Interactive Investor

Fund profile: BlackRock Smaller Companies

17th November 2014 08:57

Rebecca Jones from interactive investor

Money Observer Rated Fund BlackRock Smaller Companies was the top-performing UK smaller company investment trust in 2013, returning 70.4% in share price terms compared to an average of 45% from the IT smaller companies sector.

The trust's long-term track record is equally impressive, returning 198% over five years and 368% over 10 years to 13 November, making it the second-best performing trust in the sector over both time periods.

But the trust has suffered from sell-offs in small-cap markets this year, as investors pulled out of the asset class following a spectacular two-year run.

Year-to-date the BlackRock Smaller Companies trust has lost a painful 13%, compared to an average loss of 5% from the sector, dragging its one-year return down to 2.5%.

Great companies

Mike Prentis, manager of the trust for over 10 years, remains fairly sanguine in the face of this decline, which has seen the trust's share price discount to net asset value (NAV) widen to 9% as at 13 November, after narrowing to trade close to par in January.

"If you look at the last 15 years, smaller companies underperform on the way into a recession or at times of vulnerability, but when that nervousness disappears they bounce back very strongly.

"There are lots of worries out there and plenty of things for investors including me to worry about, but am I worried about my portfolio? In the medium term, absolutely not," he says.

Prentis's main source of confidence is the belief he has in the companies he holds, all of which he says he and his team analyse as thoroughly as possible before investing.

Some of his favoured company characteristics include wide profit margins, strong cash flow and virtually zero debt, which all act as a buffer during "wobbles" such as smaller companies are going through now.

Dominant

"Our companies dominate their markets, they have market positions protected by something special - be it intellectual property, a brand, a distribution network, something that really gives them power in their market place - alongside sustainability and pricing power.

"Quite often they have higher margins than your average business, so they can both achieve higher profits and profit growth and turn those profits into cash," he says.

As an example he cites his top holding, Workspace Solutions, which provides flexible office space on the outskirts of central London.

With 90% occupancy, the company has a regular and predictable income stream, while Prentis believes the value of its property portfolio is likely to be in excess of current estimations if the 2010 sale of its industrial portfolio - at a 30% premium to book value - is anything to go by.

CVS Group, which buys and manages veterinary practices throughout the UK, is another favourite of Prentis. The largest independent owner of vet surgeries in the country, CVS has been acquiring smaller practices apace and now owns around 200 surgeries throughout the UK.

The main draw for Prentis is growth alongside a strong and steady income stream via its own branded products, lab activities and membership schemes.

Diversification is king

Aside from owning "great companies", Prentis also credits strong diversification as a factor in his past outperformance. Currently the manager has around 180 holdings in his portfolio, with his top 10 only accounting for only around 16% of the trust.

"I'm nervous of concentrated funds; it doesn't really work in small cap in my view. It might work in large caps where there is liquidity, but in our market there isn't much liquidity," he says.

However, he insists that such a large number of holdings does not impede on his due diligence process, adding that for those companies where he cannot be as "high conviction" as he would like he will typically only invest around 0.25% of the portfolio.

"The ones at the smaller end are more in an incubator type situation, which is why the position is small as we're getting to know them. They're not perfectly formed and we're waiting to see whether they will become fully fledged, really attractive growth companies in time. Some of them will, some of them won't," he says.

Despite his faith in his fund, over the short term Prentis is bracing himself for further volatility, while remaining convinced that the current dip in markets is a blip rather than the beginning of another recession.

"Is this going to be like 2007 and followed by a recession? In my view, no. First, both the UK and US economies are doing pretty well, and you've got central banks co-ordinating around the world to support economies. My bet is that they'll throw everything at it to make sure 2008 doesn't happen again. So we won't have another recession next year, we will have a bounce back," he says.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.