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By Holly Cook | 11-10-2015 01:00 PM

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: 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. 

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.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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