Buy small-caps at a discount with BlackRock Throgmorton

BlackRock Throgmorton trust has performed broadly in line with BlackRock Smaller Companies since BlackRock started running it in July 2008, and has outperformed Numis Smaller Companies ex Aim ex IT index and the Association of Investment Companies (AIC) UK Smaller Companies sector average over one, three and five years.

Mr Prentis has 25 years' experience of investing in smaller companies, and has outperformed his peer group composite in six out of a possible seven years of rising markets and two out of a possible three years of falling markets, according to research company Trustnet.

Like BlackRock Smaller Companies, BlackRock Throgmorton provides exposure to a diversified portfolio of growth companies, but a key differentiator with the former trust and other UK smaller companies investment trusts is its use of contracts for difference (CFDs) to boost returns, instead of bank debt. The CFD portfolio is managed by Dan Whitestone, who takes long CFD positions in the same shares as the trust invests in, and short CFD positions in companies with weak balance sheets that they think are overvalued.

The trust typically has about 30 per cent of its portfolio in CFD positions in around 100 companies, with long positions making up around two-thirds of the CFD portfolio and short positions one-third. In May 2017, the managers were short on certain biotech and consumer services companies.

Analysts at broker Stifel say: "The CFD portfolio continues to add value in performance terms and provides an innovative form of leverage."

BlackRock Throgmorton is also well diversified, with no single investment accounting for more than 4 per cent of its assets.

However, the trust is more expensive than some of its smaller companies trust peers due to its performance fee, which pushed up its ongoing charge for 2016 from 1.06 per cent to 1.34 per cent. The trust levies an annual management fee of 0.7 per cent of the value of its long-only portfolio, plus the gross value of the underlying equities exposed to CFD contracts. The performance fee is 10 per cent of outperformance of the NAV return against its benchmark, Numis Smaller Companies ex Aim ex IT index.

But over the past few years the performance fee has been reduced, most recently in June 2015 when the performance fee cap was reduced from 2 per cent to 1 per cent of the performance fee market value, in the event that NAV total return over the annual performance period is zero or positive.

UK smaller companies are at greater risk than other UK equities from the possibility of higher trade tariffs when the UK leaves the European Union (EU). They could also experience problems if leaving the EU causes an economic downturn in the UK, as they are typically more exposed to the domestic economy.

BlackRock Throgmorton has also traded at a wider discount to NAV than its current level, meaning it is not at its cheapest and the discount could widen.

However, despite a performance dip in the second half of 2016 UK smaller companies have since rallied strongly and are on good valuations. BlackRock Throgmorton's portfolio also includes several stocks that generate significant earnings from overseas, such as 4Imprint (FOUR) and Next Fifteen (NFC), which are US focused.

And even though the trust is not at its cheapest, it could still deliver good performance going forward which might lead to discount tightening.

Although BlackRock Throgmorton has a higher ongoing charge than some of its peers, it has more than compensated its shareholders with good performance, so still looks like a good way to access some of the stronger UK smaller companies at a good price. Buy.

Source: Morningstar, as at 26.06.17 & *Winterflood

Performance

Source: FE Analytics, as at 27 June 2017

Top 10 holdings as at 31 May 2017 (%)

Source: BlackRock, as at 31.05.17

Sector weightings, as at 31 May 2017 (%)

Source: BlackRock, as at 31.05.17

IC Tip rating