Sharesify podcast with Simon Barnard of Smithson Equity Fund

In our latest podcast special, Steven Frazer and James Crux are joined by Simon Barnard, manager of Smithson Equity Fund (BLBNK48). Smithson invests in small and mid cap companies with superior operating numbers.

Our special guest discusses Smithson’s transition from an investment trust to an open-ended fund. Barnard explains why he is sticking with his strategy of investing in high-quality global small and mid-cap companies.

He talks about the steps he has taken to improve the fund’s performance. Barnard then explains why he is seeing lots of value opportunities within his preferred parts of the global small and mid cap market.

Barnard also walks us through the fund’s exposure to the AI theme and why Smithson Equity has such a significant allocation to the US.

Finally, Barnard tells the Sharesify team why Italian luxury fashion brand Moncler (MONC) is his preferred sector pick. The outerwear purveyor boasts sector-beating gross margins and its 2020 acquisition of Stone Island has provided Moncler with an additional growth leg.

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Transcript

SPEAKER_01 0:08

Hello and welcome to a very special episode of the podcast. Today we're delighted to be joined by Simon Barnard, manager of Smithson Equity Fund, which invests in small and mid-cap companies with superior operating numbers. Simon, thanks for your time today. How are you?

SPEAKER_02 0:21

Good, thanks, James. Nice to see you.

SPEAKER_01 0:24

Excellent. Now, following the transition from an investment trust to an open-ended fund, you're sticking with that strategy of investing in quality, global, small and mid-caps. But have you had to increase the liquidity profile of the portfolio since the conversion?

SPEAKER_02 0:37

Actually, not at all. And in fact, before we decided to go through with the conversion, one of the main reasons we chose that is because we were already running the trust in a way that we wouldn't have to change anything. And we recognized that the liquidity was fine. But to put it into perspective, I mean, you know, we list ourselves as smaller mid-cap, but actually we're more in mid-cap. Our average market cap is around 5 billion pounds of the underlying companies. Um, and the liquidity in that is very strong. I mean, I think we've got about a seven-day liquidity of 97%. That means we could liquidate 97% of the fund within seven days. So we've not had to change anything.

SPEAKER_01 1:18

Right. And um, so you haven't seen too much selling since the conversion. Investors have chosen to stick with the strategy, have they?

SPEAKER_02 1:25

Yeah, well, when we went through the conversion, uh, we bought back around 58% uh of the fund at NAV. Um, but bear in mind that included the activist uh hedge fund that got involved with the Smithson Investment Trust. Uh, and it also included quite a few other institutions that could only hold investment trusts and they couldn't come with us into the OIC. So our estimation was only about 20 or 30 percent of that was underlying retail shareholders.

SPEAKER_00 1:54

Interesting, I suppose. Um the benchmark is always going to be uh returns. Um, so I just wonder what sort of steps you've taken. The past few years have been um a tricky place to be for the trust and now the fund. Just wonder what sort of steps you've taken to address any returns um dips that you might feel you you've had.

SPEAKER_02 2:16

Yeah, well, I mean, we're always looking for improvement, and especially uh in times like this when we've had underperformance for a year or two, uh, we step up those efforts uh in terms of the post-mortem. And I think there are a couple of things that we identified that we could have done better. Um, one of those is uh broadening our investable universe. So, this is the list of companies that we have found in the world, because we have a global mandate, that are the highest quality uh mid-cap companies that we can find. Uh, currently the list is about 95, and that has expanded. And we've made a concerted effort to broaden that list into different areas of the market that we've not looked at before. And the second point that we realized is that uh we had been holding on to our winners uh for too long, and uh once they'd got to quite stretched valuation. So addressing those two issues has actually already started to help. So, for example, by broadening into different parts of the technology sector, we found a company called Vertive uh listed in the US, which we bought last year, and that's already up four times in value since we've owned it. Um, and then on the second point, uh last year we sold two companies, Equifax and Verisk, both of which uh had reached uh relatively high valuations. In fact, some of the highest we'd seen them trading on uh in their history. Uh so we sold both of those, and actually since then they're both down around 40% uh within a year. So I think uh those steps alone have already started to help.

SPEAKER_00 3:48

It's I mean, it's always one of the toughest things to work out, is any investor, retail or professional, is when do you sell a stock? And the idea that you run your winners, you know, it's it sounds so simple and it's hard, but there's so much complexity in it, and it's such a difficult decision. So brilliant, we're up 40, 50, 60 percent. Should we sell it now?

SPEAKER_02 4:11

It is, and I think you just have to be disciplined on valuation, and it's worth remembering all of these points I'm mentioning is simply tweaks. You know, we believe very strongly that our underlying strategy of buying good companies, not overpaying for them, and then holding them for the long term is the correct one, and it has worked over many years, if not decades, in other people's strategies. Um, so these are only tweaks we're talking about, but I think being more disciplined on valuation can't hurt you over time.

SPEAKER_00 4:37

Yeah, great. James, I'm just gonna leapfrog a question here because it kind of segues nicely. You mentioned Vertive. I know the company relatively well, it's very much in the kind of AI infrastructure space. Um, just looking across the top 10 holdings, there's not an obvious uh lever into the AI uh investment theme. I just wonder what your thought your feelings are about AI and and where the fund positions itself in terms of that thing.

SPEAKER_02 5:00

Well, it's gonna be a long answer, but um uh I mean on AI generally, look, clearly there is no question that this is a game-changing technology uh that is going to change a lot of things and the way we do things in the world. And we've even observed that ourselves and the way we've deployed it within our team. You know, tasks that used to take days or weeks are now taking hours. Um, and it's really made a big difference in the way we operate and the speed at which we operate. So I think that that is a clear point to make first. However, um, I think investors have become particularly enamored with certain areas of the market related to AI. And I think we're getting to the point now where it is becoming difficult to justify the valuations in some of these areas, however much growth we expect from this game-changing technology. And it's also starting to become difficult to justify the amount of capex that's being spent by some companies in this area. Uh so I think these are big question marks rising up over the assets related to AI, however strongly you believe in the AI technology itself. So for us, um, because of that very clear structural growth uh in the technology, we do believe it's important to have some exposure. And I've mentioned Vertiv, which is a US-based uh producer of custom liquid cooling solutions for data centers, so clearly uh right in the mix of AI demand. But we also have some other companies like uh Belemo, which sells actuators that uh so these are automated devices which open and close valves for either water or air movement, also actually feeding into liquid cooling solutions for data centers. In fact, they have the number one position in actuators for liquid cooling. Uh, we also have uh less direct exposure through companies like Diploma, for example, that through some of their divisions are supplying cabling and other infrastructure for data centers. Uh, and we have uh other uh semiconductor-related companies like Infocon, which sells uh vacuum um sensors into semiconductor manufacturing. All of these companies have done extremely well uh during this process. Um, but while acknowledging we need exposure to this theme, I think we also, going back to my earlier comment, need to be cognizant of the valuation. So uh there have been opportunities to get hold of these companies at reasonable valuations. So we bought Vertiv last year on 20 times earnings. I mean, it was incredible, helped, of course, by the sell-off uh in the Liberation Day announcements. Uh and we've recently had a chance to buy uh Belemo because it sold off uh during the Iran conflict concerns. Uh so we've had opportunities. Um, but now that, for example, Vertive has gone up four times in a year, uh, its earnings of expectations roughly doubled. So now it's on 40 plus times earnings. You know, this is a different equation. And put it in perspective, we bought a 3% position initially. You said there's nothing in our top 10. Well, if we'd left that uh to run, it would be over a 10% position. Now we'd have to adjust that for USITS rules, but uh it's a 2% position. So you can see there again our uh discipline on valuation taking effect. Uh, and so we are, you know, I think a lot of the market is is coming into a different difficult point now. How do you justify these valuations and how do you maintain your exposure when uh valuations are stretched?

SPEAKER_01 8:47

Indeed, indeed. Yeah, and and any other sort of other parts of the market, you know, your sort of preferred hunting grounds of quality and SMID where you're seeing particularly good value.

SPEAKER_02 8:57

Yeah, I mean, in a word, lots. So I mean, the counterpoint to what we've just been talking about is, you know, there are a lot of older world uh, let's say, uh, stocks which are very high quality, still growing high single digits, low double digits, but are at extremely attractive valuations. And actually, even when we look at the portfolio as a whole, the Smithson portfolio is now the cheapest it has been for the last 10 years or more. Uh, and for the first time since inception, when we look on free cash flow yields, uh the portfolio is now cheaper than the market. And that's bearing in mind that we own higher quality, that means higher returns, higher margin companies, which are growing faster than the border market. And because they're in the quality bucket, they're now cheaper than the overall market. I mean, we've not seen this before, and it's actually making us quite excited. Uh, so uh we've just seen in the last few days, with actually there's been quite a sharp sell-off in AI-related assets, and all of these companies suddenly jumping in in price. So uh you can see that there's quite a clear counterbalance here. Um, but it is very much the case that we are surrounded by opportunities in these types of stocks.

SPEAKER_01 10:08

Excellent. Yeah, I was also going to ask, just looking at the fact sheet, there's a that large allocation to the US, is there anything structural at play, superior margin businesses or or management teams? What's the reasoning for that?

SPEAKER_02 10:21

Not in that way. We don't sit here thinking we should have what we do currently do, which is about 50% in the US and 40% in Europe. Rather, it's a very bottom-up approach. So we're constantly scouring the world for the best quality companies that we can find in our mid-cap range. Um, we follow them uh as if we own them, and then on any given day when the valuations are attractive, then we acquire a position. And so that uh allocation to the US has broadly been bottom up through that process. But that clearly means that around half the opportunities that we currently see right now is coming from the US. And the reason for that probably is because when you think about small and mid-cat companies, actually their domestic markets are more important to them than for large cap companies. Clearly, because they haven't grown to the point where the international markets are becoming larger than their domestic market. And so it's worth remembering that the US is still the world's largest, most liquid, most dynamic, most business-friendly market in the world. Uh, and so you're just gonna find the most attractive companies there in general uh at this point, uh, which is why half our portfolio happens to be there.

SPEAKER_00 11:39

It's it's interesting, Simon, that just looking at the UK market um over the last couple of years, but it's rallied up from 7,000 or two to now over 10,000. Seems like it's had a very strong run, and of course it has. But I mean, lots of comment commentary and conversation we've had in recent times. Um managers seem to be looking at the UK still as very, very discounted, certainly against the US and even against other parts of the world. Is that your experience as well? Are you finding quality companies at below quality prices?

SPEAKER_02 12:08

Uh I'd say yes and no. So, funnily enough, over the last few years, we've had a significant overweight to the UK in the portfolio. So 15 to 20 percent of the portfolio has been in the UK the last few years. Uh, when we thought it was extremely good value for the type quality companies we were looking at. However, actually, over the last year or so, that has reduced quite meaningfully as those companies perform so well. And we are looking uh at uh valuations now in the specific areas where we're focused. So, for example, Halma is a company that has done extremely well for us. We've owned that for seven years and have only very recently sold out of it as it's uh gone beyond uh I think it was 30, 35 times earnings, which for us we felt was was becoming stretched. Um and Diploma 2, we we had a very large position, but again, uh is becoming increasingly highly rated. So we've been reducing that. So funnily enough, uh that weighting to the UK for us has been reducing over the last 12 months, but only because it's done so well. Uh and we still do own uh companies in the UK, um which we still believe are good value, but but just for us, it's actually less so.

SPEAKER_01 13:24

Right. Yeah, I just had a stock specific question as well. Um just saying it's a luxury, uh Monclair. Perhaps what what makes that business special? You know, why have you picked that out of all the kind of cling names you might have opted for?

SPEAKER_02 13:36

Um well uh the first thing to say is a luxury is an attractive industry, okay? Um, and you know, you only need to realize that human greed and vanity are eternal. Uh and you need therefore this luxury industry will be attractive probably for a very, very long time. And you can see that in the numbers, you know, over the last 25-30 years, uh the luxury industry sales have been growing at about six to seven percent um Kager. Uh so it's up, you know, five times in the last 25 years. Um, and within that, uh, Montclair has done even better. So Montclair is an extremely well-run, uh smaller luxury company. And so, you know, over the last 10 to 15 years, their growth has been more like 16% a year, uh, with a higher gross margin than the rest of luxury. So, luxury on average have gross margins around 70%, and that speaks very much to the pricing power that they have in luxury goods. Whereas Montclair, uh their gross margin is more like 80%, so even better. And the growth they've experienced uh is clearly taking market share, and that's because as a smaller company, they've been opening more of their own brand stores, and they've also been adding more lines. So, Montclair obviously has this heritage of outerwear. So, you know, in the 80s it was shiny puffer jackets, now it's a bit different, but but they have been broadening that uh offering into knitwear, into footwear, into accessories, uh, something that these larger groups have done, you know, many years ago. Montclair is just going through this process now, which is why they've experienced such strong growth. Uh, but on top of that, they bought another brand called Stone Island uh back in 2020. And this has added a whole new leg of growth. So Montclair actually, in the early 2000s, was almost going bust uh before it went through a management buyout by its current um CEO chairman Remy Ruffini, uh, who did an amazing job um rebranding the company, uh redesigning all the product and elevating uh the offering in terms of price and value and getting Montclair to where it is today. So now they have acquired another brand, Stone Island, which is in a similar spot to where Montclair was uh in around 2000, and they can just apply the same playbook to it again, uh, and clearly avoiding some of the mistakes they made to accelerate that process. So we've got this whole new leg of growth coming from Stone Island for the next 10 or 20 years. Now, what makes it exciting right now is of course, uh, due to the Iran conflict, a lot of luxury stocks, including Monclair, has sold off because people are worried about luxury sales in the short term. But actually, for Monclair, only about 2% of their sales are in the Middle East anyway. So it doesn't really affect them all that much. Uh, yet the stock has sold off with the rest. Uh, so it's now trading on uh over a 6% free cash flow yield or or about 18 times forward earnings, which again is is the cheapest I think I've ever seen it. Uh so you've got this incredibly attractive valuation entry point for a business that uh that that achieves double-digit growth over the long term. So I think it's very attractive.

SPEAKER_00 16:56

Well, thank you, Simon. I think that's a perfect place to wrap things up. That's uh a fascinating insight into the Smithson Equity Fund now. Uh was the Smithson uh investment trust and no longer. Um, thank you very much for your time and listeners. Thank you very much for tuning in to this podcast special with uh Sam Bernard of the Smithson Equity Fund. See you next time. Cheerio. Thank you.