Transcript of audio recorded on Tuesday 28th April 2020
Podcasts from Aberdeen Standard Investment Trusts - invest in good company.
Interviewer: Hello and welcome to the latest in our podcast series where we look at how the managers on the Aberdeen Standard Investment Trust range are handling these complex and unpredictable markets. Today we're talking to Abby Glennie manager of the Aberdeen Smaller Companies Income Trust. Welcome Abby. Could we start by looking at the impact of the measures to curb the spread of the virus on smaller companies? It seems to me that the market’s assumption is that smaller companies are particularly vulnerable, but are you seeing that reflected among the companies in your portfolio.
Abby: So I think the impacts really depend on the nature of the business and in particular what sector it's operating in. So some of the investments in the portfolio have seen operations which have been incredibly resilient. So, for instance, businesses like Assura, whereas others have been more heavily impacted by the lockdown. So an obvious example would be Hollywood Bowl. And I think the market sometimes has quite generalist views though that smaller companies get hit harder than large companies. And if we look at the market reaction in general, across five categories, we have seen that, and I think that’s actually quite unfair. Often we find smaller companies are more nimble, they can actually adapt their business models quicker and more efficiently than large companies. We can see even if everyone looks in their own lives, we can look at how SMEs in your local community have adjusted. And I think that's a good example of where small companies can be nimble. And the government schemes have been really critical in helping businesses to financially get through this lockdown and putting them in a position where, coming out of this, they can retain the staff employment levels that they need to be in a good position to start up again. The main thing for us would be, because of our quality focus, the portfolio went into this environment with a focus on resilient businesses. Companies with strong balance sheets, cash liquidity, and therefore actually, the level of financial distress that we've seen has been very limited across our companies. They might be small companies, big companies, it doesn't matter, it’s really been that quality focus. We have seen a small number of capital raising, either to get through this period without sort of market concerns about cash flow and liquidity, or actually for some of them, just in terms of being able to continue on their growth plans, post lockdown period.
Interviewer: Okay, and I mean, presumably, you're in regular contact with the companies in your portfolio. Is there a mood music to how they're feeling about this period and their sort of immediate future or is it so sector dependent that it's very difficult to kind of draw generalisations?
Abby: I think it is very sector dependent. But I think the key thing I would characterise is just levels of uncertainty. And because no one really knows when or how we're going to come out of it. And it does feel that that will be quite sector dependent. And in the past, I think we're week five or six now of working from home lockdown, we've had a huge number of meetings with companies that we invest in, and also a lot of interaction with sell-side analysts. And we have seen most companies utilising the government help schemes in some way. I would say in particular the furlough scheme. One side effect of the increased focus on cash liquidity and balance sheets and the support received by government is that we have seen a lot of dividend cancellations across the market. So to some extent, this has actually been irrelevant of the sector or the financial stability, there seems to just be an aspect whereby it’s unacceptable to pay dividends if you're going to ask the government for aid. If we think about sectors I mean, travel and leisure is probably obviously one of the most impacted sectors, those companies are seeing virtually 100% reduction in activity, meaning no revenue. We've got quite limited exposure here. One company is Hollywood Bowl, which we do have. It went into this with a very, very strong balance sheet but, they have done a small 5% equity raising and extended bank facilities. This means that you know, they're really well placed to get through what could be an extended lockdown for them and still be in a position to get back on the growth aspects coming out of this. I think sectors which have been more resilient have been technology where businesses have adapted well for work at home models. And in many cases, demand for their products and services has remained. Companies like Assura in the property space or Chesnara in insurance, revenue streams there really haven't been negatively impacted. So we're really pleased those types of companies can continue to pay dividends.
Interviewer: You mentioned that some companies you feel have been kind of unfairly treated by the market? Have you taken advantage of that? And indeed does the Investment Trust structure make it somewhat easier to do so? And if so, has that been kind of focused in any areas? Or is it perhaps too early to be making those sort of moves?
Abby: Yeah, so I mean, I mentioned earlier the breadth and depth of dividend cuts and cancellations. I mean, overall this has impacted across the board. Like I said it hasn't necessarily been sector specific because of that reliance on those government schemes. We have reshaped the portfolio a little bit. So we remain long term investors - we don't want to veer away from our quality growth momentum focus. But the hunt for income in this environment has definitely got a bit trickier. We went into this market with cash levels higher than usual in terms of providing some protection in tougher markets. So that means we've been able to increase exposure to some names which we've felt confident about in this environment. So for instance, Softcat is a value add IT re-seller. We’ve trimmed some businesses where we expect to see larger earnings decline and slower recoveries unfortunately. So things like Robert Walters workspace. And we have taken this opportunity as well to add new holdings to the fund where we feel optimistic about the quality growth momentum aspects, but also the income resilience. And so Primary Health Properties and Target Health REIT - both of those have been added where we think there's strong investment cases. The other thing we've been able to do is that, in this fund we have the ability to have fixed income exposure. And in this environment, we think there's a big income support for that, as well as these investments having their own structural investment cases. So we have been adding a handful of new holdings there, well diversified across sectors. I would say the other thing, I mean, you mentioned about the structure of the investment trust obviously. I mean, running closed-end vehicles here means that the manager doesn't have to focus on the risk of outflows, and you're thinking about cash to fund what those might be. Having said that, our corporate team, we really haven’t actually seen outflows which has been very pleasing. And I mean, I think the thing for clients about the investment trust space is that the market has obviously had a really sharp reaction. So we've seen that discount really widen out and investors who are willing to take a longer term view, hopefully, you know, at this sort of discount level we can provide an attractive entry point.
Interviewer: Okay. I know in previous discussions, you’ve talked about your matrix tool that helps shape your, your views. I wonder if you could just explain quickly what that is and what it's telling you today?
Abby: Sure, so the matrix is our stock screening tool. It's a core part of our process. And this is our internally developed tool that we've used for well over 20 years now within the team. It's really focused on looking at data which fits our quality growth momentum investment process and it helps us screen that wide addressable market that we have. Now, we do continue to use the matrix in this environment. But it’s fair to say that in times of sharp market correction, there's more uncertainty about forecasts in the market, and therefore some of the data that’s out there. So I think, you know, fundamental stock analysis and engaging with companies is really always core to any of our investment decisions. But I think at the moment that's become even more so. Within the matrix, the sort of quality factors, I think are increasingly important at the moment. The data for those is much more long term data. It doesn't have the same volatility. And so I think we feel very comfortable continuing to rely on that. And also, I think that in this sort of market environment, quality aspects will increasingly be well rewarded by shareholders.
Interviewer: Okay, it may, it may be too soon to consider recovery. But I guess gradually the picture does become clearer as more and more data points come into play? Do you have any sense of whether the companies in your portfolio will be able to pick up where they left off when the dust settles? And what sort of a recovery we might be looking at?
Abby: I mean, I think we feel confident that a lot of the companies we invest in will be in a strong position coming out of this. And, you know, especially financially balance sheet wise because of that quality focus. But I think when we think about areas like consumer confidence and economic growth, it just feels incredibly hard to judge at the moment. We could be faced with a long period of tough environments. A lot I think it is dependent on what happens with some of the government support schemes as well. So companies, for instance, are very dependent at the moment on that furlough scheme, and how the government tapers that off and helps companies to manage that sort of cash burn I guess, once they're getting up to full operations again, is going to be critical. I guess the other field of points I should probably mention on that would just be that, going into this we were already cautious that we've been in a very long bull market and 2019 definitely showed signs of slowing economic growth already. I think one of the things that have come to my attention increasingly in this environment is just the benefit of investing in what we believe are high quality management teams. We’ve seen that as we've been engaging with these companies through the past couple of months, and we've seen the strategies and leadership that they provided, you know, I think those high quality management teams are coming through on their own. So a good example, I said Hollywood Bowl did a capital raise. In that meeting we talked through a lot of the actions that they took both before and around the period of lockdown, which should mean that actually in terms of trading and operationally when they're permitted to reopen, they're in a very, very strong position to do.
Interviewer: How are you judging that ahead of time? Because, I mean, presumably, any kind of crisis, you're never quite sure how a management team will behave until they get there. But are you making sort of working assumptions based on a team's previous experience, whether they've delivered and that sort of thing?
Abby: Yeah, I mean, I think that management quality is always one of our key focuses. Investing in a high quality management team tends to be something that's easy to say you do, but actually, in practicality is much more challenging. We've got long relationships with a lot of these management teams and I think we're very lucky that we tend to meet all of our companies face to face. I mean, obviously, at the moment, face to face isn't really possible but we have built up relationships with them over the years. And a lot of these companies as well, you know, we will have owned in some portfolios for many, many years. So it's been an ongoing engagement, but has seen how those management teams have reacted I guess. I mean we have seen lots of different market environments. This is probably the sort of sharpest change anyone's ever seen, but we have experience on how that have handled different situations previously. And then I think at the moment, our engagement with them is sort of critical in terms of also, you know, the next step up of how quickly they can adapt business models. So I think that's going to teach us something as well going forward, you know, about the quality of different management teams.
Interviewer: And how are valuations looking today? I mean, quite often small caps have traded at a as a small discount to the large caps, but where does that large, mid, small, kind of relative valuation fall today?
Abby: Yeah, so if you think about the UK market as a whole lot at the moment, I mean, going into this, because of Brexit and political uncertainty, you know, UK equities as a whole hasn’t been a place that investors have been that optimistic or buoyant about in recent years, actually, in terms of inflows that we've seen to that area. Even though we've seen strong markets, actually, when we look at the relative valuations of UK equities, I think already compared to other regions, they were pretty attractive levels. And what we've seen in this environment is that, sort of all regions have been challenged by this COVID-19 situation. So, you know, we’re definitely not on our own here. But in that way, I think when we look at valuations now, compared to other markets, I think they look attractive, but the challenge is that the outlook for earnings is still very uncertain. But I think that's true across all regions. If we look at, and think about P/E (price to earnings) ratios of the market, unfortunately the one number that we really don't have certainty about is the earnings number. But we would encourage people to be long term investors. And, you know, historically, if you've been an investor in any of the portfolios within our team, we’ve shown that we really encourage you to not try and time the market and to be long term investors in our funds. And, I mean, if there's any insight that we have, I guess from the global financial crash would be that actually, that was a good entry point for a long term investor. So if you think that this environment is anything similar to that in terms of market correction, hopefully this is an attractive entry point.
Interviewer: Great. Okay. Thank you, Abby, for your time today and thank you to all our listeners for tuning in. You can find out more about the trust at www.aberdeensmallercompanies.co.uk. Please do join us for future podcasts.
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