Finding hidden gems among smaller investment trusts

It seems that big is increasingly beautiful for investment companies, with recent years seeing growing pressure on trusts to become larger and more liquid.

The most successful now have net asset values (NAVs) in the billions of pounds.

PLC (), by far the largest, has a NAV of around £17bn and is firmly in the FTSE 100.

In the layer below, PLC (), PLC (), PLC (), PLC (), (), (), The Renewables Infrastructure Group Ltd (), Tritax Big Box PLC () and   Ltd () all have NAVs above £3bn, and there are around 50 more ICs with NAVs of between £1 and £3 billion.

Why should size be considered advantageous? Most obviously, greater market capitalisation provides greater liquidity, which makes it easier for large wealth managers – where so much IC investment is now concentrated – to deal successfully.

READ: Using investment trusts to invest in Big Tech

As Priyesh Parmar, associate director at broker Numis, explains: “Trading liquidity is one of the most challenging issues facing the investment companies sector, particularly as wealth managers have consolidated in recent years and make increasing use of centralised buy-lists.”

Andrew McHattie, in his excellent new book Investment Trusts – A Complete Guide, puts it succinctly: “For wealth managers and institutions needing to deal in larger blocks of shares, it can be extremely frustrating if the normal dealing size is too small to accommodate those needs.”

McHattie points out that in 2010 the minimum size of trust workable for a wealth manager was considered to be £50 million; now it is £200 million. Yet around 45% (by number) of the closed-ended universe of around 400 companies are worth less than £200 million, according to Numis.

Such small investment companies never make it on to the radar of most institutional investors, and many are trading on wide discounts as a consequence.

READ: Which stocks, investment trusts and funds are people adding to their ISA and SIPPs?

There are further benefits to being big. Large companies can tap into economies of scale as they’re able to spread fixed costs – such the fees for auditors and directors or the printing of the annual report – over a larger asset base.

Dealing spreads also tend to be smaller for larger, more liquid and more widely traded companies.

Again, smaller, relatively illiquid peers lose out.

The upshot is that big, successful companies tend to get bigger, while those small funds “that are undifferentiated from their peers and limited in scale need a strategy for growth or improvement if they are to survive”, according to Numis’s Ewan Lovett-Turner.

Some boards have simply wound up in the face of that pressure: AIC data shows 20 companies were closed in 2020.

But not all small investment companies are anxious to grow. For those investing in niche areas with limited investment capacity, such as micro caps, there can be disadvantages in being too large.

The best example of ‘deliberate smallness’ among the handful of micro cap ICs is River & Mercantile UK Micro Cap (LON:RMMC), which runs a concentrated portfolio of around 40 companies and has limited its size to £100 million ever since its IPO in 2014.

George Ensor, manager of the company, sets out the rationale behind this approach: “Contrary to both the broader trend for larger trusts and the commercial incentive of running a larger trust, the size of RMMC is limited because we believe it will enable us to deliver higher returns to shareholders.

“We look to invest in a part of the market – companies with a market capitalisation of less than £100 million – which is often overlooked by others. It is challenging for larger funds to gain significant exposure to these micro-cap companies.

“The constraint on the size of the trust is really a result of the size of the companies we are investing in and the number of…