Acorn Income discount widens as investors retreat from small-cap – Acorn Income (AIF), the UK-focused small-cap equity and fixed-income trust, discusses the difficulties it faced in 2018 and the outlook for its strategy, in its annual report published today, covering the year to December 31. The company invests in two portfolios – smaller companies (70-80%) and income (20-30%).
Chairman, Helen Green, had this to say: “The NAV total return of the company’s ordinary shares in 2018 was -16.9%. Whilst this was disappointing, the UK market in general and smaller companies in particular suffered under a difficult global macro backdrop and the ongoing uncertainty of a Brexit resolution; the total return on the All-Share Index and the Numis Smaller Companies (ex-investment companies) Index was -9.5% and -15.4% respectively. The share price total return was -23.7%, reflecting a significant widening of the discount during the year. The fall in share price total return comprises two elements – a reduction in the value of the assets and a widening of the discount.”
We note that the fall in the discount, from 5% to over 13% at year-end reflected the more pessimistic view taken on UK small-caps.
Brexit and smaller companies
Discussing her view on Brexit’s impact on the company, Helen added: “The board has carefully considered the potential impact of Brexit on the company. We have noted that domestically focused UK smaller companies could be exposed to weaker consumer demand and higher input costs from imported goods that might arise from a badly managed Brexit. However, these concerns are already to a degree discounted in the current valuations of UK smaller companies and our investment adviser remains in close contact with our investee companies to assess the impact of any ultimate Brexit scenario on their trading prospects.”
Portfolio view
Simon Moon and Fraser Mackersie, the smaller companies managers, drew attention to the value opportunity created by the broad-based dislike for UK small-cap in 2018. “Negative returns from other holdings were generally driven by de-ratings on market sentiment rather than stock specific issues. The extent of this derating was stark with the average price earnings multiple on the portfolio falling by some 18% over the year, as such the portfolio now sits at far more attractive valuations than it did at the beginning of the period.
This was clearly a challenging period for the portfolio as a combination of negative market sentiment and one major stock specific issue combined to generate a disappointing negative total return, albeit ahead of the portfolio benchmark. Despite this setback we remain confident with the long-term prospects for our investee companies. The continued growth in dividends received during the year provides further confidence in the strength of the portfolio and the derating experienced over the year positions the portfolio on an attractive valuation.”
AIF’s fixed income manager, Paul Smith, discussed how the fund is positioning itself give the prevailing macroeconomic and monetary environment, saying: “Against this backdrop, the outlook for credit valuations still feels challenged, especially if slower growth and lower corporate earnings transpire. We maintain that long dated/high duration (a measure of bond price sensitivity to changes in interest rates) credit will continue to be volatile and vulnerable to further capital losses and prefer to maintain more modest duration exposure in instruments which we feel have better risk-return characteristics.
Examples of bonds which fit this criteria and have the benefit of adding some global exposure away from the UK include Wells Fargo bonds which mature in 2022 and Fidelity international bonds maturing in 2024 which both have an attractive yield relative to an equivalent gilt. Hybrid bonds issued by telecoms company Orange have an attractive yield to call in 2023 which we feel the company is likely to exercise.
We also hold protection against rising US inflation Whilst inflation in the U.S. has fallen, some members of the U.S federal reserve have suggested that it is considering letting inflation run hotter in some periods to balance out periods of undershooting and this should mean that inflation risk needs to be priced higher. Markets also seem too complacent that falling inflation is a foregone trend especially as wage growth continues to rise and could work its way into higher output prices as companies look to sustain margins.”
AIF: Acorn Income discount widens as investors retreat from small-cap