BlackRock Throgmorton Trust (THRG) aims for long-term capital growth and an attractive total return through investment in UK small- and mid-cap companies. Uniquely in the sector, THRG has both a long and a short book, meaning manager Dan Whitestone can capitalise on opportunities, regardless of the wider market environment.
The ability to short has been beneficial over the past few years, when Dan has achieved significantly stronger returns than peers, as we discuss in the Performance section. In fact, in each of the past ten years the trust has outperformed the benchmark, and has achieved the fourth-highest returns in the sector.
In the long book, Dan owns two types of investment. The first are high-quality differentiated long-term-growth companies, and the second are companies which are leading industry change – ‘disruptors’. For Dan, high-quality businesses have strong management teams and a protected market position. They also possess a unique and compelling product offering with an attractive route to market which perhaps benefits from structural growth, and they are well financed. He aims to short those businesses with the opposite characteristics, i.e. the victims of industry change (‘the disrupted’), as well as companies with commoditised product offerings and weak financial structures, which are facing structural or cyclical industry pressures. The trust invests primarily in the UK small- and mid-cap market; however, Dan also has the flexibility to hold up to 15% outside the UK.
The trust’s discount has narrowed since the post-referendum lows, and the board has been able to issue a large number of shares to investors over the past year. Currently the trust is trading on a slight premium of 0.4%.
Reliability of returns is a key pillar of THRG’s appeal. Over the past decade the trust has outperformed the benchmark in each calendar year, delivering one of the highest returns of any in the sector. This has been achieved at relatively low levels of volatility, and over the past five years THRG has the fourth-highest Sharpe ratio in the sector.
A vital contributor to this has been Dan’s ability to short stocks, which means he is able to generate alpha in ways other managers simply cannot. In the current volatile environment this is particularly useful, with the trust not necessarily relying on general macroeconomic conditions changing. Alongside this, the diversified approach to risk that Dan employs has helped to protect capital while not appearing to impact performance during bull markets. In the financial year ending November 2019, for example, the short book delivered 1% in absolute performance. This is a strong result considering the backdrop of a rising market during the period, and highlights the trust’s ability to generate stock-specific alpha on the short side.
Given the trust’s strong track record and defensive characteristics, it is unsurprising that it has spent a great deal of time trading at a premium. The trust moved to a discount in the midst of the market volatility during Q1 2020; however, this was short-lived and market participants soon took advantage of the opportunity, with the trust moving back to a premium in recent weeks.
|Exceptional track record of outperforming peers and the benchmark||Smaller companies are typically a difficult space during a downturn|
|Short book diversifies sources of alpha and gives downside-protection potential||The UK continues to lack positive investor sentiment|
|Trading on a discount to recent history||The bias to mid caps means it is not a purely small-cap exposure
Long-term manager Dan Whitestone runs the portfolio of BlackRock Throgmorton, which is predominantly made up of UK small- and mid-cap companies; however, the trust also has the flexibility to own up to 15% in non-UK-listed companies. The trust is unique in the sector in that it uses both long and short positions to grow capital, meaning its returns are highly differentiated to those of its peers, as we discuss in the Performance section.
Dan aims to own differentiated growth companies as well as companies leading industry change, and this means there is a strong tilt to the growth style. In fact, growth companies make up close to 80% of the portfolio, according to Morningstar. Value companies on the other hand make up less than 5%. The portfolio has a bias towards larger companies in the universe, with the average market cap of a company in the portfolio sitting at £1.37bn, considerably larger than the average in the sector of £570.6m. This bias towards mid-cap companies stems from Dan’s previous experience working at UBS and on the hedge fund he runs at BlackRock. This is also the area where he finds the most opportunities to short, therefore he can balance the risk by holding long positions elsewhere at a similar market-cap level.
In the long book, Dan’s focus is on owning two types of investment. The first are high-quality differentiated long-term-growth companies, and the second are companies that are leading industry change, or ‘disruptors’. For Dan, high-quality businesses have strong management teams and a protected market position. They also possess a unique and compelling product offering with an attractive route to market which perhaps benefits from structural growth, and they are well financed.
For the short book, Dan aims to short those businesses with the opposite characteristics, i.e. the victims of industry change (‘the disrupted’), as well as companies with commoditised product offerings and weak financial structures, which are facing structural or cyclical industry pressures.
In order to identify opportunities Dan takes a bottom-up approach, although he does consider some top-down factors, such as any structural changes facing certain industries. As such, he typically avoids sectors like banking and oil & gas. To identify quality companies, Dan looks mainly at five characteristics:
- The management team and their vision for the future
- The core product, and the strength and quality of it
- The structural drivers of the industry
- A good conversion of earnings into cash
- A sound balance sheet
Dan places a high level of importance on meeting the management of a company. Through this part of the process he is able to better understand where the company is heading, and the more intricate parts of how the business works. In this area, BlackRock is at an advantage relative to the smaller investment houses. Its extensive resources mean that Dan and the rest of the emerging-companies team are able to attend more than 700 company meetings each year.
A particularly unique aspect of the portfolio is Dan’s capacity to run both a long and a short book. As we discuss in the Performance section, this has been beneficial to the trust’s returns. Typically the portfolio will be managed so that net exposure amounts to between 100% and 115% of NAV, although the trust could, in theory, go from 70% up to 130% long. Gross exposure started 2020 at around 125%; however, this has now reduced to around 112%. Of this, net exposure reduced from 115% to the current level of c. 105%. The shorts are typically a smaller size than long positions, at between 0.5% and 1% of NAV.
Like BlackRock’s other UK smaller-companies trust, BlackRock Smaller Companies, THRG is well diversified. It currently has 115 holdings, relative to a peer-group average of just 50. As of the end of March, the top ten holdings made up 26.1%, the lowest percentage of any trust in the sector.
top ten holdings
||% of net assets
|Watches of Switzerland
Source: BlackRock, as at 31/03/2020
At a sectoral level, the largest overweight positions are towards communication services, technology and industrials. However, the largest absolute allocations are in industrials, consumer services and financials.
Although the trust is UK-focussed, manager Dan Whitestone does have capacity to invest up to 15% of the portfolio in overseas companies. This change was also made when the board announced the removal of the restrictions on AIM-listed companies in 2018. Currently 9.5% is invested overseas.
The trust gears through the use of contracts for difference (CFDs) rather than bank borrowing, which is more commonly used by its peers. CFDs are cheaper and allow the Dan greater flexibility to act opportunistically. The board has set a limit that gross gearing via CFDs doesn’t exceed 30% of net assets.
CFDs allow Dan to gain exposure to companies by putting down only a small margin rather than buying the full quota of shares, hence the gearing effect. Currently, BlackRock Throgmorton’s effective gross exposure stands at 112%, although the net exposure (deducting shorts) is 105%. This has been reduced throughout 2020 as the pandemic has hit, leaving Dan in a strong position to invest as opportunities arise.
Performance of the trust is measured relative to the Numis Smaller Companies plus AIM (ex ITs) Index. Over the past ten years the trust has comfortably outperformed the benchmark’s returns of 60%, delivering returns of 329.9%. THRG has also generated considerably stronger returns than the IA and AIC peer groups, which have generated returns of 193.4% and 195% respectively.
As can be seen in the annual calendar-year returns graph below, the trust has been able to generate exceptional returns in rising markets, and has also been able to protect capital when they fall. Over the ten-year period to 18/05/2020, the managers have achieved annualised alpha of 6.8%, outperforming the sector average of 4.4%.
As with most UK equity vehicles, the past few years have been particularly turbulent and 2018 saw the trust lose 11.7%; however, this was favourable in comparison to the losses of the benchmark (18.1%) and AIC peer group (13.3%). Dan cites the capacity to hold both long and short positions as the key differentiator for returns. This allowed him to generate alpha from alternative areas despite the challenging market environment. 2019, on the other hand, saw markets rise considerably. Over the year the trust generated NAV returns of 39.6%, more than double those of the benchmark (which generated returns of 18.8%). This was a year that once more wasn’t without a number of macroeconomic hurdles, including global trade concerns and the uncertain political environment in the UK due to Brexit. However, Dan believes that 2019 illustrated that stock and industry specifics can triumph over macro factors, particularly during times of uncertainty. In comparison to 2018, where short positions were vital to outperformance, the long book drove most of the returns in 2019. However, a positive contribution from shorts nonetheless helped. Over the year the trust predominantly benefitted from its long book, with JD Sports, AVEVA and 4imprint leading the way in stock attribution.
THRG has not been as successful in protecting capital during the current pandemic as it has been during previous troubled markets. 2020 year to date has been challenging, but THRG has outperformed its benchmark, with Dan once again demonstrating his ability to protect capital and deliver differentiated alpha regardless of the market backdrop. Dan admits that the trust could have performed more strongly, given his long-term views of avoiding sectors like banking and oil companies, which have been overdistributing dividends and have therefore been hit particularly hard. However, the trust’s high net exposure, which started the year at 110%, was a drag on performance, as was THRG’s exposure to consumer-facing companies.
Looking forward, Dan believes there are a lot of opportunities in the market. A number of industries will never look the same again after the pandemic, he says, and it is about distinguishing the winners from the losers. In recent weeks Dan has highlighted some positive trading statements from companies in the portfolio, supporting some of his high-conviction views about changing industry dynamics. These are providing Dan with confidence that the level of industry change is accelerating as a result of COVID-19, and as such he believes that some of these important themes will deliver for the trust in the coming quarters and years: for example, through the acceleration in digital transformation. As such he has been exiting companies that will need to increase their debt to recover (resulting in a change to their financial structure), and he has been adding to those which he believes will see their long-term growth rates accelerating as a result of this.
Income has become an increasingly important aspect of the trust’s return over the years. THRG has delivered annualised dividend growth of 18.3% over five years, 5% greater than the AIC UK Smaller Companies sector average. At 2.1%, the trust’s yield is still relatively low; however, it is in line with that of most other trusts in the sector, where the average is 2.2%.
Given the current environment, it is unlikely that the dividend will be able to continue to grow at this rate. However, the team have built up healthy reserves over the years. The most recent full-year dividend of 10.2p was covered 1.45x by revenue reserves, despite the fact that 20% of the dividend was paid from the previous year’s reserves.
Previously the trust had a structure consisting of two separate portfolios. This was amended in early 2018, and the two portfolios were combined. After this change Dan Whitestone, who had been co-manager alongside Mike Prentis from 2015, took full responsibility for the portfolio.
Dan is not only the manager of THRG, but also manages the BlackRock UK Emerging Companies Hedge Fund and the BSF UK Emerging Companies Absolute Return Fund. Dan has been at BlackRock since 2013, and prior to this he worked for UBS, where he was the head of the UK small- and mid-cap sales desk.
Dan is supported by the BlackRock emerging-companies team, consisting of four investment professionals. The team have a vast amount of experience, which means that they are able to rapidly identify investment opportunities.
THRG trades on a premium to NAV of 0.4%, which we attribute to its excellent long-term track record as well as to a differentiated strategy which includes the ability to short stocks, which investors are likely to view as attractive in the current volatile environment. Following the emergence of the pandemic, the trust’s discount did widen out considerably, as did the sector average. However, since then it has returned to its premium rating versus both NAV and the peer group (where the average discount is 9%).
The board doesn’t have a hard discount-control mechanism, which means it can fluctuate with sentiment. However, when the trust has been trading at a premium the board has been issuing shares. So far in 2020, 6,738,222 shares have been issued, increasing the number of shares in issue by 8%.
Currently THRG charges an OCF of 0.59%, one of the cheapest in a sector where the average is 1.06%. However, there is also a performance fee, which is calculated on an annualised rolling two-year basis with a maximum annual fee of 0.9% of the two-year rolling average month-end gross assets. The fee is 15% of the outperformance of the benchmark. When one includes this, the charges rise to 1.75% of net assets as at the end of the most recent financial year (November 2019). However, a cap on the total fees, including the performance fee, has been put in place at 1.25% of average gross assets over two years.
The KID RIY for the trust is 2.06%, in comparison to the sector weighted average of 1.98%. It is nevertheless important to recognise that some trusts take different approaches to calculating the KID RIY.
Dan sees Environmental, Social and Governance (ESG) information as a way to improve risk-adjusted returns. As such, ESG is built into the entire investment process, starting with the research and due diligence on new investments, all the way through to monitoring investments. This does not mean the trust is ESG-focussed, but instead means that the economic and financial indicators that Dan looks at include ESG issues. In particular, Dan is looking for potentially negative events or poor corporate behaviour which could potentially harm investor returns in the future.
Governance is an area of particular interest to Dan, and he works alongside the BlackRock Investment Stewardship (BIS) team to assess this. Financial-statement integrity is a key focus, and the BIS team will look at a range of systematic measures to highlight companies’ accounting ratios in their assessment of balance-sheet and earnings-quality risks. For other areas of governance (like audit quality or executive pay), the BIS team use their internal research to flag potential risks, including regulatory filings announcements and public newsfeeds. Environmental and social factors are assessed using third-party data from MSCI. The team will examine this data to determine whether specific environmental and/or social exposure exists, and if so, to determine how well such exposure is being managed.