BlackRock
Updated 05 May 2023
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Disclaimer

This is a non-independent marketing communication commissioned by BlackRock. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

While the UK market is a good hunting ground for income-seekers, that income is often concentrated in a handful of stocks and sectors. “A small cap allocation can help to diversify this, and the investment trust structure has unique features that makes it attractive to income seekers” says Roland Arnold on the BlackRock Smaller Companies Trust.

The UK stock market has a well-deserved reputation for income. There is an established dividend culture among many UK companies and the FTSE All Share outpaces many of its global peers for yield.1 In 2022, UK companies paid out £94.3bn in dividends, an 8% rise on the previous year. This was led by a strong performance from the mining and financials sectors.2

However, UK income strategies focused on larger companies often have a diversification problem. The recurring criticism is that UK income funds are concentrated in a handful of companies and sectors.3 This is unarguable. In 2022, £1 in every £6 paid in dividends came from the mining sector alone.4 The top five companies – Rio Tinto, Shell, British American Tobacco, HSBC and Glencore – accounted for 28% of all dividends paid.5 Too often, UK dividend strategies are narrowly focused on a handful of mining, energy and financial companies.

This can be problematic. The mining sector, for example, can be sensitive to shifts in the global economy. Mining dividends had already started to decline in the second half of 2022 and are forecast to drop further in 2023.6 Banks saw dividend growth of over 50% in 2022, but dividends have yet to return to pre-pandemic levels.7 It is a reminder of the importance of a diverse dividend stream.

The small and mid cap sectors are often over-looked by income investors, and yet can provide a potential solution to this diversification problem. There are compelling yields available from UK smaller companies, with the MSCI UK Small Cap index currently yielding 3.1%.7 compared to 2.1% for the MSCI World Small Cap.8

Small caps are, by their nature, more diverse. There are more of them – almost 1,500 included in the Numis Smaller Companies plus Aim index (excluding Investment Companies), the benchmark for the BlackRock Smaller Companies Trust – and they are spread across multiple sectors, rather than being dominated by just a handful. The small cap universe includes industrials, technology, property and healthcare.9

Diversification Diversification and asset allocation may not fully protect you from market risk

They are also faster-growing. At a time of higher bond yields, income seekers have greater choice. The advantage of equities over bonds is that dividends can grow over time, whereas the income from a bond is static. This may give investors greater protection from inflation. Smaller company dividends could deliver this growth.

Equity risk The value of equities and equity-related securities can be affected by daily stock market movements. Other influential factors include political, economic news, company earnings and significant corporate events.

In the BlackRock Smaller Companies portfolio, we have invested in companies where the initial dividend yield looked unremarkable, but the growth in dividends over time has been compelling for many of our companies because of their cash generative business models, which allow this cash to be deployed in capital expenditure, acquisitions or dividends. The trust has now increased its annual dividend every year since 2003 with an annualised increase in dividends paid since this date of 12.2%.10

To find the best smaller companies that can grow their income over time, we focus on certain factors that indicate a company’s quality. Companies need strong cash flow, for example, a sound business model, strong competitive advantages and a capable management team to sustain and grow their payouts to investors. These are all at the core of our process on the BlackRock Smaller Companies Trust.

Investment strategy There can be no guarantee that the investment strategy can be successful and the value of investments may go down as well as up.

The investment trust structure has unique features that makes it attractive to income seekers. In particular, it allows us to reserve income in buoyant times (by holding back up to 15% of the income received each year) to boost distributions to shareholders in leaner times, giving us the flexibility to grow our payouts to investors over time. It is notable that the industry body for investment trusts (the Association of Investment Companies (AIC) maintains a list of ‘dividend heroes’, being investment companies that have increased dividends over a sustained period of time. The AIC released an update on 14 March 2023 noting (inter alia) that BlackRock Smaller Companies is leading a next generation of dividend heroes, having increased its dividend for 19 consecutive years.11 As of 31 August 2022, the company had £684m12 in distributable reserves, including revenue reserves of £17.9m.13

Many investors will be looking at their income options for this year’s ISA allocation. ISAs allow investors to build up a tax-free income stream over time. While the UK could optically be a great place to look for income, investors need to ensure that income is properly diversified and small caps could provide a great balance.

1https://markets.ft.com/data/dataarchive/ajax/fetchreport?reportCode=GWSM&documentKey=688_GWSM_230315, 18th October 2022

2 https://720106e1.flowpaper.com/LinkGroupUKDividendMonitorIssue52Q422/#page=2, January 2023

3 https://www.trustnet.com/news/503541/are-the-highest-yielding-uk-equity-income-funds-too-risky , 15th April 2014

4 https://www.linkgroup.eu/insights/publications/uk-dividend-monitor-q4-2022/ , 26th October 2022

5 https://www.msci.com/documents/10199/facc2bc4-c6ed-46aa-9c1e-356fab513812 , 28th February 2023

6 https://720106e1.flowpaper.com/LinkGroupUKDividendMonitorIssue52Q422/#page=2 , January 2023

7 https://720106e1.flowpaper.com/LinkGroupUKDividendMonitorIssue52Q422/#page=2 , January 2023

8 file:///C:/Users/reyna/Downloads/GEISSC_20230228%20(1).pdf , December 2022

9 https://www.msci.com/documents/10199/facc2bc4-c6ed-46aa-9c1e-356fab513812 , 28th February 2023

10 https://www.numiscorp.com/docs/Quick%20Guide%20to%20the%20Numis%20Smaller%20Companies%20Index.pdf , 14th January 2021

11 https://www.fundslibrary.co.uk/FundsLibrary.DataRetrieval/Documents.aspx/?type=sl.ra.full&id=1db99dd6-1675-439b-aa16-e66bf508a172&user=A%2fHYRXBAZNadVzh6Sr4d4aWgJtmMM03Pe%2b9Rz25NPNBZdj9ex3ymtOlPwWIRUtkZ&r=1 , February 2023

12 SOURCE: BlackRock Smaller Companies Annual Report 2022, 28 February 2022

13 Unaudited data sourced from the company’s interim financial statements, 31 August 2022.

Risk Warnings

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time.

Counterparty Risk

The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.

Gearing Risk

Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.

Liquidity Risk

The Fund's investments may have low liquidity which often causes the value of these investments to be less predictable. In extreme cases, the Fund may not be able to realise the investment at the latest market price or at a price considered fair.

Smaller Company Investments

Shares in smaller companies typically trade in less volume and experience greater price variations than larger companies.

Important Information

Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: + 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.

UK Investment Trust Funds: This document is marketing material. The Company is managed by BlackRock Fund Managers Limited (BFM) as the AIFM. BFM has delegated certain investment management and other ancillary services to BlackRock Investment Management (UK) Limited. The Company’s shares are traded on the London Stock Exchange and dealing may only be through a member of the Exchange. The Company will not invest more than 15% of its gross assets in other listed investment trusts. SEDOL™ is a trademark of the London Stock Exchange plc and is used under licence.

Net Asset Value (NAV) performance is not the same as share price performance, and shareholders may realise returns that are lower or higher than NAV performance.

The investment trusts listed in this document currently conduct their affairs so that their securities can be recommended by IFAs to ordinary retail investors in accordance with the Financial Conduct Authority’s rules in relation to nonmainstream investment products and intend to continue to do so for the foreseeable future. The securities are excluded from the Financial Conduct Authority’s restrictions which apply to non-mainstream investment products because they are securities issued by investment trusts. Investors should understand all characteristics of the funds objective before investing. For information on investor rights and how to raise complaints please go to https://www.blackrock.com/corporate/compliance/investor-right available in local language in registered jurisdictions.

Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy.

This document is for information purposes only and does not constitute an offer or invitation to anyone to invest in any BlackRock funds and has not been prepared in connection with any such offer.

© 2023 BlackRock, Inc. All Rights reserved. BLACKROCK, BLACKROCK SOLUTIONS and iSHARES are trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.

MKTGH0323E/S-2803920

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