recover from the negative impact on investor sentiment of US bank failures earlier in the year.

Exhibit 14: Top 10 holdings at 30 June 2023

 

 

Portfolio weight

Portfolio weight

Company

Index

Industry

30 June-23

31-Oct-22

Vertu Motors

AIM

Automotive retail

3.8

2.4*

Barclays

Large-cap

Banks

3.7

3.4

Boku

AIM

Industrial support services

2.8

2.5

HSBC

Large-cap

Banks

2.6

2.7

Standard Chartered

Large-cap

Banks

2.6

1.9*

Rio Tinto

Large-cap

Mining

2.5

2.2*

Serica Energy

AIM

Oil & gas producers

2.4

3.3

Next Fifteen Communications

AIM

Media

2.3

2.9

Zoo Digital

AIM

Software & computer services

2.3

2.9

Tracsis

AIM

Software & computer services

2.3

2.1*

Top 10 (% of holdings)

27.3

29.0

Source: Henderson Opportunities Trust, Edison Investment Research. Note: *Held at 31 October 2022 but not in top 10. **Actual top 10 weighting at 31 October and does not equal sum of holdings above.

The AIM stocks are a diverse group, by activity and size (market caps shown are as at the date of publication):

Vertu Motors (market cap: c £250m) is a car dealer with a successful track record and strong balance sheet. Recent performance has been driven by strong earnings, enabling the company to increase its dividend and announce a share buyback.

Boku (market cap: c £400m) is a mobile payments company which allows its customers to charge for their services via an individual’s mobile bill. The company is growing rapidly and is establishing itself globally, including Apple and Spotify among its customer base.

Serica Energy (market cap: c £780m) is an oil exploration and production business focused on the North Sea and acquired assets at attractive prices as the oil and gas majors were reducing capital expenditure. The mangers note that the share price, negatively affected by the petroleum revenue (‘windfall’) tax and weaker oil prices, has left the company’s assets significantly undervalued, while fossil fuels will inevitably remain a major source of energy supply for a very long time to come.

Next Fifteen Communications (market cap: c £675) is a marketing and PR company with a focus on the faster-growing technology industry.

Zoo Digital (market cap: c £60m) provides localisation services such as dubbing and subtitling, assisting content producers to extend their reach globally. It is growing rapidly on the back of strong demand for content and the investment managers expect this to continue. The share price has nonetheless weakened recently because of disappointing financial results and investor concerns that some of its business could be replaced by artificial intelligence.

Tracsis (market cap c £270m) provides specialist software for the transportation industry, supporting customers in delivering mission-critical activities with increased efficiency, enhanced performance, higher productivity and increased safety.

For completeness, we show the portfolio sector weightings in Exhibit 15. These are an output of stock selection rather than a target or input into the investment process, but nonetheless show a broad spread of exposures.

Exhibit 15: Portfolio sector weightings

Portfolio weight

 

Benchmark

 

 

ICB industry

30 June 2023

31 October 2022

Change

30 June 2023

Active weight vs benchmark

Trust weight/benchmark weight

Industrials

25.8

21.1

4.8

11.9

13.9

2.2

Financials

20.4

20.6

(1.0)

23.2

(2.8)

0.9

Consumer discretionary

19.0

17.1

1.7

12.0

7.0

1.6

Technology

10.8

11.7

(0.7)

1.2

9.6

9.3

Energy

8.1

13.1

(4.4)

10.7

(2.6)

0.8

Basic materials

6.4

6.7

(0.7)

7.2

(0.8)

0.9

Healthcare

3.8

3.4

0.9

11.6

(7.8)

0.3

Consumer staples

3.5

3.1

0.4

15.0

(11.5)

0.2

Telecommunications

1.0

2.3

(1.1)

1.3

(0.2)

0.8

Real estate

1.0

0.9

0.1

2.3

(1.3)

0.4

Utilities

0.0

3.6

(3.6)

0.0

Total

100.0

100.0

Source: Henderson Opportunities Trust, Edison Investment Research

Exposure by ‘bucket’ is the true guide to portfolio positioning

To help investors make sense of the trust’s broadly diversified, stock-driven, all-cap portfolio, HOT’s managers look deeper than the basic distinctions of small-, mid- and large-cap, instead classifying their holdings under one of six classifications or ‘buckets’: early stage, small-cap growth, small- and mid-cap (SMID) compounders, large-cap growth, recovery/special situations and natural resources. To clarify the process even further, the buckets are grouped under two broad headings: ‘tomorrow’s leaders’ (the three small/mid-cap buckets and recovery/special situations) and ‘stabilisers’ (large-caps and natural resources). Each bucket has an indicative weighting range and, while HOT may choose to have no exposure to early-stage or recovery situations, it is a feature of the trust that natural resources must always be represented. The investment managers comment that the indicative exposure ranges provide them with a useful challenge, asking themselves ‘is there a good reason that we have a lower or higher exposure?’

Exhibit 16 shows the current portfolio positioning across the buckets, as well as its development over the past three years. Exposure to tomorrow’s leaders is currently lower than it has generally been over this period, and stabilisers lower, but this has begun to reverse. The changes over the period reflect a combination of capital allocation towards those areas in which the managers identify the most attractive opportunities, as well as performance. During 2021, the managers were reducing exposure to smaller growth stocks where they considered that valuations had become stretched, reallocating the proceeds to larger-cap stocks, recovery stocks and natural resources. Reflecting the sharp de-rating of small-cap stocks with continuing strong growth prospects, the managers expect the weighting to tomorrow’s leaders will continue to increase.

Exhibit 16: Portfolio positioning across buckets

30-Apr-23

31-Oct-22

30-Apr-22

31-Oct-21

30-Apr-21

31-Oct-20

H123

H222

H122

H221

H121

H220

SMID compounders (20–40%)

26%

25%

23%

24%

24%

27%

Growth – small cap (20–40%)

16%

17%

18%

20%

19%

27%

Early stage (0–20%)

7%

7%

10%

13%

15%

17%

Recovery/special situations (0–30%)

14%

10%

11%

11%

11%

6%

Tomorrow’s leaders

63%

59%

62%

68%

69%

77%

Growth – large cap (10–30%)

24%

24%

22%

21%

19%

15%

Natural resources (5–15%)

13%

17%

16%

11%

11%

8%

Stabilisers

37%

41%

38%

32%

30%

23%

Portfolio total

100%

100%

100%

100%

99%

100%

Source: Henderson Opportunities Trust, Edison Investment Research. Note: Latest split as at 30 April 2023.

Early stage (0–20%)

These companies are typically addressing potentially large end-markets but are at an early stage of commercialisation and yet to generate meaningful revenues and earnings. In aggregate, they offer significant upside potential, but individually they represent the highest element of risk in the portfolio. Share price performance is typically volatile, driven by the developments within these businesses and investor perceptions of their prospects, often with little correlation to wider equity market moves or the economy. These made up 7% of the portfolio at H123, around half the level at end FY20.

Example: Ceres Power is an investment in renewable energy and, specifically, a potential global leader in hydrogen fuel cell technology and the transition to green energy.

Growth small cap (20–40%)

Although still at the beginnings of their life cycle, these are quality companies, more established than the early-stage companies, and forecast to grow sales and earnings at a fast pace.

Example: Tracsis, as described above with the top 10 holdings.

Small- and mid-cap compounders (20–40% of the portfolio)

These are typically good-quality, well-established companies with strong management and a consistent record of sales and earnings growth, offering long-term compounding of returns.

Example: RWS Group is already established as a market leader in translation services, working with more than 80% of the world’s top 100 brands, more than three-quarters of Fortune’s ‘World’s Most Admired Companies’ and nearly all the top pharmaceutical companies, investment banks, law firms and patent filers.

Recovery/special situations (0–30%)

These are typically out-of-favour companies, where the managers have identified a specific trigger for a re-rating, providing contrarian value opportunities. The triggers for unlocking this value may include a strategic repositioning of the business, management change or the prospects for a sales and earnings recovery. Exposure has more than doubled since end FY20, to 14% from 6%, including new investments across a range of market caps.

Example: Marks & Spencer has benefited from a range of self-help measures, despite a challenging consumer environment. The managers believe this process has further to go and that revitalisation of the business and the strength of the brand remains under-appreciated in the market.

Growth large cap (10–30%)

These are generally large, well-managed and reliable companies where the managers expect continuing sales and earnings growth, albeit at a more modest pace than for those companies at an earlier stage in their life cycle. These can increase the liquidity of the overall portfolio and may also be an important source of yield. Exposure to this area is around 60% higher than it was at end FY20.

Example: Legal & General is one of the UK’s leading financial services groups and a major global investor, with a strong track record of earnings and dividend growth.

Natural resources (5–15%)

Commodity selection determines positioning within the sector, but the lower end of the exposure range has been deliberately set at 5% (not zero), meaning that there will always be some exposure, providing the managers with scope to benefit from unexpected developments in commodity markets. The managers have additionally sought to add value by paying attention to smaller companies in the sector.

Example: Serica Energy, the oil exploration and production business and a top 10 holding discussed above. Another top 10 holding, Rio Tinto, with good-quality assets across a broad range of resources, from a relatively low cost base, is also held within this category.

Current opportunities

The managers continue to identify good-quality companies, with sound long-term business plans, trading at very undemanding valuations, and with the capacity to be tomorrow’s leaders. They have recently added to, or increased existing positions in, companies across each of the buckets and the investment managers highlight:

Hvivo (early-stage): a specialist contract clinical research organisation with a leading position in testing infectious and respiratory disease vaccines and therapeutics using human challenge clinical trials. It has a fast-growing order book and low valuation.

Boku (growth small-cap) is already one of the largest holdings in the portfolio, but the mangers believe the valuation has failed to keep pace with the performance of the business.

Marks Electrical (small/mid-cap compounder): a fast-growing online electrical retailer with a scalable e-commerce platform. The existing position was increased following strong results.

Workspace (recovery/special situations): the provider of flexible offices, an area of the office market that continues to grow. The company has a good-quality asset base and strong balance sheet but trades at a significant discount to asset value. The existing position has been increased following strong results.

Flutter Entertainment (growth large-cap) is a leading global provider of gambling services with a strong track record of sales and earnings growth. It is a scale operator, with a diversified product offering, in a market that is widely expected to grow further. The existing position has been increased on a pull-back in the shares.

Jubilee Metals (natural resources) is a producer of platinum used in catalytic converters, laboratory equipment, electrical contacts and electrodes, platinum resistance thermometers, dentistry equipment and jewellery. The company has put in substantial new capacity, which the managers expect to be reflected in earnings growth over the next two years.

Peer group comparison

HOT is a member of the AIC’s UK All Companies sector, comprising eight member trusts, of which HOT is the smallest. Given there are separate sectors for UK Equity Income and UK Smaller Companies, in reality the UK All Companies sector is home to UK equity funds that do not have a specific income or small-cap mandate. Within the sector, HOT is the only trust that is truly UK and truly all-cap (noting the large percentage in AIM stocks, which come in a variety of sizes, and the broad spread of investments by market cap shown in Exhibit 2).

Looking at the constituents in greater detail, while there is undoubtedly overlap between investment strategies, there are also significant differences in emphasis. As their names suggest, JPMorgan Mid Cap and Schroder UK Mid Cap are mid-cap specialists, while Mercantile invests in small- and mid-caps. Aurora, with a concentrated portfolio of 15–20 stocks, and Baillie Gifford UK Growth Trust, both have a mid-cap bias (c 50% or over), while Artemis Alpha Trust and Fidelity Special Values both have significant (c 20–30%) non-UK holdings.

HOT’s exposure to the weakness of AIM-listed stocks in particular has significantly affected its short-term performance versus the peer group and this has fed through to the long-term performance data, although on a 10-year basis this remains solid and well ahead of the benchmark.

We consider that the above-average discount to NAV on which the shares trade in part reflects the recent performance of the trust and that of AIM stocks in particular. The positive NAV impact of a turn in sentiment for smaller stocks would be reinforced by the trust’s gearing, which is above the sector average. If followed by discount narrowing, this would represent a further benefit to shareholders. As noted above, although focused on capital growth, dividend growth has been strong and HOT provides the second highest yield in the sector.

Exhibit 17: Selected peer group as at 17 July 2023*

% unless stated

Market cap £m

NAV TR
1 year

NAV TR
3 year

NAV TR
5 year

NAV TR
10 year

Ongoing
charge

Perf.
fee

Discount
(cum-fair)

Net
gearing

Dividend
yield

Henderson Opportunities Trust

74.4

(8.8)

19.9

(6.0)

72.5

0.9

Yes

(15.8)

113

3.6

Artemis Alpha Trust

100.4

7.5

10.7

(9.6)

29.9

1.1

No

(13.9)

94

2.0

Aurora

156.7

10.9

45.1

15.0

58.8

0.4

Yes

(12.5)

98

1.4

Baillie Gifford UK Growth Trust

251.0

10.8

5.5

(0.2)

30.7

0.7

No

(14.5)

104

2.2

Fidelity Special Values

860.5

7.8

53.6

19.7

104.7

0.7

No

(8.8)

107

2.9

JPMorgan Mid Cap

185.3

4.2

9.7

(12.1)

68.4

0.9

No

(16.8)

112

3.4

Mercantile

1,537.2

8.9

22.8

7.9

90.1

0.5

No

(15.4)

112

3.7

Schroder UK Mid Cap

181.2

0.9

25.4

6.1

74.4

0.9

No

(15.5)

108

3.6

Simple average

418.3

5.3

24.1

2.6

66.2

0.8

(14.2)

106

2.9

HOT rank in peer group

8

8

5

6

4

3

7

1

3

Source: Morningstar, Edison Investment Research. Note: *Performance as at 17 July 2023 based on cum-fair NAV. TR = total return. Net gearing is total assets less cash and equivalents as a percentage of net assets (100 = ungeared).

HOT’s approach to ESG

Janus Henderson Investors’ fund managers follow a responsible investing framework that does not rigidly exclude either sectors or companies which score poorly on sustainability metrics, but instead tries to understand why some companies score poorly, whether it is material to the investment case and whether the company is improving.

That said, the managers see a role in the HOT portfolio for stocks that contribute positively to environmental, social and corporate governance (ESG), not simply those where there is the absence of a negative. This would include businesses that are involved in the transition to a lower carbon economy, such as clean hydrogen specialist Ceres Power and battery technology company Ilika, as well as those whose activities contribute positively to society, such as Deltex Medical, which manufactures systems to accurately manage blood circulation, reducing the risk of post-operative complications and the length of hospital stays.

For HOT’s full ESG statement, please see its entry on the AIC website.

Additional company information

Fees and charges

Henderson Investment Funds, a subsidiary of Janus Henderson Investors and HOT’s alternative investment fund manager (AIFM) under the AIFM Directive, is paid an annual management fee of 0.55% of net assets. A performance fee (15% of any outperformance of the benchmark) may also be paid, subject to the NAV having increased in absolute terms, with a cap on total management and performance fees of 1.5% of average net assets. Any underperformance versus the index (or any unrewarded outperformance over the fee cap) is carried forward and set against outperformance or underperformance in subsequent years. No performance fee was paid during FY22, and none was accrued in the six months to 30 April 2023 (H123). Excluding performance fees, the ongoing charge ratio was 0.90% in 2022 (2021: 0.87%).

Gearing: Mid-teens level is still broadly neutral

HOT has a £30m unsecured, floating rate loan facility which enables borrowing as and when the company deems it appropriate. It is priced at a margin the SONIA benchmark rate. The board has set a limit on net gearing of 25%. At 31 May 2023, net gearing was 15%. At end H123, net gearing was 14.9% and at 31 October 2022 (FY22) it was 13.9%.

Capital structure

HOT has one class of share, with 7.9m ordinary shares in issue (unchanged over the past 12 months) excluding 0.1m held in treasury. No shares were issued or repurchased during H123 or FY22. The trust is widely held by retail investors, with holdings via the platforms Hargreaves Lansdown, Interactive Investor and Halifax Share Dealing accounting for c 42% of shares outstanding. The volume of shares traded daily has averaged 7,000 over the past 12 months, with c 22% of HOT’s shares changing hands. A stock split being considered by the board would have the potential to enhance liquidity, although its main purpose would be to assist monthly savers and those who reinvest their dividends, or those who are looking to invest smaller amounts (such as younger investors). If the board decides that this is in the best interests of shareholders, it is likely to bring forward a proposal at the AGM in 2024.

A continuation vote is held every three years, most recently at the March 2023 AGM. A clear majority of votes cast (c 76%) were in favour of continuation, although this was lower than in 2020 (99%).

Exhibit 18: Major shareholders at 31 October 2022.

Exhibit 19: Average daily volume

Source: Henderson Opportunities Trust 2022 Annual Report.

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

Exhibit 18: Major shareholders at 31 October 2022.

Source: Henderson Opportunities Trust 2022 Annual Report.

Exhibit 19: Average daily volume

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

The board

Exhibit 20: Henderson Opportunities Trust’s board of directors serving during 2022

Board member

Date of appointment

Remuneration in FY2022

Shareholdings at end-2022

Wendy Colquhoun (chairman)

2018 (2021)

£33,183

2,000

Frances Daley (audit & risk committee chair)

2015 (2018)

£27,976

2,000

Davina Curling

2019

£22,735

800

Harry Morgan

2021

£22,730

1,250

Chris Hills (retired 10 March 2022)

2010

£7,864

4,000

Source: Henderson Opportunities Trust

Board members are all independent and non-executive (NED). Wendy Colquhoun joined the board in 2018 and has been chairman since 2021. She was previously a senior corporate partner at international law firm CMS Cameron McKenna Nabarro Olswang and advised investment trust boards for more than 25 years. She is also a NED of Schroders Mid-Cap Fund and of Capital Gearing Trust. The other current directors are Frances Daley, Davina Curling and Harry Morgan. Detailed biographies can be found in the 2022 annual report.

Janus Henderson Investors provides long experience and deep resources

James Henderson and Laura Foll are supported in the management of HOT by the deep resources of JHI, with its long and broad-ranging experience in active equity management. JHI has c £150bn of equity assets under management, with investment and research capabilities across a wide range strategies, sectors and styles. The investment team comprises more than 150 equity investment professionals, with an average of approximately 20 years’ financial industry experience, including specialist teams focusing on key sectors including healthcare, technology and energy. All JHI’s investment professionals, whatever their particular focus, combine insights gleaned from company meetings, generating the proprietary knowledge, which enables them to generate the original, independent views that shape investment strategy across the company. Specifically in relation to HOT, Henderson joined the industry in 1982 and the company in 1984, and Foll joined the industry and the company in 2009. They are both members of the JHI global equity team and work closely with the UK smaller and mid-sized companies teams.


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General disclaimer and copyright

This report has been commissioned by Henderson Opportunities Trust and prepared and issued by Edison, in consideration of a fee payable by Henderson Opportunities 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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