M&A is Exciting the UK Small-Cap Market

International firms' acquisitions of UK small-cap companies is an exciting current theme within the sector, says Henderson Smaller Companies Trust manager Neil Hermon

Holly Cook 10 November, 2015 | 1:37PM
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Holly Cook: Hello, and welcome to the Morningstar series 'Why Should I Invest With You'. I am joined today by Neil Hermon, he is the manager of Henderson Smaller Companies Trust (HSL). 

Neil, thanks for joining me. 

Neil Hermon: Good morning, Holly. 

Cook: So as you're investing, looking for attractive UK small caps, are there any specific themes that are sort of exciting you as we are coming towards the end of 2015? 

Hermon: I think one of the themes that certainly is playing out in small caps currently is potential for M&A activity, mergers and acquisitions. Certainly, we're in an upcycle for that and it was a very fallow period post-financial crisis. But given that interests are very low, debt is cheap, growth is difficult to achieve, what we're seeing is a number of overseas corporates look to buy in the UK market. We’ve seen a number of bids for companies in our portfolio in the last 12 months, we think that continues into 2016. 

Cook: Okay. And then if we look sort of more specifically at your process, I understand you have quite a disciplined process, what is it that you are specifically looking for in those stocks? 

Hermon: As you said, the process has been consistent now for the last kind of 13 years in my period as manager of the trust. We essentially have a growth bias portfolio. We are looking for companies that can grow over the longer term. We look for certain companies or certain characteristics in the companies we invest in, around a sound business model, a strong management team, a good balance sheet, strong cash flow characteristics and strong earnings growth. I'd like to add the fact we are very long-term in our approach, average holding period is over five years. So it's a high conviction portfolio and on a long-term basis. 

Cook: As you say, you've been managing the fund now for 13 years, and typically it has outperformed its peer category average. But of course, it is a bit of a bumpy ride and you would expect that with small caps, but I'm wondering how much of a role does gearing play in that volatility? 

Hermon: As you said, performance has been strong. I think if you look at the returns over the last 13 years, it's about 17% compound, which if you multiply that up is about a 700% rate of return. So it has been a strong performance period for the trust overall. Gearing has played a part in that performance. Clearly with a rising market, gearing is a positive. We flex gearing depending on our view on the overall markets, our kind of macro perspective. So, currently, we are around 8%, 9% geared, which reflects our positive view in equity markets going forward. 

Cook: Well, Neil Hermon, thank you very much for sharing your views with us today. 

Hermon: Thank you. 

Cook: For Morningstar, I'm Holly Cook. Thanks for watching.

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Holly Cook

Holly Cook  is Manager, Morningstar EMEA Websites