These small-cap investment trusts have been crushing the FTSE 100

These small-cap investment trusts have massively outperformed the FTSE 100 (INDEXFTSE: UKX) over the past five years.

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A standout performer in the UK small-cap space is the Rights & Issues Investment Trust (LSE: RIII). Over the past five years, the fund has delivered a net asset value (NAV) total return of 172%. This compares favourably to its FTSE All-Share benchmark’s gain of 80% and the FTSE 100’s performance of 37% over the same period.

Picking winners

With more than 30 years service as the fund’s investment manager, Simon Knott has a long track record for picking winners. He uses a bottom-up investing approach to seek out small-cap companies that are trading at a discount to their fundamental value.

Knott likes to maintain a very concentrated portfolio of his high-conviction picks. The fund’s five biggest holdings in its portfolio account for 60.6% of its investments, and they include Colefax Group (23.9%), Titon Holdings (11.6%), Macfarlane Group (11.0%), Treatt (8.3%) and Elecosoft (5.8%).

Although a concentrated portfolio gives investors greater exposure to Knott’s best ideas, with the objective of generating outperformance against its benchmark, a concentrated approach can also lead to more volatile returns.

Shareholder-friendly

Surprisingly for a fund focused on small-caps, Rights & Issues comes into its own in terms of costs. With an ongoing charges figure of just 0.41% last year, it is one of the cheapest funds to own, not just for small-caps but across all markets.

The fund’s shareholder-friendly approach is likely due to its self-managed structure, which means the trust doesn’t incur unnecessary costs, like having to pay a lot of third-party advisors. Another reason is that board members own substantial stakes in the investment company itself, aligning their interests with those of external shareholders.

To demonstrate, the fund has consistently kept portfolio turnover very low, incurring just over £30,000 in transaction costs over the past two years.

Moreover, the trust has been proactive in addressing its discount to NAV — the extent to which its share price is lower than its NAV per share — by aggressively buying back its own shares. Share buybacks at a price below NAV create value for continuing shareholders, by increasing its NAV per share and potentially causing the discount to narrow.

High income

Another highly-rated fund is the Chelverton Small Companies Dividend Trust (LSE: SDV). The diversified small-cap fund aims to deliver a high and growing income through investing in high-yielding companies capitalised at less than £500m.

It only invests in a company for the first time if it yields at least 4% on a 12-month horizon. This is a cast iron rule to which there are no exceptions. Aside from a high dividend yield, the fund managers look for companies with strong management teams and which generate cash on a sustainable basis, to avoid buying into value traps. This means that although the fund employs a strict screening process, it doesn’t invest in a stock just because of its high yield.

Optimistic

Notwithstanding the recent stock market sell-off, fund managers David Horner and David Taylor are optimistic on the outlook for UK corporate earnings. Additionally, they reckon current valuations are broadly supportive, with dividend growth for its portfolio looking set to remain strong.

In terms of its past performance, the trust sits in the top quartile position in the UK equity income sector, with a NAV total returns of 118% over the past five years. Shares in the trust currently yield 3.6%.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jack Tang has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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