Whenever I sit down with investment trust nerds (like me), I like to play a game. 

I first ask how many IPOs they reckon there’s been since 2023. And, of course, they all collectively say just one – from Ashoka via its new Whiteoak global emerging markets mandate (which has now grown to over £40m). I then smile and say, well, actually, there were two. 

Assuming they’ve not heard of the other one – I’ll come to that in a moment – I then ask them what sector they think would support another IPO. No-one has ever suggested UK small cap equities. I mean, who would say such a crazy thing? It’s famously well-known that…

·       The small cap premium has faded away in recent years

·       The UK small cap market is tiny, under-researched and deeply unloved

·       Many small caps trade on AIM, and the less said about that utterly dismal market, the better

·       If all that wasn’t bad enough, UK small caps are famously supposed to be exposed mostly to the UK domestic economy, and again, the less said about that, the better.

The reality is that the other IPO from the last two years is in fact in the UK small caps sector: Onward Opportunities (ONWD ). 

Its young manager, Laurence Hulse, has had a blowout start to his career running his own fund. To date, performance has been excellent. The fund’s net asset value (NAV) has grown by 27.6% over the last 12 months, according to data from Deutsche Numis. It is second only to Rockwood Strategic, which is up 29.6% over the same period.  

As a result, the fund has steadily grown from £12m at IPO to £33m at present. It is one of the very few trusts on the London market to trade at a premium, currently 5.8%.

But Hulse’s recent success also, I think, helps to knock down some of those shibboleths I listed above: the UK market isn’t a hopeless basket case, that small cap investing isn’t futile, and the UK economy isn’t (entirely) a disaster zone. 

More to the point, many UK small caps do have significant international exposure (more on that later). 

Don’t lose faith in trusts

Talking to the youthful and enthusiastic Hulse is helpful in understanding how the land lies. Take my own slightly pessimistic take on the structural defects lurking within the UK investment trust sector. The lack of IPOs reflects, I would argue, a deep dissatisfaction with the structure of investment trusts among fund groups and fund buyers, especially in the institutional and wealth segment. 

Yet despite all the negativity around the trust structure, Hulse is still a fan: ‘In trusts I trust! They are accessible, transparent, long-standing and robust … much like any good portfolio should be. We wanted to be purely focused on portfolio management and stock picking, which the close-ended nature of trusts supports.

‘The manager is not at the mercy of inflows and outflows, as is the case with open-ended fund structures. This has been so damaging for many fund managers in the past couple of years.’

But Hulse isn’t blind to the structural challenges facing the investment trust market. He recognises that everybody wants large, long-standing successful trusts to invest in for their clients. However few people want to invest before that stage. Unfortunately, this is required to create new successful trusts. 

The irony is most of the trusts that investors love today started very small. But back then, investors were prepared, keen even, to find ways to invest in them at an early stage and back them.

Consolidation stifles innovation

This, in turn, speaks to a risk with the current wave of consolidation amongst funds. It is a necessary corrective, but one that is likely to result in less choice for investors and less innovation, as more and more money gets sucked up by large asset managers, potentially leaving smaller boutiques to fend for themselves or opt for active ETFs. 

Hulse is very much alive to this risk: ‘I am not sure narrower and narrower pools of capital is great for the ecosystem overall.’ 

Significant structural challenges face the London market, but if Hulse had to identify one change that could be made, what would it be?

‘There are many things that need to be fixed, but if I had to pick one, I would pick incentivisation. I think we need to better encourage capital into public markets, in some instances by just giving it a level playing field with private markets. 

‘The low-cost silver bullet for any government running a tight deficit is, I think, amending tax subsidies like ISA and pension contributions. These could be restricted to domestic investment in recognition that we are in a much more competitive world for capital and many other markets do ringfence such incentives into their own economies.’ 

Increased capital seeking public market investments in the UK would be a starting gun for lots of other problems being remedied, like the number of IPOs, liquidity, opportunistic M&A, public engagement, as well as the cost/benefit of listing a company, he said. 

‘This is, of course, not without controversy, but nobody would be prevented from investing internationally,’ he added.

Back to basics

All of this brings me to a final insight: that UK small caps can be international. As I talk through the Onward Opportunities portfolio with Hulse, it becomes obvious that a sizeable share of the fund’s assets are invested in smaller cap (and micro-cap) companies with significant international exposure. 

That is deliberate, according to Hulse: ‘Competition for capital is fiercer than ever and therefore valuation arbitrages or low single-digit earnings growth will not be enough. UK companies will have to command capital on a case-by-case basis. 

‘Those with an international earnings element or catalysts to unlock value that they can take control of are likely to outperform domestic “vanilla” growth stories, we think.’

I think there is a moral in the success of his Onward Opportunities trust and the much bigger Ashoka IPO: the investment trust world needs to get back to basics and refocus on active equity selection. 

Most private investors want it and will increasingly call the shots, as the wealth managers move away from trusts and refocus on ETFs. The whole space has become far too clever for its own good and oversold itself to big institutions boasting legions of pointy-head types. 

Yet the all-important secondary market, where discounts become crucial, is dominated by investors who prize alpha and focus. Sure, that will require actual delivery of alpha returns – and with this in mind, Saba is right to criticise some trusts’ returns profiles. 

But even in the most unpleasant asset classes, like UK small caps, the opportunity set is real and arguably getting bigger by the month. 

Any opinions expressed by Citywire, its staff or columnists do not constitute a personal recommendation to you to buy, sell, underwrite or subscribe for any particular investment and should not be relied upon when making (or refraining from making) any investment decisions. In particular, the information and opinions provided by Citywire do not take into account people’s personal circumstances.