Abrdn Smaller Companies Income Trust (ASCI ) has announced a strategic review, which it says could result in a merger with another trust, possibly alongside a cash exit opportunity. Before last week’s announcement ASCI’s shares traded on about a 19% discount and had a market value of about £54m, though following a spike in the shares the discount has narrowed to 8%.

ASCI, managed by Abby Glennie and Amanda Yeaman, underperformed its Numis Smaller Companies ex Investment Companies benchmark by 15 percentage points over 2022 and this dragged down its long-term returns so that it was marginally behind its benchmark over five years.

Most of the trust’s underperformance can be attributed to the market shift from growth to value in the first half of its year as, despite its yield requirement, the equity portfolio is still managed using a quality, growth and momentum approach. ASCI also has a small portfolio of fixed interest stocks (about 3% of net assets at the end of December 2022), which help boost its revenue account, as does some modest gearing.

One regular complaint of mine is there are too many, very small UK trusts. In the UK Smaller Companies sector, 11 trusts have a market capitalisation of under £100m. One of these, Crystal Amber (CRS ) has already fallen on its sword and is engaged in a realisation process. Three of these funds specialise in micro-cap stocks and need to be small to stay nimble. Just one of the 11, Rockwood Strategic (RKW ), has a realistic chance of issuing shares this year, in my view.

In the UK Equity Income sector, three trusts have a market value less than £100m. Two of these, Chelverton UK Dividend (SDV ) and Shires Income (SHRS ), would probably make good merger candidates for ASCI.

Shires seems to be the bookies’ favourite, helped by it being run by the same group, although in the hands of Abrdn’s Iain Pyle and Charles Luke, and having a stake in ASCI. Over the past five years, Shires has outperformed ASCI by a decent margin (annualised returns of 5.2% to ASCI’s 1.2%). However, its portfolio yields quite a bit more than ASCI’s and is tilted more towards larger companies, so some meaningful realignment would be required.

The approach that JPMorgan Global Growth and Income (JGGI ) used with the merger with JPMorgan Elect – issuing C-shares in exchange for the less liquid part of the portfolio – might work here.

Incidentally, those C-shares are trading on a double-digit discount, which I find quite odd. As soon as the realisation process is finished, they will be merged with the ordinary shares, which trade on a 1% premium.

Shires trades on a discount of about 3%, which would not be a barrier to an effective merger but would likely mean that ASCI shareholders would have to be offered a cash alternative.

Chelverton UK Dividend’s case is complicated by its split capital structure, which includes a sizeable element of zero dividend preference shares which do not mature until 2025. However, it has an advantage in that its shares trade on a premium, so it might be possible to dispense with the cash option.

The main stumbling block might be its relatively poor performance over five years (0.7% per annum on average), although over 10 years it ranks much higher: third in its sector, behind Finsbury Growth and Income (FGT ) and Law Debenture (LWDB ).

A simpler option might be to opt for a deal with one of the larger UK equity income trusts that trade at a premium. I think ASCI shareholders would be happy to end up with investments in Law Debenture, City of London (CTY ) or Merchants Trust (MRCH ).

If the preference was to stick with small-cap funds, the only trust not trading at a discount – Odyssean (OIT ) – does not offer a yield. However, Montanaro UK Smaller Companies (MTU ) has a policy of distributing 1% of asset value as a dividend each quarter, which would imply a modest income uplift for ASCI shareholders, and it stands on a discount of 3.6%. Its investment approach has similarities to ASCI’s but its performance is a little better. I think it might be a good option.

Lastly, but probably least likely, there is always the possibility of seeking a merger with a global equity income fund like JGGI, which in addition to Elect absorbed Scottish investment trust. There is no global small cap income trust as an option – so the leap might be too great.

James Carthew is a co-founder and head of investment companies research at QuotedData. 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, objectives and attitude towards risk.