Potential buying opportunity for BlackRock Smaller Companies

It has been a brutal few months for many growth-oriented trusts including in the UK smaller companies sector, with the sell-off giving longer term investors the chance to pick up a few bargains.

A prime example is the £931m BlackRock Smaller Companies Trust (LON: BRSC),which hasoutperformed its benchmark in 18 out of the last 19 financial years.Over this period the NAV total return is 1,751% versus 465% for the index, which is equivalent to an annualised excess return of 7.1%.

Despite the impressive record its shares have fallen from a November high of £21.75 to £14.08 at time of writing, a decline of 35%, while the discount to NAV has widened to 16% from a 12 month average of five percent.The problem has been the central banks’ switch to monetary tightening to deal with the surge in inflation that has hit many growth stocks exceptionally hard.

Investec says that as we transition to a new economic regime there is likely to be further headwinds and in this environment they would focus on those managers with a proven track record of generating alpha. They regard the recent indiscriminate de-rating as an opportunity to acquire BlackRock Smaller as a core strategic holding on a distressed discount.

Proven process

The manager aims to put together a well-diversified portfolio of high-quality companies with sustainable business growth models. In order to do this he relies on strong fundamental research that combines both bottom-up and top-down analysis, which is where BlackRock’s depth of resource gives the fund a competitive advantage.

They look for companies with proven, trustworthy and entrepreneurial management teams, market leading positions, a clear record of earnings growth, a good conversion of earnings into cash and well capitalised balance sheets. The result is a 105-stock portfolio where none of the individual holdings exceed three percent of NAV on acquisition.

In essence, what they are doing is looking amongst the under-researched UK small caps for high-quality growth companies that can rapidly adapt their businesses to changing market dynamics. The manager believes that the portfolio holdings went into the pandemic in good shape − both operationally and financially − and have come out in an even better position to take market share.

Is now the time to invest?

Normally with a growth-oriented trust you wouldn’t expect much in the way of income, yet BlackRock Smaller is yielding just under 2.5% and over the last 19 years has achieved an annualised increase in dividends of 12.2%. It was even able to increase the pay-outs during the pandemic thanks to the strategic use of its revenue reserves.

As to whether you should buy now really depends on your outlook. If you think that central banks will have to raise interest rates aggressively to bring inflation under control then prices probably still have a long way to fall, so the best option would be to monitor BlackRock Smaller via a watch list.

Longer term investors who are expecting inflation to pull back naturally as economic growth slows and who are sceptical about the central banks’ ability to tighten dramatically might think that yields don’t have much higher to go. In this scenario the safest approach would be to drip feed money in over the next few months to minimise the risk of bad timing.