The Times - Cycle turns again towards Smithson Trust

Will rising inflation mean that technology stocks are set for a bumpier ride? According to Simon Barnard, the Smithson Trust asset manager, “yes, that’s possible”. But he is sanguine about any long-term threat to earnings for the companies in the FTSE 250 constituent’s portfolio, which attributes almost half its net asset value to businesses within the information technology sector.

Perhaps he is right to be. In the face of rising market volatility that has greeted the new variant of Covid-19, the recovery in cheaply valued stocks most affected by pandemic restrictions has come to an abrupt halt. There’s a chance that companies priced for high earnings growth are again perceived as safe havens.

Smithson was launched in 2018 by Fundsmith, the fund manager, to replicate the approach taken by its chief executive, the famed stockpicker Terry Smith, via his open-ended equity fund. The difference between Smithson and the Fundsmith trust is that it focuses on globally listed small and medium-sized companies, with a market cap of between £500 million and £15 billion at the time of initial investment. The theory is that smaller companies have greater scope to increase earnings and are less well-covered by analysts, which leaves the potential for a discrepancy between the share price and valuation. The flip side? In bad times, a relatively lower level of liquidity in the shares means that the value of those companies can oscillate more wildly.

Smithson seeks to invest according to three main tenets: “buy good companies”; “don’t overpay”; and “do nothing”. It tries to buy stocks that have a high and sustainable return on invested capital and to hold them for an average of ten years-plus. It eschews companies with a high level of debt or that rely upon leverage to generate an adequate return, as well as those operating in rapidly changing industries.

That gives it a pretty narrow scope. Commodities are out, as are the asset-rich and highly indebted utilities and telecoms sectors, as well as real estate and financial services. Instead, it picks technology, healthcare and consumer goods groups with intangible assets, brand names or patents that give a dominant market position or services that are difficult to replicate. Top holdings at the end of last month were Rightmove, the online property portal, Fortinet, an American cybersecurity group, and Fevertree Drinks, the posh tonic maker.

It might have a high level of exposure to the IT sector, at 45 per cent of NAV, but some of those companies have very distinct markets that make them more akin to other industries, Barnard said. Cognex, for example, makes sensors and software used in manufacturing by customers ranging from the automotive and electronics industries to medical devices and healthcare. When Smithson talks about investing in technology, it doesn’t mean loss-making companies in their early stages but those with a track record of generating a decent profit.

Amid the shift in taste towards stocks with beaten-up valuations — think financial services, oil and gas and travel companies — the trust underperformed its benchmark, the MSCI World Small and Mid-Cap Index, during the first six months of this year, the first time it has done so. Since its launch, it has generated a share price total return of almost 94 per cent, versus just under 46 per cent by the benchmark. Unsettled markets led Barnard to top up holdings in tech stocks that were sold off in the past couple of weeks. A narrowing of the share price premium to NAV of just 0.3 per cent means Smithson now holds value.

ADVICE: Buy

WHY: The trust has a solid long-term performance record and could generate superior returns to the index amid continued market volatility.