Greenshoots are sprouting, the recession is thawing, and directors are buying -- ready to rock with smaller companies?
Smaller companies do worse in downturns, for both economic reasons (they're often more closely geared to domestic growth than larger companies, for instance) and sentiment-driven ones (if the sky is falling, you'd rather shelter under a big tent like BP (LSE: BP) or GlaxoSmithKline (LSE: GSK) than the flimsy umbrella of a FTSE Fledgling).
This time we also had a credit crisis, which did smaller listed companies no favours either.
Six months ago investors wondered whether some smaller indebted companies would be completely unable to re-finance their borrowings. Those that did so boasted of it in their RNS statements. What was usually a formality had become a matter of life-or-death.
Not surprisingly then, 2008 was one of the worst years for small caps in The Hoare Govett Smaller Companies (HGSC) index's 54-year history. The index posted a wealth-destroying total return of -39.6%, compared to -30% for the FTSE All-Share, with companies at the smallest end of the spectrum or on AIM doing even worse.
Bank's big idea saves the little guys
Thank goodness then for quantitative easing (QE) or at least the expectation that such monetary loosening would eventually work.
Soon after the QE ball got rolling in early March, the debt fears that had crippled the market abated, fuelling the 'dash to trash' rally that has evolved into what I believe is a new bull market.
And the run has really seen beaten down smallcaps recover their mojo. The FTSE SmallCap index (excluding investment trusts) rose 26.4% in the first half of 2009, compared to a 1.6% fall in the FTSE 100.
Enter the BlackRock Smaller Companies board
Will the outperformance continue? Three non-executive directors of the £115 million BlackRock Smaller Companies Investment Trust (LSE: BRSC) seem to think so.
Robert Robertson, John Davies and board chairman Richard Brewster all bought repeatedly in July. They paid around 235p a share.
The trades weren't massive -- ranging from £10,000 to £35,000 -- and buying by non-execs isn't as encouraging as when managers themselves invest in their shares, although I don't think this is such an issue with funds compared to companies.
More relevant is that two of these directors have served on BRSC trust's board since the late 1990s and so have seen it through a couple of market cycles. If these experience small cap watchers think the worst is behind us enough to risk their cash, I'd say that warrants a second look.
Shuffling the pack
BRSC's investment manager Mike Prentis, who has been with the fund since 2002, didn't comment on smaller companies' relative prospects in his update last month.
He did however reveal that he'd sold out of star performer Chemring Group (LSE: CHG) as he reduced his over-exposure to the defence and aerospace sector, fearing cutbacks.
He's also sold out of larger-sized holdings such as 3i Group (LSE: III) and Burberry (LSE: BRBY) and is actively looking for smaller outfits to invest in. "In the very short term we see UK consumer stocks and real estate stocks as safer than late cycle industrials," he said.
The investment trust's current top 10 holdings is more notable for including several investment managers though:
In terms of sectors, BRSC's largest exposure is to Software & Computer Services (11.1%), followed by Financial Services (10.3%), Support Services (9%) and Oil & Gas Producers (8.6%).
Ready to roll with BlackRock?
Should you follow the directors and buy shares in BRSC?
There's three parts to this question.
Firstly, should you get specific exposure to smaller capitalisation shares? I think so. Academic research has shown that along with buying value, investing in smaller companies is one way we can, over time, get an edge over wider index trackers.
Secondly, should you buy through a managed fund like this investment trust? Doesn't standard Motley Fool wisdom say you should buy index trackers, rather than paying managers to fail to beat the market?
That's true, but there's a paucity of passive vehicles for tracking UK smallcaps. Also, there's arguably more chance of managers outperforming with smaller shares than big ones. In any event, we don't currently have much choice but to choose managed funds or investment trusts in the UK, or else go through the hassle, expense and extra risk of building your own smallcap portfolio.
Finally, is BlackRock Smaller Companies good value?
At BRSC costs 239p per share -- a 17% discount to net assets allowing for its modest gearing. That's about an average discount for this trust recently. The shares yield 2.1%. Management fees are less than 0.65%.
The trust is doing pretty well compared to its blended AIM and Hoare Govett Smaller Companies index benchmark:
| | One month to 30 June | Three months | One year | Three years |
|---|
| Net asset value | 1.2% | 25.2% | -31.4% | -21.2% |
| Share price | -0.6% | 23.0% | -31.0% | -22.7% |
| Benchmark | -0.7% | 22.6% | -26.5% | -34.6% |
Sources: BlackRock RNS
Personally, I think the best bet is to hold several different smallcap trusts in order to get the broadest exposure to these dynamic companies, and so dilute the risk of picking a dud.
Accordingly, while I don't currently hold BlackRock Smaller Companies (it recently changed its name from Merryl Lynch, incidentally), I'll definitely look to add it to my holdings as funds become available.
More from Owain Bennallack:
Note: Performance data on the BlackRock Smaller Companies Trust varies across sources, with even BlackRock's own website warning its figures are currently unreliable. The name and ticker change is to blame, I'd expect. I've taken the data above from the last relevant RNS, issued on 16 July, which gives performance to the end of June.
> Owain owns shares in City of London Investment Group.
