Norman Lamont buys into the Small Companies Dividend Trust.
I was going to start by saying that a former Chancellor of the Exchequer buying shares in a company is surely a good sign that at the least that company isn't about to go bust.
Then I remembered the former Chancellor in question, Norman Lamont, presided over the UK's entry into -- and ejection out of -- the ERM.
The ERM debacle, dubbed Black Wednesday, saw the nation lose a bet with hedge fund manager George Soros to the tune of $1 billion. Perhaps we'd do better to see what shares Soros is buying! (Perhaps not -- he was very wrong in Spring 2009).
On the other hand, Lamont (aka Baron Lamont of Lerwick) reportedly sang in the bath with happiness after we left the ERM. He then went on to lay the foundations of the inflation-targeting framework that served us so well, at least until the credit crisis.
The Baron buys in
Politics is a murky business but money talks. And Lamont, who is chairman of the Small Companies Dividend Trust (LSE: SDV), splashed his cash to double his holding last week.
It wasn't a Soros-sized investment. The bold Baron spent £15,435 to buy 21,000 shares, increasing his exposure to 35,825 shares.
Lamont paid 73.5p per share -- a price still available today. Should we follow his lead?
Undoing the splits
It could be an exciting ride -- the Small Companies Dividend Trust's past is not short of incident.
The trust was set up to deliver income from investing in smaller companies, with the potential for some capital gain. For many years it achieved this as an award-winning split capital investment trust, but the Zero Dividend Preference shares were wound up in 2007, presumably in light of the wider split-cap scandal of the early noughties. (Ironically splits are now making a comeback).
The trust remained geared up through a £10 million bank loan -- a seemingly great idea as the price rose towards 250p in 2007, but a big problem when market plunged. To avoid breaching its banking covenants, the trust paid back £6 million, selling investments to do so -- not ideal in a falling market!
The trust's net asset value (NAV) fell from £24 million in 2008, to just over £10 million by April 2009. The share price fell to 34p.
The income situation is not much rosier. Investors were paid 14p a share as a dividend over 2007 -- the trust even chucked in a penny per share from its reserves.
In the 2008-2009 year though, shareholders received just 7.3p a share, and income for the year to April 2010 will almost certainly be lower still.
Divining the dividend
The company pays dividends quarterly, and it has so far delivered 3.75p to shareholders. If the final dividend is held at 1.25p, that would make 5p for the year -- a 6.8% historic yield.
But the trust tends to pay a slightly higher final dividend; at 6p for the year, say, the yield would be around 8%.
Investors shouldn't be too greedy. It's true that as of April 2009, the company held 8.4p in reserves -- enough to cover either of my scenarios. But smaller companies have cut dividends just like larger ones over the past couple of years, and even the lower yield probably can't yet be sustained by the Trust's investment income alone.
Focused portfolio
With £1.5million remaining in reserve, the trust could top up the dividend for some time. The bigger risk is of a large fall in the value of its small cap investments. That would threaten its banking agreements, potentially forcing sales again.
At least it's got a buffer now. Since the Spring 2009 lows, NAV has rebounded to nearly £18 million, compared to the ongoing loan of £4 million.
As of January 2010 the trust had positions in 59 companies (it does not invest in bonds or other assets). With five holdings each representing 3.5% or more of the portfolio, it's not exactly a conservative approach -- almost 5% is in just one company, Portmerion Group (LSE: PMP).
This focused portfolio could do well if the economy and the market keeps recovering -- especially the UK economy, concerns about which have held small caps back relative to their FTSE 100 brethren for several months.
Note that investors won't see all the benefit from a rally. The manager, Chelverton, takes 1% a year as a management fee, plus a performance fee of: "10% of the lower amount by which the net asset value plus dividends paid exceeds 10% compounded per annum and beats the FTSE SmallCap Index by 2%".
Green shoots
This is not a share for widows-and-orphans, despite the focus on income. The downside of its gearing strategy was painfully revealed in the depths of the bear market, and a new crash is always a possibility. I prefer a less risky income from small caps, hence my stake in Aberforth Smaller Companies Trust (LSE: ASL). It yields 3.8%, has very little gearing, and a substantial market cap of £490 million.
Will Lamont's share purchase prove well-timed? He's also remembered as the Chancellor who spoke of 'green shoots of recovery' in the depths of recession in 1991. Lamont was widely ridiculed in the months that followed, but history and the data proved him right. Investors will hope he'll repeat the trick here.
More from Owain Bennallack:
> Owain owns shares in the Aberforth Smaller Companies Trust.
