Montanaro UK Smaller Companies (MTU) fund manager Charles Montanaro says the “value” headwinds blowing against the company’s quality growth style and depressing its returns won’t last forever.

The question is, can the 30-year-old investment trust afford to wait for a revival in its founder’s tried-and-tested approach to stock picking?

MTU’s long-term performance is highly impressive. In the three decades from launch until 31 March this year it made a 854% total return for shareholders, way ahead of its benchmark’s 571% return.

However, the past five years have proved more difficult with rising interest rates and inflation more favourable to the “value” style of buying cheap, cyclical stocks rather than paying up for more highly valued growth companies. That combined with a domestic investor exodus from UK equities has depressed valuations with MTU shareholders sitting on a 3% loss even with dividends included. In our report on the company this summer we compared it to a “coiled spring” waiting for the rebound.

Board buys back 50.5m shares

Interim results last week, however, showed what has become a familiar pattern of underperformance by Montanaro’s 46-stock portfolio in recent years. It achieved a total underlying return of 8.4% in the six months to 30 September, half the growth in the Numis Smaller Companies + AIM index which returned 16.9%, led by the value stocks the fund manager avoids.

Unfortunately, the shares did worse. Lack of investor demand saw the trust trail at an average 10.2% below net asset value (NAV). As a result, shareholders saw a total return of 5.4% in the first half of its 2026 financial year.

That gap between share price and NAV is an improvement on the 11.9% average discount the trust traded at in the previous financial year to 31 March. It has since narrowed further to 7% but that gain has come at the cost of an enormous share buyback programme by the board that is rapidly shrinking MTU.

The interim accounts show the trust spent £16.5m repurchasing 16.4m shares in the six-month period. That is the tip of the iceberg, however. Stock market filings show that the trust began buying back its shares on 27 January after activist hedge fund Saba Capital emerged with a 12% stake in the company in December.

From that point until last Friday, it bought a total of nearly 50.5m shares or 30% of the stock it started with. That has shrunk its market value which now stands at £115m, down from £172m in January.

It is worth reiterating that this decline isn’t the result of a slump in the share price. The company bought back its first shares in January at 103p. They stood at 98.2p on Friday in it latest of 165 transactions this year.

In a flat year for performance, the company appears to have shrunk by £57m through buybacks. It also hiked its dividend last December, increasing the quarterly payout to 1.5% of assets or 6% a year.

Saba’s in and outs

Saba appears to be the main beneficiary as it buys in when discounts are wide and is bought out by the board on a tighter valuation, providing it with a turn.

MTU bought Saba’s 19.9m initial share holding on 5 March at around a 7% discount, keen to get the activist off its register in case it became hostile like it did in the New Year when it tried and failed to oust the boards of seven investment trusts.

That sale back to the company would likely have generated a good gain if the US hedge fund bought in on wider discounts a year ago.

At the end of last month, Saba returned with a 5% position, having seen the discount widen to over 11%. It made a quick exit, selling the position on 17 November when MTU bought back another £6.3m shares.

Saba is likely to be back again in future unless investor demand returns and MTU shares start to re-rate and move closer to the value of its assets. If that happens, in response to an overdue improvement in sentiment towards UK equities, then all the repurchased shares that the board is holding in treasury could start to be re-issued.

Good, long-term stocks

When that will be, Montanaro doesn’t know, refraining from calling a turn that has been absent since 2020. Until then it appears the board will keep on buying and the trust will continue eating itself.

“What we can say is that the companies we own are, in general, performing well. Balance sheets are strong, margins are being defended, and management teams remain focused on long-term growth rather than short-term noise. When the market begins to look past the latest fashion and returns to fundamentals, we believe MUSCIT [the acronym the manager uses for the trust] will be well positioned,” said Montanaro.

The trust retains at least one big long-term investor. The West Yorkshire Pension Fund emerged with a 7% stake on the same day as Saba recently exited, suggesting it may have bought some of the activist’s shares.

MTU needs more shareholders like this. Buying back cheap shares is good governance and improves returns for shareholders, but if prolonged, buybacks can make trusts unattractively small to institutional investors, exacerbating the pressure on the discount, and also damaging liquidity in the trust’s shares, making them harder to buy and sell in large quantities.

Of course, MTU is hardly alone. The whole investment company sector is also contracting with UK-listed funds buying back a record £8.6bn of shares so far this year as average discounts stick at around 13%-14%.

While other trusts are repurchasing big quantities of their shares, the problem for MTU is that it is getting close to the £100m mark below which it will fall off the radar of some professional investors. That will make Montanaro’s job of returning MTU to its previous winning ways all the harder. The fund manager and his loyal shareholders could really do with the Budget tomorrow announcing reforms to incentivise investment in the UK stock market.