BlackRock Smaller Companies 30 April 2024

BlackRock Smaller Companies (BRSC) aims to deliver long-term capital growth, with manager Roland Arnold seeking to identify high-quality companies at the smaller end of the UK equity market. As discussed in Portfolio, the investment process has remained unchanged over the last 20 years, with Roland looking to exploit the opportunities within a notoriously under-researched area of the market.

As discussed in Performance, BRSC has generated significant outperformance of the benchmark over the long term, delivering an annualised return of 6.5% versus the 3.6% generated by the Deutsche Numis Smaller Companies plus AIM (ex. IC) Index benchmark and the 4.7% generated by the UK Smaller Companies peer group over the past ten years. That said, rising interest rates and the exodus of flows from the UK equity market have made it a challenging environment for growth strategies in recent years, leading to some weaker performance for BRSC. The trust did deliver positive returns in 2023, albeit behind those of the sector and index. As sentiment has waned, BRSC’s Discount has widened out to 12.7%, which compares to a five-year average of 7.8%.

Roland points out that BRSC’s underlying holdings have demonstrated operational resilience contributing to an increase in revenue returns over 2023, accompanied by the trust’s 20th consecutive year of dividend growth as it claimed a spot as one of the AIC’s ‘dividend heroes’ (see Dividend). Roland believes there is significant value to be had in the UK market relative to the markets damning perceptions and has looked to increase his positions in higher-conviction holdings which he believes are due to re-rate. His confidence is also reflected in the gradual increase in the trust’s level of gearing which now stands at 7.6% (see Gearing).

In our view, BRSC’s strong long-term performance record highlights the strength and consistency of the team’s bottom-up focused investment process. That said, the growth style has had a challenging couple of years, while the market as a whole has suffered. Macroeconomic uncertainties have weighed heavily on investor sentiment since Q4 2021 and have contributed to significant outflows from UK small caps. However, we think the operational resilience of BRSC’s portfolio has been demonstrated through an impressive bounce-back in revenue returns over 2022 and 2023. We would argue this highlights the strength of Roland’s research process and shows how this challenging period may have been driven more by macroeconomic factors, rather than reflecting the fundamental characteristics of the portfolio’s holdings.

Roland argues that a softer landing is more likely than a long and deep recession, and BRSC is positioned to be in a strong position should interest rates and macroeconomic pressure ease over the course of the year. Furthermore, UK small- and mid-cap equities continue to offer extreme value relative to large caps and international counterparts. Therefore, we believe that as investors search for alternative sources of alpha in what may be a lower growth environment they may look to close their underweight position to the sector which may be a catalyst for the trust to re-rate. The significantly wider-than-average discount may be a great opportunity for long-term investors.