Henderson Opportunities Trust — Riding the next wave with stabilisers

To help investors make sense of the trust’s broadly diversified, all-cap portfolio, HOT’s managers have moved past the basic distinctions of small-, mid- and large-cap, instead classifying their holdings into one of six ‘buckets’: early stage, small-cap growth, small- and mid-cap compounders, large-cap growth, recovery/special situations and natural resources (see chart on page 1 for weightings). To clarify the process even further, Henderson and Foll now group the buckets under two broad headings: ‘tomorrow’s leaders’ (the three small/mid-cap buckets and recovery/special situations) and ‘stabilisers’ (large-caps and, currently, 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. Henderson and Foll argue that this is an important discipline, since the highly cyclical nature of energy and materials stocks means it is not always immediately clear when the ‘wrong’ time to own them becomes the ‘right’ time, adding that in the current environment of high commodity prices, it is essential to be exposed to the producers, and not just the consumers, of such resources.

Looking at HOT’s top 10 holdings (Exhibit 1), natural resources companies (currently marginally over the 5–15% indicative range) are well represented, with large-cap mining stocks Anglo American and Rio Tinto (share prices each up c 10% so far in 2022) playing second fiddle to AIM-listed oil and gas operator Serica Energy (up c 36% year to date), currently the largest position. Despite the strong gains in Serica’s share price between December and mid-April (it has recently fallen back somewhat), it remains on a very low forward P/E of 2.0x, because the high price of gas in particular means its earnings per share are forecast to be very high, at c 166p on a share price of c 330p. Henderson explains that, counter to the general view that a low P/E = good value, with resources companies, the time to buy is usually when the P/E is high, because the cyclical nature of the business means that earnings are due to recover from a low base.

HOT is more than just a natural resources play, of course; indeed, more than 85% of its portfolio is invested elsewhere, with the three largest sector exposures at 30 April 2022 being in industrials, financials and consumer discretionary (Exhibit 2). Many of the financials holdings also come under the ‘stabilisers’ umbrella, including the three high street banks in or near the top 10 (Barclays, HSBC and NatWest). While these were an important contributor to HOT’s strong performance in FY21 (to 31 October), they have done less well recently (HSBC excepted), as soaring inflation and the war in Ukraine have dampened hopes for continued global economic recovery.

The core of the portfolio, however, is in ‘tomorrow’s leaders’, which currently make up around two-thirds of the total, although this could go as high as 85%. Henderson and Foll currently see fewer attractive opportunities in the growth small-cap area (which is at the bottom of its allocation range), given valuations are somewhat stretched, and they have reduced some long-standing positions in companies such as mobile payments specialist Boku and railway software firm Tracsis, although both remain in or close to the top 10 holdings. Of the allocation ranges, Foll comments: ‘The indicative ranges are meant to challenge us to think “is there a good reason we are lower or higher?”. We will of course continue to look for attractive small-cap growth companies, but we are not forced to.’ While growth small-cap valuations are on the high side, the managers comment that small and mid-cap compounders have derated significantly year to date, with translation specialist RWS Holdings down c 44% (hindered by fruitless bid speculation) and corporate advisory group K3 Capital off by c 34%. Early-stage companies have also had a rough ride, including in the fuel cell space, with the share prices of Ceres Power and AFC Energy – two of HOT’s top performers in FY20 – having declined by c 33% and c 45% respectively so far in calendar 2022. ‘We might have trimmed some of these positions, but we ask ourselves are valuations at a point where we would want to add back to them’, says Foll.

Indeed, the managers have added to the holding in AFC Energy in recent months, along with acetylated wood producer Accsys Technologies (growth small-cap), Scottish housebuilder Springfield Properties (compounders), defence company Babcock (recovery), Direct Line Insurance (growth large-cap) and Shell (natural resources). This serves to illustrate the breadth of the portfolio, with individual opportunities existing in each of the buckets even where some categories may look unattractive at the aggregate level.

‘We are looking for good strong companies on a longer view, and the diversity is important’, says Henderson. ‘The UK market is still relatively cheap and we believe earnings growth will surprise on the upside. We are trying to use the volatility and buy on the “red” days. The market is adjusting to a move up in bond yields and a change in interest rate expectations; we might have expected there to be more weakness, but so far it has mainly been in the areas that have been really strong and are highly valued.’

After a stellar year in the 12 months ended 30 April 2021 (NAV and share price total returns of 80.4% and 121.1% respectively), HOT has had a tougher time in the following period, posting absolute declines in both NAV and share price terms (Exhibit 4). Taking the two years together, the trust’s NAV and share price (total returns of 75.6% and 65.3% respectively) have still outperformed both the broad UK market (+36.7%) and the Numis Smaller Companies + AIM index (+44.1%), while narrowly beating the mid-cap index (+73.8%) in share price total return terms but slightly lagging it on an NAV basis.

30 April is HOT’s half-year end and, in the past six months, the effects of higher inflation and commodity prices, the spectre of recession and the war in Ukraine have all had an effect – for good or ill – on the share prices of UK companies. Bigger companies have performed better than small and mid-caps over this period, with the CBOE UK All Companies Index (c 80% large-cap) gaining 3.7% but the mid-cap CBOE UK 250 and Numis Smaller Companies + AIM indices declining by 10.9% and 11.2% respectively. HOT outperformed both these indices, albeit with negative NAV and share price total returns of -9.8% and -9.5% respectively. Given the magnitude of the share price falls in some of the trust’s major holdings (see previous section), the relatively muted decline illustrates the benefit of HOT’s allocation to ‘stabilisers’ in the form of larger companies and, particularly beneficial in recent times, natural resources stocks.

As shown in Exhibit 5 (right hand chart), despite the recent reversals, HOT has a solid longer-term record of outperformance versus the broad UK stock market, with annualised share price and NAV total returns of c 8–13% over three, five and 10 years, compared with c 4–7% pa for the CBOE UK All Companies Index over the same periods. The trust also has a good longer-term track record versus its peers in the AIC UK All Companies sector (Exhibit 6), being at, or near the top over three, five and 10 years and still ahead of the average over one year, a period in which eight of the nine funds have seen negative total returns. HOT also has an above-average dividend yield in the sector, yet persistently trades on one of the widest discounts to NAV.

Given there are separate sectors for UK Equity Income and UK Smaller Companies, the UK All Companies sector in reality is home to UK equity funds that do not have a specific income or small-cap mandate. Looking at the constituents in greater detail, JPMorgan Mid Cap and Schroder UK Mid Cap, as their names suggest, are mid-cap specialists, while Mercantile invests in small and mid-caps. Aurora and Baillie Gifford UK Growth both have a mid-cap bias (c 50% or over), while Artemis Alpha and Fidelity Special Values both have significant (c 20%) non-UK holdings. Independent Investment Trust, while broadly spread by size, has c 6% ex-UK and c 17% in cash (all data from AIC/Morningstar). This leaves HOT as the only trust in the sector that is truly UK (over 98%) and truly all-cap (see Exhibit 3, noting the large percentage in AIM stocks, which come in a variety of sizes), perhaps suggesting that it should be a more obvious choice for investors seeking a ‘good mixer’ to sit alongside more pedestrian UK or global holdings.