The economic outlook, both globally and in the UK, remains deeply uncertain. The war in Ukraine grinds on, tensions between the West and China remain elevated, inflation remains stubbornly high and central banks around the world continue to raise interest rates.

Domestically, inflation in the UK has dropped back from its peak of more than 11% in August 2022, but it has not fallen as fast as many had hoped. As a result, the Bank of England has signalled that it will continue to raise interest rates, leading many to forecast a recession for the UK economy. This has sparked volatility in all corners of the market, making uncertainty the new normal.

In such an environment, being selective about your investments is key. At the Henderson Smaller Companies Investment Trust, we believe that true active management will navigate you through challenging periods. Yes, there are many economic risks and challenges, but not all companies are equally exposed, and some are extremely well-placed to thrive in current environment. Active management is all about selective discernment, shutting out the noise and finding the hidden gems amongst the volatility.

It is a strategy that has served us well. Total share price returns over the last 10 years are 142% , well above our benchmark and the FTSE All-Share Index.

Selecting for excellence

The current economic and market environment is ripe for stock pickers looking for hidden gems that have been caught in the indiscriminate sell-off we have experienced over the last few years and are being overlooked by the wider market. And there are certain qualities we look for in these businesses.

We look for strong franchises – quality products, loyal customers and a valuable brand are all essential if a company is to weather tough economic conditions and grow while other businesses struggle. A sustainable competitive advantage is also key – a company with a dominate or fast-growing market share, a strong unique proposition, patented intellectual property or some other factor that gives them an edge over rivals

Within these strong franchises, we also look for skilled management teams that can grow the business and can navigate challenging market environments. A strong management team will ensure that its goals and objectives are aligned with its long-term growth and can generate sustainable revenues.

Another crucial factor is a healthy balance sheet or strong financials. Interest rates may soon peak and begin to fall once again, but they are still likely to settle at a level far above the historic lows that have been typical for the last decade or more. Companies that have depended on cheap borrowing and have high debt levels will be at risk. Those with low levels of borrowing, cash deposits or valuable tangible assets are not only less exposed to higher interest rates, but they also have the financial firepower to invest for growth.

These criteria are the starting point. Detailed analysis and research are then essential to pick out those individual businesses that not only meet these core criteria, but which have that extra factor that makes them a hidden gem of value.

The pick of the crop

Our most successful investments in recent years include Watches of Switzerland, a leading retailer of luxury watches and jewellery in the UK and US. The group has a 40% share of the UK luxury watch market and 10%+ share of the US luxury watch market. Over 50% of revenues are generated from the sale of Rolex watches. In addition to driving sales densities across existing stores through improved marketing and stock availability, management’s growth strategy is centred around expansion in the US and Europe where there is significant potential for market share gains.

Another success has been Oxford Instruments, a manufacturer of scientific and technical equipment with significant sales in the healthcare and medical sectors. Oxford Instruments’ prominence in the Henderson Smaller Companies’ portfolio has grown steadily over the years and in recent months has become a top contributor to performance.

Over the last year, we have added several investments we see as undervalued opportunities including GlobalData, a data analytics and consulting company that provides unique data, expert analysis, and innovative solutions to companies in the world’s largest industries. Another addition has been Ergomed, a company dedicated to the provision of specialized services to the pharmaceutical industry and the development of new drugs. It has provided clinical development, trial management, and pharmacovigilance services for 300+ clients, from top 10 pharmaceutical and generics organizations to small and mid-sized drug development companies. Meanwhile, we have also added Morgan Advanced Materials, a manufacturer of advanced ceramic and composite products used in industries from steel to electronics.

In the current uncertain economic environment, stock picking is the key to maintaining a successful portfolio. Quality products, strong market positions, strong balance sheets and ambitious and capable management – these are the characteristics that deliver for investors. At Henderson Smaller Companies Investment Trust, we have been following this approach for years and have outperformed the market as a result. Today, in the wake of recent crises, many high-quality smaller UK companies are significantly undervalued. It is an opportunity we do not intend to miss.

Past performance does not predict future returns.

References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.

Not for onward distribution. Before investing in an investment trust referred to in this document, you should satisfy yourself as to its suitability and the risks involved, you may wish to consult a financial adviser. This is a marketing communication. Please refer to the AIFMD Disclosure document and Annual Report of the AIF before making any final investment decisions. Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Tax assumptions and reliefs depend upon an investor’s particular circumstances and may change if those circumstances or the law change. Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment. We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

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¹ Source: Henderson Smaller Companies Trust – Factsheet