Recently taken over by the BlackRock smaller companies team, the investment trust – which trades on a 15 per cent discount to NAV – represents a compelling opportunity, according to the analyst, thanks to its improved performance record, clean debt structure and a change in strategy that allows the use of derivatives.
"We do not think the significant NAV outperformance against the benchmark and action that has been taken by the board and manager over the last couple of years is being fully recognised by the market," said Iain Scouller, analyst at Oriel Securities.
"We think that, as these attributes become recognised, there is scope for the discount to narrow to 10 per cent or lower.”
"The structure is relatively innovative in the investment trust world, with the ability to use CFDs for both long and short exposure in place of conventional bank debt."
Performance of trust vs sector since Jun-08
Source: Financial Express Analytics
According to Financial Express data, since BlackRock took over in June 2008 the fund has returned 51.9 per cent compared with its UK Smaller Companies benchmark, which returned 29.3 per cent.
However, there are a still a number of negatives for investors to consider.
"The loss of [managers] Mike Prentis or Richard Plackett would be a blow, although there is a team of five at BlackRock on small caps," added Scouller.
"There is also a relatively high performance fee of 12.5 per cent of benchmark outperformance, although this has a high watermark and reflects the use of hedge fund techniques with CFDs. Also the dividend is uncovered at 0.95x."
Overall, Scouller’s recommendation of the investment trust’s management, structure and performance record is positive.
Harry Katz, who advises at Norwest Consultants, has reservations about the strategy.
"BlackRock is a house I respect and the fund has certainly done well but I wouldn’t go nuts with it," he explained.
"I’m not very confident about the UK Smaller Companies Sector. As for the CFD strategy, I am an investor, not a gambler. I prefer to be able to see what I am invested in. I don’t like smoke and mirrors."
BlackRock's small-cap managers say that in 2010 the strongest performance came in the electronic and electrical equipment sector, where stocks such as Domino Printing Services, Gooch & Housego and Oxford Instruments all contributed significantly to relative performance.
Other stocks that performed well included Western Coal and Encore Oil, with the mining and industrial engineering sectors also experiencing significant gains.