BlackRock Throgmorton Trust (THRG) aims for long-term capital growth and an attractive total return through investment in UK small- and mid-cap companies. The manager, Dan Whitestone, allocates to both long and short positions, with the short book a key differentiator from its peers.
As we discuss under Performance, THRG’s returns have been exceptionally strong in both the short term and over the past five years, in fact the strongest in the peer group over five years. Perhaps as a result of these returns, THRG trades close to a premium (as discussed under Discount). The board has been active in issuing shares to help to manage this, recently placing 2.68m shares with institutional investors.
Dan believes the broader factors that have driven outperformance of many of his holdings are not only durable, but in fact accelerating, as we discuss under Portfolio. Following the COVID-19 pandemic and related policy responses, he anticipates significant ‘corporate Darwinism’. In this context, companies with robust balance sheets and market leading products can often look to consolidate and extend their intra-industry leads. Yet other areas are more prone than ever, in his view, to disruption from technology heavy, capital-light businesses with significant operational flexibility.
Long holdings are initiated with a typical timeframe of between 3-5 years, with Dan looking to identify companies which fall within one (or both) of two buckets. These are companies with quality differentiators, and industry disruptors. At present Dan believes there are significant opportunities for companies falling within both buckets.
Although the investment strategy is focussed on capital growth, the board has increased dividends every year for the past ten financial years.
Following the spread of the COVID-19 pandemic, and the policy responses that followed, UK equity markets largely followed their global peers in bifurcating sharply between assumed beneficiaries and victims of the ‘new’ environment. This played well to the existing strategy within THRG, with its emphasis on identifying both disruptors and the disrupted, and an emphasis on financial and operational robustness. The manager is clearly excited by the opportunities that have already arisen from this environment, and his belief that we are only at the start of sustained shifts in behaviours which will drive the companies held within THRG is compelling in its logic.
A perception of ‘normalisation’ back to pre-COVID models (and intra-market rotations to ‘value’), may have been expected to pose a short-term headwind to THRG, yet precisely such an environment has not impeded the relative return profile in recent weeks. In the longer-term, the focus on an alliance of balance sheet strength and disruptive, innovative business models seems likely to us to yield significant opportunities more or less irrespective of wider market conditions, but should the manager’s envisaged environment come to pass it would very likely prove a further tailwind to the strategy. Clearly insolvency risks remain elevated across global markets, yet little risk seems to be implied in many instances. This should, in our view, continue to offer complimentary opportunities on both the short and long book for THRG.
|Very strong track record of absolute and relative performance
||Some underlying holdings could be vulnerable to profit-taking in a market rotation
|Highly exposed to long-term industry change and secular trends accelerating as a result of COVID-19
||Net market exposure tends to be structurally in excess of 100%, exacerbating downside as well as amplifying upside
|Focus on balance sheet strength provides exposure to accelerated ‘corporate Darwinism’
||Currently trading on a premium to NAV
Blackrock Throgmorton trust (THRG) aims to provide shareholders with long term capital growth and an attractive total return through investment primarily in UK smaller and mid-cap companies, though up to 15% of the portfolio can be invested overseas. Managed by Dan Whitestone, who leads the broader BlackRock Emerging Companies Team, THRG holds both long and short positions in a variety of UK companies meeting the team’s investment criteria (or notably failing to meet them in the case of short positions).
The structure of THRG, balancing long and stock-specific short positions, is unique within the sector and offers shareholders a truly differentiated source of alpha. Within THRG, short positions will typically fall into one of two categories: 1) industries under significant pressure, which will often be the victims of industry change (the disrupted); and 2) stock specific shorts, for example companies with weak financial structures (i.e. too much debt and not enough cashflow). Dan has the option of adjusting the gross exposure on a range of anywhere between 100-130% of assets, and net exposure between 70-115%. More typically we would expect to gross equity exposure of between 120-130% at any one time, with the net exposure of the trust between 100-110%.
To illustrate how long and short positions impact the gross and net exposure, if THRG were to hypothetically hold 110% exposure to long positions and 20% exposure to shorts, this would equate to a gross position of 130% and a net position of 90%. Both gross and net exposures, as well as the balance between long and short positions, will reflect the opportunity set from a bottom-up stock perspective identified by the team at any one time. The most recently announced net positioning of c. 117.4% (as at 30/09/2020), reflects Dan’s optimistic outlook on the long opportunity set available to him at this time. This is, however, slightly below the net exposure seen at the previous financial year quarter end (31/08/2020) of c. 118.6%. Of perhaps more interest is the low level of short exposure that was held at the end of August, with only 2.4% held short.
THRG’s long positions are selected by Dan from companies falling within two thematic buckets. Long positions will represent companies he either believes to be high-quality, long-term differentiated companies, or companies that are ‘disruptors’ leading industry change. Companies falling within either bucket will often have certain commonalities, which Dan believes are crucial for a business to enjoy long-term compounding success: 1) the quality of management, and their strategy for the future; 2) a truly differentiated product; 3) the industry’s structural drivers; 4) good conversion of earnings to cash; 5) a strong financial position and robust balance sheets.
Companies more broadly falling within the ‘quality differential’ categorisation will typically display what Dan and the team regard as very strong competitive positions. These will not simply, in THRG’s constituent companies, possess sufficient relative financial clout to dominate on pricing power alone, but will instead offer products or services that are genuinely superior to those offered by industry competitors and are preferred by consumers. This should, in itself, create brand loyalty and reliable cash flows around which management teams can construct strategies. Strong management teams are considered a requirement to ensure good strategic planning, deployment of capital and execution of strategy.
YouGov, for example, enjoys structural tailwinds from an increasing demand for aggregated data services, an area where it enjoys a significant intellectual property advantage. Strong management has meant that the company has consistently beaten forecasts, and continues to deliver on its strategy to monetise its online panel data across an increasing array of industries looking for data insights. Dan sees significant further demand for this type of service and growth potential in the post-COVID world.
Industry change companies are disruptive forces within their industry, often utilising new technology to position themselves at the forefront of new consumer trends. Typically they will enjoy cost advantages over more established industry peers, and will be more receptive to changes in consumption trends or patterns. Companies falling within this categorisation usually display capital-light operational models, with an ability to nimbly apply cash flows to execute strategy and expand market share.
This is a decidedly ‘growth’ tilted approach to stock analysis, focusing on a company’s prospects with less concern for the current valuation. Indeed, Morningstar analytics suggests that THRG is the most ‘growth’ oriented trust within the broader UK smaller companies peer group.
Dan notes that the COVID-19 pandemic, associated policy responses and operational impacts upon a vast array of companies and industries means that he believes conventional valuation metrics are less relevant at this time. Instead he believes that understanding which companies can emerge as winners from the aftermath — as excess capacity is destroyed — is more pertinent to current positioning, as we have discussed further below.
In seeking to understand these factors, the broader BlackRock team conduct extensive and numerous meetings every year with company management. They target meeting a minimum of 750 company management teams a year, and have consistently exceeded this. These often serve as tangential idea generators, giving rise to new ideas about competitors or related industries, as well as the company itself.
Idea generation more generally usually comes from qualitative sources, leaning on the wider BlackRock analytical team as well as external sources. Certain macroeconomic and thematic considerations are applied, as discussed below, but these are more in the context of understanding the structural trends within an industry and a company’s ability to profit from these.
When Dan has identified an attractive long opportunity, positions are initiated. Sizing is undertaken based upon conviction. High conviction positions typically hold a c. 3% weighting; qualitative analysis of the business risks are used to trim this position until it reaches a level where Dan feels comfortable with the risk incurred whilst retaining sufficient exposure to the upside envisaged. Positions are resized on an ongoing basis back to their target weight, with 5% set as a hard limit on any position size (though sector allocations are free of any restrictions).
THRG: Top-ten long holdings
||% of gross assets
|Watches of Switzerland
|Pets at Home
|Impax Asset Management
Source: BlackRock, as at 31/10/2020
Stock specific risk is thus managed by position sizing, but risk analytics regularly feed back to Dan and the team on risk outputs from the portfolio. This serves, in some instances, to highlight when different holdings may be experiencing the same external drivers of share price returns. This allows the management team to manage position sizing accordingly. It also feeds through estimates of broader portfolio level sensitivity to different macroeconomic, factor, and market conditions. This is used by Dan to understand the portfolio and its constituents, and what drives them, as opposed to being used to adjust weightings to target outcomes.
Short positions themselves are regularly employed, and potential shorting candidates are essentially likely to display inverse characteristics to long positions. These may be in industries vulnerable to disruption or facing structural challenges (such as, in recent months, restaurants), or companies that have structurally underinvested and whose competitive position is accordingly being undermined. Whilst in many cases long ideas will concurrently give rise to potential shorting opportunities, positions are not ‘paired’ for a relative value play. Excessive leverage will make a company more likely to meet Dan’s short criteria. Shorts are held through contracts for difference (CFD), and are held without specific target exit dates or stop-losses. Instead (as with long positions) they are subject to regular rebalancing to maintain position size, with Dan exiting positions either when he believes most of the operational downside faced by the business to be reflected in market pricing or if the short thesis has been considered disproven.
Presently THRG is running a relatively high net exposure of c. 117.4%. This reflects the significant opportunities Dan is identifying in the wake of the COVID-19 pandemic and associated economic disruption. He notes that following such periods of such economic trauma there can typically be expected to come a period of consolidation and ‘corporate Darwinism’ as over extended, poorly run, and/or obsolete businesses are forced to enter insolvency or else accept their subjugation to industry leaders. The nature of the current crisis, in his view, will serve to accelerate the advantages enjoyed by capital-light, data-heavy businesses with robust balance sheets, who stand well positioned to expand their market share and more rapidly grow revenues and earnings.
Recognition of the evolving macroeconomic situation caused Dan to exit positions where the investment thesis had deteriorated accordingly, including housebuilder Redrow, serviced office provider IWG and pub group JD Wetherspoons.
Such companies can be identified in sectors where the team are more likely to be invested in any event. Capital-heavy, cyclical industries such as energy and materials are unlikely to feature in THRG’s portfolio on either the long or short book, with Dan preferring to focus on companies in industries where he believes BlackRock’s analytical team can identify drivers of company success or failure which are not dependent on factors such as commodity prices.
THRG: SECTOR EXPOSURE
As at 14/12/2020, THRG had gearing equating to c. 22% in place (Source: The AIC). However, this cannot be understood in the context of a typical long-only equity portfolio. This comprises a mixture of long and short positions; as at 31/08/2020 (the most recently available breakdown), the short book amounted to c. 2.4%. Net market exposure was 117.4% when last publicly released (30/09/2020); this is the long exposure minus the short exposure, and we think this reflects, if gearing is to be interpreted as additional exposure to market beta above that of assets, a better understanding of the geared positioning of the trust.
The additional long and short positions increase the gross exposure of the trust, but do not axiomatically denote an increase in implied beta. As we have noted under the Portfolio section, THRG operates within a structural gross exposure range of 100-130% of assets, with 120-130% a typical range. Net exposure will be between 70-115%, with 100-110% net exposure expected to be a typical range.
Gross in this sense denotes the absolute exposure via both the short book and the long book (i.e. the values of short positions are considered positive). For example, if 110% of the trust’s assets were held long, and 20% short, this would result in a 130% gross position and a 90% net position. The current net exposure (as at 30/09/2020) of c. 117.4% is reflective of the positive outlook Dan currently holds on the opportunity set available within his investment universe.
As can be seen in the chart below, Dan has increasingly been identifying attractive opportunities on the long book as 2020 has progressed. Combined with the reduction in the short book, this has seen THRG’s net exposure move significantly higher than was the case 12 months ago.
THRG: Gross, Net, Long and Short Exposure
The structural ranges THRG will operate in are a reflection of board level policy restrictions on gearing. This limits gearing through the trust’s derivatives exposure to 30% of net assets (in line with the 70% lower bound range for net market exposure). Net gearing is limited to a level of 20%.
Gearing is undertaken through contracts for difference (CFD).
THRG has been under the sole management of Dan since 12/02/2018. He had also previously served as co-manager since 2015.
Over the five years to 15/11/2020, THRG has delivered NAV and share price returns of c. 92.4% and c. 129.4% respectively. This has represented strong outperformance of the Morningstar UK Smaller Companies peer group, which has seen average NAV and share price returns over the same period of c. 36.1% and c. 37% respectively.
Indeed, THRG has enjoyed the strongest NAV and share price returns of any trust within the peer group over this period, despite it commencing near the start of a significant rally in materials companies (which the trust eschews) in 2016 and associated compounding implications. As we note below, outperformance on average has occurred in both rising and falling markets, and does not appear to have been dependent on stylistic tailwinds over this period.
It has also significantly outperformed the benchmark Numis Smaller Companies plus AIM excluding investment trusts index, which delivered returns of c. 35.2% over this period. We would highlight that investors cannot take passive exposure to this index at present, but investors wishing to take passive exposure to UK smaller companies through the iShares MSCI UK Small Cap ETF would have trailed further, with returns of c. 26.6%. Nor has this outperformance been solely the product of strong recent returns, as can be seen in the chart below (which looks at THRG’s NAV return relative to the peer group average NAV and the benchmark over the past five years).
THRG: Five-year NAV returns relative to peers and benchmark
Returns in 2020 have been boosted by positions in holdings such as Games Workshop, YouGov, and Avon Rubber, where pre-existing operational tailwinds Dan had identified for these companies accelerated in the face of COVID-19 related disruptions. This was reflective of broader market conditions which, in the wake of the severe economic contraction induced by policy responses to the COVID-19 pandemic, showed sharp divergences in the treatment of stocks presumed to be vulnerable to heightened insolvency risks and those presumed to be beneficiaries of the changed environment.
Dan had in any event been tilting the portfolio into similar areas prior to the onset of the crisis, but accelerated this shift in the wake of lockdowns. The judgement of the market has been that this was the correct move, with THRG delivering exceptional NAV returns of c. 76% from 19/03/2020 to 15/11/2020 (market low to time of writing), compared to a peer group average NAV return of c. 57% and benchmark returns of c. 60%.
THRG has benefitted broadly on a sectoral basis, with overweight allocations to consumer goods and technology and a zero-weight allocation to oil & gas notable beneficiaries. On the other side of the ledger, a lack of exposure to the materials sector has detracted as precious metals miners in particular rallied hard on the expectation of substantial policy support for the economy. Sector weights are an output of the stock selection process as opposed to a target, and these kind of sector tilts should be expected to be relatively structural. Underweight exposure to resources will have hampered relative returns over much of 2016, for example, whilst an overweight to consumer services benefitted returns over 2019.
Over the past 12 months to 15/11/2020, THRG has delivered NAV and share price returns of c. 10.2% and c. 11.9% respectively, significantly outperforming the peer group NAV (c. 0.7%) and share price (-0.5%) average over this same period. This has also represented significant outperformance of the benchmark index, which has gained c. 3.2% over this same period. The trust has outperformed after rapidly recovering from the market drawdown of Q1 2020.
THRG: 12-month returns vs peers and benchmark
It is notable that THRG has outperformed in both rising and falling markets in recent years, as we can see in the table below. The stronger relative returns under rising markets compared to falling markets is likely in part attributable to a tendency to run the net exposure in excess of 100%, yet this makes the outperformance relative to the (ungeared) benchmark in periods where markets are declining the more notable in our view. As we have noted under Portfolio, THRG structurally incorporates short positions. However, whilst this may optically suggest it should generate outperformance on the downside, the manager typically runs net exposure at between 100-110% long, ordinarily with no cash exposure. The short book is not employed to reduce market beta, but instead as an alpha generation tool.
THRG: Rolling 3-month NAV returns relative to benchmark and peers
Relative to benchmark, market negative
Relative to benchmark, market positive
Relative to peers, market negative
|% occasions outperformed
Source: Morningstar, as of 16/11/2015-15/11/2020
We cannot isolate the relative contributions of the short book and any potential outperformance on the downside from the long book to determine contributions to outperformance in periods of market drawdown. BlackRock comment that they typically expect the short book to add to factor sensitivity but reduce market beta. With ‘value’ style indices having underperformed in the Q1 drawdown, both elements in this regard should have contributed positively, though it is worth commenting that THRG experienced a sharper drawdown in Q1 2020 than the broader market or peer group. Net exposure of c. 110% detracted from returns relative to the benchmark.
THRG’s strong growth-tilt has been a tailwind in recent years. However, in the most recent sustained period in which the small cap value index outperformed the small cap growth index (2011-2013 as the below chart shows), the trust also outperformed its peers. This indicates that a stylistic headwind is not necessary for this strategy to outperform. (Although Dan had not joined the investment team during this period, the strategy was broadly the same.) Over the past ten calendar years, relative returns to both the peer group (7/10) and benchmark (9/10) have been consistently positive.
THRG: Discrete calendar year return
THRG currently yields c. 1.5% on an historic basis, as at 14/12/2020. The trust targets long-term capital growth and attractive total returns. Dividends can and will form a part of the total return profile of THRG itself, but the underlying investment mandate does not require the manager to seek income generation from the constituent companies. Net notional income from derivatives contracts, through which the short book predominantly is constructed, is assigned to the income account. This will typically mean the trust incurs negative carry from derivatives positions in relation to the income account. We estimate that this detracted c. 1.5p per share from the income account in financial year (FY) 2019, for example.
The board has acknowledged the attraction of regular dividends to shareholders, yet is cognisant of the manager’s investment approach and the variable nature of income generation amongst highly growth focussed smaller companies such as those likely to make up THRG’s portfolio. Given the manager’s current outlook (as we discuss in the Portfolio section), it is unlikely his usual investment process would typically lead him to a portfolio of companies returning significant levels of cash to shareholders instead of looking to deploy free cash flow into either (or both) internal and inorganic expansion opportunities.
THRG has paid an interim dividend in FY 2020 in line with the FY 2019 interim dividend, despite a c. 53% decline in revenue returns per share over the first half of FY 2020 (to 31/05/2020). With the board having conducted extensive share issuance over this period, this overstates the actual decline in revenues received somewhat, but we still estimate these to have declined by c. 46%.
At THRG’s interim results on 31/05/2020, it reported revenue reserves of c. £7.3m, which we estimate was equivalent to revenue reserve cover of c. 0.85x the FY 2019 dividend prior to the most recent share issuance. The trust has subsequently paid its interim dividend of 2.5p per share. We estimate that, after accounting for the interim dividend on the expanded share base, THRG will retain at least 0.6x revenue reserve cover relative to the FY 2019 dividend, even if the trust has received no net income in this period (an outcome which we consider highly unlikely). Based upon performance attribution to 31/08/2020, we would also note that we would expect that the short book will not detract from the income account over the current financial year, which should further ease any pressure to use reserves to cover the dividend. Accordingly, we believe the board retains reasonable room to continue to support the dividend in the near future.
THRG has raised its dividend every year since FY 2009. Over the past ten financial years to FY 2019, the dividend has increased by an annualised rate of 20%. Nor is it solely a result of a depressed yield following the 2008-09 financial crisis, with the past five years having seen annualised dividend growth of c. 18.3%.
THRG: Dividend and revenue return per share
Previously the trust had a structure consisting of two separate portfolios, with a long-only book and a long/short book (with the latter run by current manager Dan Whitestone). This was amended in early 2018, and the two portfolios were combined. After this change Dan, who had been co-manager alongside Mike Prentis from 2015, took full responsibility for the portfolio.
Dan is the head of the BlackRock Emerging Companies team, who oversee nine open-ended, closed-ended and hedge fund products. As well as managing THRG, Dan 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; 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 five investment professionals. The team have a vast amount of experience, with significant familiarity with the underlying investment universe from experience.
THRG trades on a discount to NAV of 0.7% as at 14/12/2020, having commonly traded at a premium to NAV throughout 2020 (c. 59% of days YTD). This has been in stark contrast to the wider sector. THRG did move briefly to a discount amidst the market sell-off of March 2020. We note that this was not uncommon amongst trusts at this time, with a dearth of ready buyers (and with market makers constrained from occupying this role by internal risk departments) seeing often mild selling pressure resulting in disproportionate mark-downs in share prices.
The board has taken advantage of the consistent premium on which THRG has traded to reissue shares held in treasury, reissuing to the market all 6.4m shares that were held in treasury at the start of the previous financial year (01/12/2019). These were reissued at a weighted average premium of c. 2.3%. By 01/04/2020, all shares from treasury had been reissued to the wider market.
Subsequently, the board has looked to manage the premium of the trust through further issuance. The board has made clear that it believes it is in the long-term interests of shareholders to ensure that the trust does not trade at an excessive premium or discount to NAV for any extended period of time.
Having issued over £90m in new equity (both from treasury and new issuance) over the past 12 months, including a successful placing of 2.68m ordinary shares (£18.4m) in November, the board has recently issued a circular to shareholders to seek a renewed authority to issue up to 10% of the Ordinary Shares that will be in issue on a non pre-emptive basis.
At the depth of the market drawdown (23/03/2020), THRG’s discount hit its widest level of c. 11.6%, but this discount opportunity proved fleeting as the trust moved to a premium within three days (by 26/03/2020). The discount has again widened briefly on subsequent occasions, but has generally rapidly attracted buyers on these occasions. This is likely in recognition of the strong returns profile THRG has demonstrated over this period, as we discuss under Performance) but also perhaps a recognition from buyers, against a fractious macroeconomic backdrop, that THRG’s portfolio has been heavily skewed towards perceived winners with sustainable business models.
Currently THRG has an OCF (excluding performance fees) of 0.59%; this is currently amongst the cheapest in a sector where the average is 0.77% (Source: JPMorgan Cazenove). This includes a management fee of 0.35%. A performance fee of 15% of the outperformance of the benchmark is also applicable, 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. 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 1.37%, although we would caution that different managers use differing methodologies to calculate this figure.
Dan sees Environmental, Social and Governance (ESG) analysis as a natural extension of the investment process that is, in any event, embedded into THRG’s stock analysis. There is a strong focus with stock selection on ensuring strong governance and good management, with long-term growth prospects and ability to protect and develop market leadership key considerations.
The focus on ‘disruptive’ companies, with technology considered a leading driver of such disruptive capabilities in many instances, will typically as an output lend itself to a portfolio of companies which screen well quantitatively on ESG screens. This is a by-product, and not a target, of the investment process.
It would seem fair to us to say this is true of ESG factors within THRG in general. THRG likely meets the criteria of many ESG-minded investors, but this is not a result of a conscious effort to do so. Instead, it is more reflective of an alignment between the factors considered important long-term drivers of returns by the analytical team, and of the factors generally considered within ESG screens. The portfolio currently scores ‘average’ on Morningstar sustainalytics.
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.
Under the auspices of BlackRock as well as the sizeable suite of products they themselves manage, one of the world’s largest asset managers, Dan and the rest of the THRG team enjoy significant access to company management. This enables them to engage with corporate management teams on ensuring good governance, as they deem it, remains in practice.