Investors looking for growth will find plenty of opportunities among UK-listed small-caps, according to BlackRock’s Mike Prentis, despite some of the misgivings of last year.
The UK referendum result in favour of exit from the EU forced many investors out of UK small-caps into more internationally focused large-caps.
However, Prentis - managing director, UK small & mid-cap equity team leader - believes that investors who are willing to spend time researching the space will see strong returns over the long term.
The manager says he looks for five thigs from potential investments: proven, trustworthy management; strong market positions; clear record of earnings growth; good conversion of earnings into cash; and sound balance sheets.
Prentis says he is able to draw upon the ideas of the BlackRock UK equity team, which includes a number of fund managers working on different strategies.
Since becoming manager of the £505.1m BlackRock Smaller Companies investment trust in 2002 it has returned 893.53 per cent, compared with a 503.39 per cent gain for the average IT UK Smaller Companies trust and 334.26 per cent for the Numis Smaller Companies + AIM ex Investment Companies index.
Performance of trust vs sector & benchmark since 2002
Source: FE Analytics
Talking about the strategy, Prentis noted: “It’s very simple: we own companies that have the potential to be much bigger over the medium-to-long term.”
Below stockpicker Prentis highlights the UK small-cap stocks that fit into his long-term growth approach for the sector.
Fever-Tree
One success story for the trust has been upmarket tonic water company Fever-Tree. After a successful IPO in 2014, the firm has continued to perform strongly. Making up about 1.2 per cent of the portfolio, the stock generated a 153.5 per cent total return for the trust in the year to 28 February.
The stock is an example of innovative UK small-caps that have found a niche in the market for their products.
4imprint
US-based promotional products firm 4imprint represent 2.2 per cent of the portfolio. Prentis says the company is well-placed to benefit from the further growth of the US economy.
Performance of 4imprint over 3yrs
Source: FE Analytics
As a London-listed US company, the manager also benefits from the currency exchange. One of the reasons that many UK smaller companies investors fled the small-cap sector in 2016 was the immediate impact of the referendum vote on sterling, which fell against all major currencies.
Within the manager’s portfolio the company falls within its ‘advantaged cash flow compounder’ theme and is well-placed “if you believe the US economy will do well over the next five years”.
JD Sports
Falling within the same theme is UK fashion retailer JD Sports.
While it may seem a bit more of a domestic play, the firm has been seeing decent growth overseas.
“If the [UK] economy suffers, in all probability, people will buy fewer things,” he said. “But they have got a good relationship with [brands] Nike and Under Armor and supply for the products that everybody wants, that supports growth.”
He added: “UK like-for-like sales has been running at around 10 per cent in the UK in recent months. They have been expanding in Europe and recently in Malaysia.”
Dechra Pharmaceuticals
Falling into its ‘growth businesses with highly predictable revenues’ theme is Dechra Pharmaceuticals. Prentis says it is as an example of a company the trust has held for more than a decade and sits in the portfolio alongside firms such as UK brewery Fuller’s.
James Carthew, head of research at Marten & Co, notes the manager can invest in some smaller AIM-listed stocks that have given the trust even greater flexibility.
He said: “BlackRock Smaller Companies has just made the move to lift the restrictions on the proportion of the portfolio that it can hold in AIM stocks from 40 per cent to 50 per cent.
“The restriction was a hangover from the bad old days of AIM when investors looked nervously at this exposure.”
He added: “Today though there are many attractive companies trading on this market and the restriction seemed anachronistic and, to us anyway, there seems little point in having the upper limit.”
Reflecting this, in the micro-cap space Prentis holds pensions and wealth management firm Mattioli Woods and pollster YouGov, which the manager believes have high potential.
The fund was down by 1.36 per cent during 2016, compared with a 3.98 per cent gain for the average sector fund and currently trades at a discount of 17.8 per cent, according to data from the Association of Investment Companies. The BlackRock factsheet lists the fund as having an ongoing charges ratio - calculated as a percentage of average net assets and using operating expenses, excluding performance fees, finance costs and taxation - of 0.7 per cent for 2016. With performance fees this rose to 0.9 per cent.
Marten & Co’s Carthew said: “Mike Prentis is a true stock picker. He has delivered fairly consistent upper quartile performance over most time periods, though by not slavishly following an index he may miss out on things like last year’s rally in resources stocks.
“Dividends have compounded at an impressive rate – we’ll find out soon what the dividend is for the financial year that just ended, but for the five years to the end of February 2016 they were compounding at over 20 per cent, per annum.”
He added: “The fund is a decent size and ongoing charges are commensurately low. In common with much of the peer group, the discount is too wide, however.”