Questor: a discounted trust that steers clear of the stocks that look richly valued

Some numbers illustrate just how much the trust’s holdings are out of kilter with the wider market.

First, the price to earnings ratio of the portfolio as a whole is 11.8, compared with 20.8 for the FTSE All Share index. In other words, the stocks held by the trust are almost twice as cheap relative to their profits as the market.

The holdings’ dividend cover is 2.8 times on average, against 1.3 for the index. Although the trust is not geared towards income, with a current yield of 2.1pc, this level of cover suggests that dividend cuts among its holdings are most unlikely – and dividend cuts are one of the surest ways to drive a share price down. In fact, the trust has a strong record of growing dividends.

A focus on smaller companies also helps to avoid the stocks that seem most richly valued. Since 1990 the valuation of shares in large companies has on average been 23pc higher than that of their smaller counterparts. That difference has now ballooned to 76pc.

“There are some fairly extreme valuations out there at the moment,” said Peter Walls, who manages the Unicorn Mastertrust, a portfolio of investment trusts. “But the p/e ratios for Aberforth Smaller’s holdings are not demanding.”

Another yardstick for valuation is how the stock market values a share relative to the amount that private equity investors – not known for overpaying – are prepared to bid for similar businesses. On average, private equity firms pay 10 times a company’s earnings, using their preferred measures of “enterprise value” and “Ebitda” earnings, while the trust is valued at 11 times on the same basis.

Walls said the low valuations of the trust’s holdings were partly caused by Brexit-related uncertainty, given that many of them are domestically focused businesses. Examples include Brewin Dolphin, the wealth manager, First Group, the bus and train firm, and Bovis, the housebuilder. “There will be some overseas exposure among the holdings but probably less than across the smaller companies sector as a whole,” he said.

“Brexit has been a major influence on valuations of UK-facing businesses but the differentials between the portfolio’s valuation metrics and those of the wider market more than discount a pessimistic outcome.”

He added: “There is a lot of stability behind the underlying portfolio. I’ve known the managers from when they started in 1990 – they stick to their guns and have a very thorough investment process. They are pure value investors and their style has been out of favour for at least five years but they have managed to make quite a good fist of it. This portfolio is not going to go disastrously wrong. In a stressed market it is likely to perform better than other types of fund.

“On a five-year-plus view you should be OK. If you are thinking about long-term compounding of returns you will do better in this kind of fund than in some other areas. We are at a mature stage of the market cycle now and it’s not the time to be piling on the risk.”

The discount also looks attractive at 14pc, slightly above peer group average.

Questor says: buy

Ticker: ASL

Share price at close: £13.66

Investment trust news

Pershing Square, tipped in May last year, is to benefit from a management fee reduction to the tune of 0.35pc of net asset value over two years, following the conclusion of a legal case.

Strategic Equity Capital has reduced its base management fee to 0.75pc of NAV from the lower of 1pc of NAV or market value. The performance fee has also been reduced and the performance fee cap of 1.75pc of NAV has been replaced by a cap on the total fees payable to the management company.

JP Morgan Indian’s management fee will fall from 1pc to 0.75pc on gross assets of more than £300m.