Callum Stokeld
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Updated 18 May 2021
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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by BlackRock Smaller Companies. 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.

  • Last week, BlackRock Smaller Companies (BRSC) released its final results for the financial year (FY) 2020. Over the 12 months ending 28/02/2021, the trust delivered NAV total returns (with income reinvested) of 16.1%. Over the same period, BRSC’s share price rose 17.2% (with income reinvested); the discount proved volatile, but ultimately narrowed slightly from c. 4.7% to c. 4.3%. Over the longer-term, BRSC has generated NAV total returns of 97.9% over the previous five years, against benchmark returns of 63.9%.
  • Looking forward, the manager, Roland Arnold, believes that UK small and mid-sized companies will continue to provide many exciting investment opportunities. The board has made clear its belief that the strategy remains appropriate, particularly given the uncertain backdrop, stating: “The portfolio manager’s focus on financially strong businesses with robust balance sheets provides us with confidence that the company’s portfolio is well placed to weather the storm”.
  • Revenue returns per share for the financial year amounted to 13.36 pence per share, compared with 37.13 pence per share for the previous year. This represents a fall of 64%, with the board noting that “a substantial portion of companies in the portfolio had reduced or cancelled dividends in response to the impact of the pandemic as well as government restrictions”. Despite this, the board were able to utilise their substantial revenue reserves to increase the total dividend to 33.30 pence per share, an increase of c. 2.5%. 

    Kepler View

    BlackRock Smaller Companies (BRSC) may have underperformed the benchmark Numis Smaller Companies Index over the financial year to 28/02/2021, but this seems more a circumstance of timing than anything else. In our most recent research update, we estimated that “if investors had bought BRSC at any daily point in the previous five years, they would have subsequent 12-month NAV outperformance to the peer group NAV average and benchmark on c. 92% and c. 95% of occasions, respectively”. Underperformance over the financial year (which saw events of an exceptional nature) in our view represents the exception, rather than the rule, as seen by this being the first instance in 18 financial years where BRSC has underperformed.

    In this vein, we note that over the previous twelve months to 10/05/2021, BRSC generated NAV total returns of c. 62.4%, against a benchmark return of c. 55.7%. BRSC’s underperformance over the financial year was a result of underperformance in the sharp market drawdown which characterised the majority of March 2020; we note that BRSC’s NAV underperformed the benchmark index by c. 5.9% over the period 01/03/2021-19/03/2021, when the Numis index troughed. Subsequently, BRSC’s NAV total return over the period 19/03/2020-28/02/2021 was c. 6.2% greater than that of the Numis index, but the lower starting point as a result of greater drawdown resulted in financial year underperformance.

    Underperformance was in part driven by deployment of gearing in a falling market, as we discussed in our most recent research note. Whilst this was not towards the upper end of the range within which the manager has deployed gearing in recent years, BRSC entered the most recent financial year with gearing of c. 7% (against a five-year range of c. 1-11%). With the manager having become increasingly positive on the potential for rerating of UK domestic-facing stocks, sector and stock allocations detracted in this period too with several of these companies facing a total cessation of operations for large parts of 2020 following the introduction of lockdown policies.

    However, outperformance in the recovery has been encouraging. In a reverse of the initial drawdown, gearing has been a tailwind in a rising market, but the manager notes that many of the portfolio companies emerged from the pandemic with relatively unimpaired operations and, in many instances, with a strengthened market position. The latter aspect, in particular, seems to have been an output of the stockpicking process, which emphasises identifying companies and management teams who are leaders in their sector. As economic support measures are phased-out in the coming months and years, the additional focus on ensuring constituent companies are well capitalised with robust balance sheets should potentially offer them the opportunity to further gain at the expense of less financially-strong companies.

    Detracting from returns has been an ongoing underweight to the mining and energy sectors; the managers note that many of the constituent companies in these areas simply do not meet their ‘quality’ criteria. Nonetheless, they have been adding to those companies which do, such as Gulf Keystone Petroleum and Central Asia Metals. However, as we have previously noted, often in rallies in these sectors which are driven by rising prices in the underlying commodities, much of the rally can be led by lower-quality names where the fundamental viability of these companies is changed by higher spot prices (unlike those higher quality names, which are viable at lower prices).

    The number of stocks within the portfolio has expanded to 122, from 110 on 31/08/2020. We understand that this reflects the number of stock-specific opportunities the managers are identifying at this time, and has included in particular adding to positions which the manager believes to be likely beneficiaries of a recovery in UK consumer spending.

    Positions are, however, introduced with a long-term outlook and the manager continues to ‘run his winners’ whilst operational momentum and improvements continue to be exhibited. This has led the board to propose a change to the investment policy of the company to remove the existing 50% limit on AIM-listed stocks. Currently, the portfolio is approaching this limit, in part because of the outperformance of many underlying positions (and the operational outperformance of the underlying company). The board and the manager both believe that maintaining this limit is not in the interests of shareholders as it effectively reduces the investment universe available to the manager, who is more focussed on identifying the characteristics and drivers of the underlying company than the index on which it is listed.

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