Acorn’s smaller companies portfolio suffers in the wake of Brexit

Acorn Income Fund has announced its interim results for the six months ended 30 June 2016. During the period, Acorn’s gross assets provided a total return of -8.13%, whilst its NAV total return was -13.95%. Reflecting an increase in the premium to NAV at which the company’s shares traded, the share price total return was -10.96%. The company’s chairman, Helen green, says that, following an excellent 2015, the first half of 2016 was not so favourable for Acorn. She says that the market was thrown into turmoil, following the unexpected referendum result, which impacted smaller companies more severely than larger companies that generally have a greater exposure to overseas earnings and therefore benefit from weak sterling.

In terms of individual portfolio performance, the company says that the total return on its Smaller Companies Portfolio over the period was -10% and that the Income Portfolio return was flat missing out on much of the strength in sterling bond markets by having taken a very defensive low duration position. However, the company says that its bond portfolio did protect value during a time when the equity portfolio was falling.

In terms of portfolio activity, the company says that the split between the Smaller Companies Portfolio and the Income Portfolio has remained at approximately 77.5% to the Smaller Companies Portfolio and 22.5% to the Income Portfolio throughout the period. The split is based on the board’s and the advisers’ continuing belief that the Smaller Companies Portfolio offers an attractive income stream whilst fixed interest securities, although generally lower risk than equites, remain exposed to an eventual increase in interest rates and an increasing default rate.

Acorn first quarterly dividend for the year, paid in March was 3.5p and represented a 7.7% increase on the corresponding dividend in 2015. In announcing the second interim dividend the Directors say that they noted that Acorn’s portfolio of UK smaller companies continues to deliver earnings and dividend growth. The dividend was increased to 4.0p on the second interim payment, which was paid on 28 June 2016 and this represented a 14.3% increase on the preceding distribution of 3.5p.

In terms of the development of the smaller companies’ portfolio, five new holdings were initiated and three existing holdings were exited in full. Two of the new investments made were through initial public offerings (IPO). The new positions initiated during the period were: BBA Aviation, a global aviation support and aftermarket services company; Midwich Group, a specialist AV and document solutions distributor; Card Factory, the vertically integrated retailer of greeting cards; NewRiver Retail, a retail property focused REIT and Morses Club, a leading UK non-standard consumer finance company. Positions in Vp and Diploma were exited in full during the period. The managers say that both had experienced significant yield compression after several years of capital outperformance and were offering below average dividend yields. The position in DX Group, the parcels, mail and logistics operator was also exited in full.

In terms of performance attribution, fore the smaller companies’ portfolio, the managers say that the strongest contribution came from Somero Enterprises, the manufacturer of industrial machinery, which ended the period 33% higher. They say that the company released final results during the period and posted strong growth in profits, led by robust trading in North America, Europe and the Middle East. Other notable performers reportedly include British Polythene Industries, a manufacturer of polythene products, whose share price rose by 34% driven by a bid for the company and BBA Aviation, which saw its share price rise by 17%.

The managers say that the primary negative contribution to performance came from Secure Trust Bank, which fell by 38%. They say that sentiment towards the banking sector deteriorated on the run-up to and in the aftermath of the EU referendum but that the challenger bank provided a number of updates on trading during the period, which were generally encouraging and also announced the sale of the Everyday Loans Group and the subsequent payment of a special dividend with the proceeds. The managers say that another notable detractor from performance was Sprue Aegis, the manufacturer of smoke and carbon monoxide detectors, whose share price fell by 51% following a disappointing update in which sales into France slowed and an exceptional warranty charge to address issues with the battery used in certain models.

Looking at the income portfolio, the manager says that overall portfolio performance was flat and stable as finding value within a tighter credit market required greater care and diversification away from traditional bonds whilst the portfolio did not benefit from rapidly declining sovereign yields given the short duration posture. Portfolio activity included adding to the company’s position in DW Catalyst Fund, buying shares at a material discount to NAV, and initiating a position in JPM Global Convertibles Fund, a portfolio which traded close to its aggregate ‘bond floor’ while benefiting from material upside from a retracement in either equities or credit spreads. The manager says that they proceeded to focus the portfolio, exiting positions including Transport for London, IBM, GE Capital and Sky, while increasing conviction positions including BT Group, Enterprise Inns and the preference shares of Real Estate Credit Investments, as difficult conditions provided opportunities to buy value. The manager says that they took profits in some of the JP Morgan Global Convertibles holding later in the period, after the underlying portfolio proved defensive throughout the volatile first quarter, and then rallied strongly with equity markets. The holding in GLI Finance ZDPs was reduced on recent performance and a reduced visibility in management’s strategy going forward. Positions in Grainger and RSL Finance were exited given the potential for a vote to leave the EU to negatively impact the UK housing market. A new holding was purchased a Soc Gen Issuer 3.2% 10/1/2021, in a structured investment offering a defined return as long as European high yield credit events/ defaults did not rise significantly above levels experienced during the depths of the credit crisis.

In terms of outlook, the chairman says that the political and market reaction to the Brexit vote has unfolded rapidly in the few weeks since the period end but that the longer term economic consequences of Brexit are difficult to judge given the many potential trading arrangements that might be negotiated with the EU and other countries. She thinks that markets will suffer from the uncertainties surrounding the UK’s exit from the EU until there is a clearer picture of what the future holds. The Bank of England has cut interest rates and recommenced quantitative easing, which has helped stimulate a broad based market recovery. The initial rally, in the last week of June was restricted to larger companies but small and mid cap indices as well as the FTSE 100 index have recovered to levels which are higher than they stood at immediately preceding the Brexit vote. Acorn’s net asset value had also recovered to above the pre Brexit level. Looking forward, the chairman says that Brexit may make some investments less attractive but will also open up new opportunities. Any adjustments required to Acorn’s investments can be accommodated within the normal management of Acorn’s portfolios. The Directors see no advantage in deviating from the broad strategy and investment process that has served Acorn well since its inception.

Acorn’s smaller companies portfolio suffers in the wake of Brexit : AIF

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