BlackRock Smaller Companies reports on challenging year

BlackRock Smaller Companies (BRSC) reported annual results to 28 February 2021, with an NAV  of 13.5% and return to shareholders of 14.4%. This represented an underperformance of the benchmark (Numis Smaller Companies plus AIM (excluding Investment Companies) Index) return of 23.1%. Returns shown are without the re-investment of dividends and with debt at par value.

Extract from the manager’s report

BRSC’s manager, Roland Arnold, had the following to say: “The company’s financial year has almost perfectly coincided with the arrival of the COVID-19 pandemic in the UK, the first impacts of which were felt in equity markets in February 2020. Since then the pandemic has proved to be the primary driver of investment returns, as well as impacting economies and lives around the world. The outbreak of the virus catalysed one of the most rapid falls in equity markets ever witnessed, as investors attempted to gauge the impact on the economy. Virus case numbers rose and fell in waves throughout the period as countries entered into lockdowns of varying rigour, resulting in a sharp contraction in global economic activity. In response, governments and central banks around the world announced unprecedented levels of fiscal and monetary stimulus. These included both aggressive monetary stimulus measures, including unconventional direct interventions to cover labour costs and ease business expenses in the face of a mandated shutdown.

The second half of our year was characterised by vaccine news and recovery, with many equity markets rebounding from the falls of the first half. Politics were, as expected, a significant market factor with US elections and Brexit negotiations providing a degree of uncertainty. But the pandemic and its ramifications remained the major source of market change. The approval and subsequent deployment of several vaccines gave hope that economic activity would soon return to normal. Equity markets have soared as vaccine progress has provided an encouraging backdrop. With rising markets, value-orientated sectors have led the rally, many of these businesses having been some of the biggest victims of the initial pandemic induced falls. The growth shares that form the core of our portfolio lagged behind in this rebound. For UK domestic investors, December finally delivered positive progress on Brexit, with an agreement on trade terms for goods, removing a significant tail risk from the market.

The company’s NAV per share (debt at par) rose by 13.5% during the financial year, underperforming our benchmark which rose 23.1%. For comparison, the large cap FTSE 100 Index fell 1.5% during the period (all percentages stated without income reinvested).

While the company’s NAV rose over the year, we were clearly disappointed by our results relative to our stated benchmark. This underperformance was concentrated in the first half of the year, with the company’s return in the second half broadly in-line with the benchmark. Therefore, while positive for the year in absolute terms, we were unable to offset the losses from earlier in the year.

As always, hindsight allows us to see where we could have done better. First, we started the year with too much exposure to the UK domestic economy. Following years of being underweight, we felt that a clear UK election result would finally lift the cloud over the UK by increasing the likelihood of progress with Brexit negotiations. Coupled with what would traditionally be seen as a business-friendly government, we thought this would provide the catalyst for investors to reappraise the attractiveness and the value offered by UK plc. Unfortunately, as the COVID-19 virus began to make its way from China into the rest of the world, these sectors were among the worst impacted by the lockdown restrictions, and several portfolio companies were mandated to suspend operations. Never did we anticipate scenarios in which some of our investment companies would have virtually no revenue at all for significant periods during the year. Sadly, this was where we found ourselves in March and April. Exhibitions business Hyve, for example, saw its share price collapse early in the year, as travel restrictions and lockdown measures resulted in major disruption to a number of the company’s scheduled events during 2020. Since the announcement of the vaccine the shares have made up some lost ground, and we believe there will be further upside potential as more of its events resume. Flexible office space provider Workspace Group faced similar challenges as the business saw a significant slowdown in enquiries and rents received as tenants were no longer allowed to use their contracted space.

We were also too early to take part in some of the COVID-19 related recapitalisations taking place in this period. While we expect these companies to endure the pandemic and emerge stronger than before, we were too early with this call. For example, we took part in placings for SSP and JD Wetherspoon, which continued to struggle throughout the year as lockdown went on longer than initially hoped. Longer-term, we believe that the businesses that we have exposure to in these areas are best in class, with sufficient liquidity to survive the pandemic and emerge stronger than before. Furthermore, given the high levels of uncertainty around the economic outlook, the decision was also taken to reduce the single stock risk by reducing position sizes in some of the largest holdings in the portfolio. However, many of these holdings like Watches of Switzerland, Ergomed, IntegraFin and Pets at Home continued to trade extremely well throughout the pandemic, growing revenues and profits, beating expectations and raising guidance.

Other detractors during the year included defence technology business Qinetiq Group, which fell after it warned that global restrictions to prevent the spread of COVID-19 would negatively impact revenue, although like many businesses earnings expectations for the coming years are now higher than pre-pandemic levels. 4imprint Group, a long-term core holding for the Company, fell after the company reported a 99% fall in profits in the first half as COVID-19 resulted in a collapse in customer demand. This is a business that has been a significant contributor to relative performance over a number of years, having consistently delivered revenue growth through taking share in highly fragmented end markets. While there remain challenges to the business as a result of COVID-19 uncertainties, we remain confident that the company’s leading market position and flexible capital light business model will ensure that the business will emerge from the pandemic in a stronger position relative to peers.

While overall performance was constrained, many of our top 30 holdings delivered impressive results throughout the period. It is encouraging that many of these quality businesses were able to successfully navigate the pandemic, and in many cases thrive. The single largest contributor during the year was pharmaceutical services business Ergomed. The defensive nature of the pharmaceuticals industry meant that Ergomed was less impacted by the effects of the pandemic, and the company upgraded earnings expectations throughout the year. Furthermore, the company expanded into the strategically important US market through the acquisition of MedSource. Shares in cell engineering specialist MaxCyte have been exceptionally strong during the year. The company upgraded guidance throughout the period, despite the challenges brought on by COVID-19, as revenue growth continued to accelerate, reflecting the increasing adoption of the company’s products and technologies. Specialist sustainable investing fund manager, Impax Asset Management ,rose during the year as the business reported continued growth in assets under management, as their high performing strategies continued to benefit from the trend of increasing investor demand for sustainable products. Watches of Switzerland also performed well, as demand for high end watches and jewellery has been far stronger than expected and the relationship with Rolex has proved a point of differentiation in securing access to watches where demand continues to exceed supply.”

BRSC: BlackRock Smaller Companies reports on challenging year