BlackRock Smaller Companies (BRSC) aims to grow capital over the long term by investing in a portfolio of UK listed smaller companies. The trust has an exceptional long-term track record relative to the benchmark, outperforming in each of the past ten calendar years, as we discuss further in the Performance section.
The manager, Roland Arnold, pays particular attention to growth companies which have the potential to become market leaders in their fields. As such, he favours companies towards the smaller end of the market cap spectrum. The portfolio is one of the most diversified in the UK Smaller Companies sector, with close to 130 stocks. The holdings come from a wide range of industries with diversified sources of revenue, and many of them have an international element to their revenues.
Over the past five years the trust has delivered NAV total returns of 42.7%, compared to 7.1% from the benchmark, and 28.1% and 23.8% respectively from the IA and AIC peer groups. Although the trust has been unable to generate positive returns in 2020, it has held up well in comparison to the rest of the sector. This has principally been due to the high quality, growth focus of the underlying companies, as well as the well diversified approach to risk employed by Roland.
Although capital growth is the main focus, the trust also has a strong history of dividend growth. Currently yielding 2.5%, BRSC has grown its dividend at a rate of 21.1% over the past five years.
Currently (as at 07/05/20) the trust is trading at a discount of 1%.
BRSC has an exceptional long-term record of outperformance relative to both the benchmark and peer groups. Roland became sole manager a year ago, having been co-manager since 2018; and although he has only been the sole manager for a year, little has changed in the trust’s approach to stock selection.
We believe BRSC’s diversified approach to single stock risk is particularly attractive in the current uncertain environment. The trust has dramatically outperformed its peers and the benchmark in falling markets over the past decade, and we attribute this in part to its sensible diversification among companies, sectors and economies. However, the trust still retains a focus on high growth companies, which has helped it outperform in many rising markets too. BRSC performed relatively strongly through the recent market downturn – triggered by the coronavirus pandemic – due to outperformance by its favoured growth stocks. Given its diversified blend of high quality growth companies, we think the trust could be in a good position irrespective of whether markets fall or rebound.
Due to its strong performance in both rising and falling markets, the trust is trading at discount of 1.0%.
|Excellent long-term performance in both rising and falling markets||In bear markets high levels of gearing could drag on performance|
|Well diversified approach helps protect capital in the current uncertain conditions||UK Smaller Companies continues to be one of the most out-of-favour sectors|
|Relatively low ongoing charges fee||Highly diversified portfolios require more ideas to be successful|
BlackRock Smaller Companies Trust (BRSC) is run by Roland Arnold, who uses a bottom-up stock picking approach to finding opportunities. Roland favours high quality, cash generative companies with strong management teams that are able to generate their own growth regardless of the wider economic environment. This is a particularly important aspect of the trust in the current environment, as many of the underlying companies in the portfolio have been impacted to a lesser extent than their peers. An example is games developer Team17, which has seen its share price rise by c. 40% since the start of the year. Team17 works with a number of third-party developers using a revenue share model. This business approach, alongside the fact that game budgets are typically under £1m, means the company has very little capital at risk from the success of a particular game. Revenue is also well diversified, with a significant proportion driven by back-catalogue titles.
According to Morningstar, the trust has 64% of its portfolio in growth companies, relative to a sector average of 41.4%. As one might anticipate, this growth focus means that BRSC has a considerable bias towards companies with a lower market capitalisation in the smaller companies universe. This is illustrated by the fact that the portfolio has 46% of its holdings in micro-caps and just 1% in mid-caps. In fact, the average market cap in the portfolio is £611m, less than half that of BlackRock’s other smaller companies trust BlackRock Throgmorton.
Another standout characteristic of the trust is its diversified approach to risk. The portfolio is built up of 127 companies, more than any other trust in the sector, where the average is 51. These companies are also varied among sectors and geographies, with only around 50% of revenue coming from the UK. As we illustrate in the Performance section, Roland believes that due to the volatile nature of smaller companies, it is important not to place all his eggs in one basket. The holding size of his companies is therefore relatively small, with the top ten holdings making up just 23.4% of total NAV. This is the second lowest in the sector, and considerably lower than the average of 51%.
top ten holdings
||% of fund
|Stock Spirits Group
|Central Asia Metals
|Sirius Real Estate
Source: BlackRock – 31/03/2020
As a general rule Roland will ‘dip his toe in’ before fully investing, using this period to gain greater insight into the company and its management. After an initial position of between 0.25% and 0.5%, he will typically increase his investment by up to 2% as his confidence grows.
In order for Roland to find his ‘hidden gems’ he looks at five key criteria:
- Proven, trustworthy management
- Strong market positions
- Clear record of earnings growth
- Good conversion of earnings into cash
- Sound balance sheet
Those companies that tick all five boxes are the ones that Roland believes will have the greatest potential going forward. Among the five characteristics, a particular area of focus in the current climate is the balance sheet. Due to the unusual environment, where revenue streams are under significant pressure, he is focusing particularly on debt structure. Companies which can defer or delay their debt are likely to be in considerably stronger positions than those that have more complex structures.
Due to the nature of the trust’s investment process, sector exposure is purely a result of bottom-up stock selection. Industrials is currently the largest sectoral allocation, representing 33.5% of the portfolio. Financials (20.8%) and consumer services (17.0%) also make up large positions.
The BRSC board anticipates that typically the trust’s gearing will sit between zero and 15% of net assets, with 15% being the maximum drawdown available. As can be seen below, gearing is a relatively consistent feature of the trust, although it was reduced throughout 2019, reflecting the manager’s cautious market view.
Gearing has increased as a percentage of net assets in 2020, but this has been principally due to the significant fall in NAV. Currently gearing sits at 6.5%, in comparison to the one year average of 5.6%.
The team place a high level of importance on balancing out the trust’s borrowing facilities, and as such it holds a range of long and short-term debt, with a mixture of fixed and floating rates of interest. Fixed rate funding consists of £20m private placement notes, maturing in 2044 at a coupon of 2.41%; a £15m debenture, which matures in 2022; and £25m in senior unsecured fixed rate private placement notes, at a coupon of 2.74%, with a 2037 maturity. In total these issues amount to 9.6% of NAV. Shorter term variable rate funding consists of a £35m three year revolving loan facility and an uncommitted overdraft facility of £10m.
BRSC has an excellent track record relative to the benchmark, the Numis SC Plus AIM ex Investment Companies, and to the AIC and IA Smaller Companies peer groups. The trust has outperformed the benchmark in every one of the past ten calendar years, producing returns of 257.3%, vs the benchmark return of 38.9%. As can be seen below, the trust has not just outperformed in one particular type of market, which illustrates the potential of the strategy to participate in bull markets while still protecting capital in bear markets.
Over the past five years the trust has delivered NAV total returns of 42.7%, compared to -7.1% from the benchmark, and 28.1% and 23.8% respectively from the IA and AIC peer groups. Most of the absolute returns over this period have been lost in 2020, as we discuss in greater detail below. Still, the trust has remained a standout performer in the sector in relative terms, despite the recent sell-off. BRSC has an annualised alpha of 7.3%, the fourth highest in the sector, while maintaining a standard deviation (19.2%) that is considerably lower than the average trust in the sector (22.6%).
As with most trusts, the past 12 months have been difficult for the manager. The final quarter of 2019 saw the market perform a ‘Boris bounce’, with a number of smaller companies trusts benefitting significantly. However the coronavirus pandemic has triggered a reversal of those gains. As we note in our recent sector piece, 'The fight in the dog', the recent market moves have seen large disparities among the constituents in the sector, but on relative terms BRSC has held up better than most. This is largely due to the trust’s exposure to high growth companies, including the likes of IntegraFin and Team17, both of which sit in its top ten holdings. The portfolio has also benefitted from the manager’s diversified approach. As we have often documented, a number of trusts have moved to becoming more concentrated in recent years. However, this ‘all your eggs in one basket’ approach can result in large losses should the manager get it wrong.
One area that has hindered performance has been the trust’s high exposure to financials (20.8%) which has been an area particularly impacted in the downturn. Alongside this the trust’s gearing level has also been a drag on returns.
Roland admits it is difficult to anticipate what will happen next, given that we are witnessing a very different downturn to those encountered previously. He does believe that things will return to normality, however, whether due to herd immunity or a vaccine; and that a lot of market leading companies will be available at cheap valuations at that time. As such, the team are continuing to focus on their regular five criteria for target investments, but paying particular attention to those sectors which will reopen first.
Although income is not a specific focus for Roland, BRSC has an excellent track record of dividend growth. In fact the trust has now increased its dividend for 17 years consecutively. Currently it is yielding 2.5%, marginally below the sector weighted average of 2.7% (source: JPMorgan Cazenove).
Over the past five years the company has grown its dividend at a rate of 21.1% p.a., substantially more than the weighted average of smaller companies trusts, which has increased by 12.8% p.a. during the same period. The interim dividend for 2020 equated to 12.8p, an increase of 6.7% from the previous year. However, a final dividend is yet to be announced. Despite the fact that a number of UK companies have cut their dividends during 2020, BRSC’s deep reserves could give the board some room to avoid a dividend cut, in our view. Currently revenue reserves cover the dividend 1.6x.
Following the trust’s AGM in June 2019, long-term manager Mike Prentis retired and Roland Arnold took over as sole manager, having been co-manager since April 2018.
Roland has worked at BlackRock for almost 20 years, and managed UK equity funds since 2010, with a focus on small and mid-cap stocks. Alongside BRSC, Roland continues to run the open-ended BlackRock UK Smaller Companies Fund, which he took over in March 2015; as well as being the sole manager of the BlackRock UK Special Situations Fund.
Since the 2016 referendum, when the discount widened right out to 20%, it has since narrowed significantly. The one year average discount (to 06/05/2020) is 2.6%, although BRSC is currently trading closer to NAV, on a discount of 1.0%. This is the tightest discount in the UK Smaller Companies sector, where the weighted average discount is 7.8%. We think this likely reflects the trust’s strong performance record, and its diversified approach to risk in the current environment.
The board has long viewed creating demand for the shares in the secondary market as the best way to narrow the discount, and believes this will be more likely achieved through strong performance than through share buybacks. As such, no shares have been repurchased over the past year.
discount to nav
BRSC sits towards the cheaper end of the 16-strong UK Smaller Companies sector. Currently, the ongoing charges fee (OCF) for the company is 0.70%, considerably less than the sector average of 1.06%. The management fee is based on a rate of 0.6% of the first £750m of assets, reducing to 0.5% above this level. The trust does not charge a performance fee.
The KID RIY for the trust is 0.83%, considerably lower than the average of 1.98% in the sector. However, it is worth noting that calculation methodologies can vary among different trusts.
The board aims to ensure that BRSC is a socially responsible investor, recognising the importance of investing in companies whose boards respect ESG issues.
Accordingly, ESG is built into the entire investment process. Prior to investing in a company, Roland will look at its environmental and social policies and track record. However, this is not a dedicated ESG trust.