Montanaro UK Smaller Companies (MTU) has published its interim results for the six months to 30 September 2024 which include the announcement of a couple of key changes for the trust. First, with effect from 31 December 2024, MTU will be paying a regular quarterly dividend equivalent to 1.5% of the company’s NAV, amounting to a yield of around 6% annually. Second, MTU’s investment management fee of 0.50% per annum will now be calculated based on net assets rather than gross assets – also with effect from 31 December 2024. The fee change follows discussions with shareholders and, at 0.50% of net assets, remains among the most competitive in the UK smaller companies sector.

Growth headwind remains an issue

MTU provided an NAV total return of 4.2%, underperforming its benchmark which returned 10.6% in comparison; MTU’s discount to NAV narrowed to 12.8% from 15.1%, resulting in a higher share price total return of +7.3%. MTU says that, over the past four years, the dominance in performance of value over growth as an investment style has been a key theme in small cap investing – and it remains as relevant as ever. It adds that the last six months have again posed challenges for growth managers, including its own, as small cap growth stocks underperformed small cap value by more than 7% (and a staggering 78% over four years). MTU’s underperformance of 6.4% over the past six months is consistent with that of Growth over this period. AIM also continued to underperform, lagging the main list small cap by 8% during the period. MTU, which held between 15% and 22% in companies traded on AIM during this period, underperformed its benchmark (inclusive of AIM) by less at -3.4%.

Dividend policy update

MTU’s board last updated the trust’s dividend policy in 2018 when it introduced quarterly dividends amounting to 1% of NAV, resulting in yield of approximately 4% per annum. The rationale was that it offered investors an attractive way to earn regular income and helped to broaden the appeal of MTU’s shares. MTU’s board says that it is aware the interest rate environment has changed considerably since 2018. At the time of the change in the dividend policy in 2018, 10-year gilt yields stood at around 1.3%, which compares to approximately 4.5% today.

MTU’s board wants the dividend policy to continue to fulfil its role of attracting new investors and as a result helping to narrow the discount so, with effect from 31 December 2024, MTU will be paying a regular quarterly dividend equivalent to 1.5% of the company’s NAV, amounting to a yield of c.6% annually. At the current discount of 12.8% the share price yield would be 6.9%. The first dividend payment to be made at the increased rate will be in February 2025.

The dividends will continue to be funded partly from capital reserves and partly from current year revenue. Currently, it is estimated that there are sufficient capital reserves to pay this level of dividend for 28 years even assuming no growth in capital or income in the underlying portfolio companies shares. The board will keep the dividend policy and its impact on the demand for the company’s shares under regular review.

It is important to note that there will be no change to the existing investment policy or to the strategy following the dividend policy change. MTU says that its manager will continue to seek high quality companies that have strong growth prospects for its portfolio and dividend yield will not be a significant part of the investment process.

Investment manager’s review

“While some assume that the summer months are a quieter time for stock markets, with fund managers escaping to sunnier destinations, this is not the case for us. After reducing our AIM exposure through the sale of YouGov and Judges Scientific, we have been actively seeking new investment opportunities. Our universe constantly evolves, with new flotations, takeovers, spin-offs, and so-called “fallen angels” – companies that were once too large for our focus but now fit our scope. Staying active is essential, as we continue searching for the best opportunities. Our work resulted in us investing in several quality companies, including Alpha Group, Gamma Communications, Telecom Plus, Baltic Classifieds and JTC.

“We also participated in the IPO of Raspberry Pi, a Cambridge-based developer of computer boards and computing units serving the Education & Enthusiasts and Industrial & Embedded markets. Founded by Eben Upton in 2008, Raspberry Pi began as a charitable foundation to inspire young minds in computer science, producing credit-card-sized computers priced under £15 for schools. The product line now includes semiconductors, computer modules, and various accessories. With a market capitalisation of approximately £500 million, Raspberry Pi’s size aligns well with our focus and is often overlooked by larger institutions. It began trading on June 10, 2024, at £2.80 per share and is currently around £3.30.

“As we write these lines, the much-anticipated Budget announcement has come and gone. Despite a range of tax increases – including those on capital gains, National Insurance and Inheritance Tax on AIM – the changes were less severe than feared, and we believe smaller companies will adapt.

“Many of these factors are arguably already reflected in current share prices. UK SmallCap valuations look attractive across multiple metrics and, at 15.6x, the Shiller P/E ratio points to the potential for strong returns in SmallCap over the next five years. Earnings expectations are also promising: while SmallCap lagged behind LargeCap in EPS growth in 2022 and 2023, it is projected to catch up in 2024 and move decisively ahead in 2025, with an anticipated 15% growth versus 7% for LargeCap (source: FactSet).

“It feels as though the headwinds of the past three years are finally easing. Disinflation is taking hold, political uncertainties have subsided and M&A activity is picking up. SmallCap as a whole has outperformed LargeCap over the past six and twelve months, suggesting that the worst may indeed be behind us. If SmallCap is entering a new, multi-year cycle of outperformance, MUSCIT stands to benefit – particularly given its current discount of around 13%, which compares to a 3% premium less than two years ago.  And while waiting, shareholders can enjoy a 6% yield on NAV (c.7% based on share price).”