BLACKROCK SMALLER COMPANIES TRUST PLC

UK Smaller Companies - An alternative to the income dilemma?

The economic shock from the coronavirus is, as yet, unknown. However, in the interim, central bankers have responded by pushing interest rates to historic lows and launching a fresh round of quantitative easing. As the dust settles on the crisis, investors may find it even more difficult to generate an income from their investments. Smaller companies may provide a solution to this income dilemma, says Roland Arnold, Portfolio Manager of the BlackRock Smaller Companies Trust plc.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Generating income has been a hot topic for the financial industry since the financial crisis. As a nation we are generally living longer, therefore we need to make our savings and investments work harder for us to fund a longer retirement. Interest rates were already at historically low levels even prior to the coronavirus crisis and therefore returns on cash savings are almost non-existent. For investors it's important not to forget the impact of inflation eroding savings held in cash.

Equity Income funds have to some extent been presented as a solution to the income dilemma facing investors. With the average income fund in the UK Equity income sector yielding slightly above 4%1, this seems like a sensible solution. However, many of the largest holdings within equity income funds tend to be companies that have delivered consistent but moderate earnings growth, which are often larger more defensive companies. Given these typical characteristics, it might seem a little odd to be discussing a UK small cap trust and the need for income in the same breath, as smaller companies are more often associated with the potential to generate capital growth rather than income.

Smaller companies are often thought of as young, immature business models, that may be entering new markets, adapting to changing market dynamics or leading technological change, trying to establish themselves among the competition and take market share. Therefore, and rightly so, the priority for many of these companies is investing for growth, and it is assumed that returning cash to shareholders is not high on the list of priorities for a smaller company. While many of these statements are true, and in fact are in part many of the attractions of investing in our universe, we would also argue that UK small and mid-caps can be a differentiated source of income.

This is an output of our process, but one that has been very successful in enabling the Trust to generate not only consistent capital returns since inception, outperforming our benchmark for 16 consecutive years, but also increase our dividend every year for the last 16 years.

We do not specifically target high yielding shares, instead our focus has always been on finding high quality, cash generative business that are run by exceptional management teams, that are therefore able to invest for continued growth and in many cases deliver growing dividend to shareholders over the long term. This is an output of our process, but one that has been very successful in enabling the Trust to generate not only consistent capital returns since inception, outperforming our benchmark for 16 consecutive years, but also increase our dividend every year for the last 16 years. It is this ability to grow our dividend that we feel has and will be a valuable component to people’s retirement as income growth needs to keep pace with inflation in order to maintain, if not grow purchasing power as one goes through retirement.

BlackRock Smaller Companies Trust plc: Growing Capital and Income

BlackRock Smaller Companies Trust plc: Growing Capital and Incomee.

 

The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. Smaller company investments are often associated with greater investment risk than those of larger company shares. UK income sector median distribution refers to the median yield on the income sector i.e. what amounts of distributions in income investors would receive from holding the median income fund. Source: BlackRock, BlackRock Smaller Companies Trust plc NAV total Return net of fees. As at 31 December 2019. For the purpose of comparing income growth versus funds which have income generation as a primary objective - Figures based on £1,000 invested at 31 March 2006 in BlackRock Smaller Companies Trust plc and the IA UK Income sector median. BlackRock Smaller Companies Trust plc dividends do not include special dividends paid between 2007 and 2010 of 1.25p, 0.7p and 0.5p.

 

Returns in GBP31/12/18 to 31/12/1931/12/17 to 31/12/1831/12/16 to 31/12/1731/12/15 to 31/12/1631/12/14 to 31/12/15
Trust Return* 32.5% -11.9% 33.3% 11.0% 19.0%
Numis Smaller Cos +AIM ex IT (Constraint index)** 22.2% -15.8% 21.9% 12.0% 8.6%
Relative +10.4% +3.9% +11.4% -1.0% +10.4%

The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results. Source: BlackRock as at 31 December 2019. Smaller company investments are often associated with greater investment risk than those of larger company shares. Source: BlackRock, *NAV Total Return net of fees. Performance benchmark is Numis Smaller Companies Ex Investment Trusts + Alternative Investment Market. Index returns are for illustrative purposes only. Index performance returns do not reflect any management fees, transaction costs or expenses. Indices are unmanaged and one cannot invest directly in an index. ** Benchmark: FTSE SmallCap index (excluding investment companies) until 31/8/07; Numis Smaller Companies + AIM index (excluding investment companies) since 31/8/07.

At times of economic stress or recession, some companies may be unable to grow their dividends and in fact may have to suspend the dividend. The structure of a trust like BlackRock Smaller Companies Trust plc, enables us to keep a proportion of our dividend income received in a revenue reserve, currently the reserve on the Trust is around 1.73 years2. The benefit of having an income reserve is that even in times when companies may be holding back on the cash that they return to shareholders, the Trust will be able to pay out a dividend. To date the Trust has not needed to use any income reserves, and even in the financial crisis of 2008, the Trust was able to grow the dividend through income generated from our holdings.

Many investors view their ISAs as an important source of tax-free income but finding the right option in today’s low interest rate world can be tough. We believe the need for income is something that looks to be here to stay. The ability to invest in these, in our opinion, great companies, that are able to compound over time and potentially deliver consistent dividend growth, coupled with a dividend reserve, makes BlackRock Smaller Companies Trust plc a reliable and differentiated solution to the income dilemma and a potential option in a diversified ISA portfolio.

Unless otherwise stated all data is sourced from BlackRock as at February 2020.

1Morningstar, January 2020
2Based on the level of dividend paid in 2019 and revenue reserves as at 28 February 2020