BlackRock Smaller Companies Trust plc

00:00:24,700 --> 00:00:27,833
I think which is worthwhile, starting
with a reminder of the investment

00:00:27,833 --> 00:00:31,666
strategy of the fund and what it is
that we are looking to achieve.

00:00:32,666 --> 00:00:36,600
The process for stock identification
and the strategy

00:00:36,600 --> 00:00:39,700
for the portfolio has been unchanged for
for many years now.

00:00:40,200 --> 00:00:43,400
We fundamentally believe that
when investing in UK small and mid-cap,

00:00:43,633 --> 00:00:46,633
that you want to invest in growth
companies.

00:00:47,466 --> 00:00:48,866
Small caps are illiquid.

00:00:48,866 --> 00:00:50,566
They're risky.

00:00:50,566 --> 00:00:52,266
They're immature businesses.

00:00:52,266 --> 00:00:55,800
And so we believe that the quid pro quo
for taking those risks

00:00:55,800 --> 00:00:59,200
is to get long term growth, long term
fundamental growth.

00:01:00,133 --> 00:01:02,700
We've always used these five criteria

00:01:02,700 --> 00:01:04,733
to identify the businesses
that we're looking for.

00:01:04,733 --> 00:01:07,700
We're looking for a well-managed
business run by entrepreneurs.

00:01:07,700 --> 00:01:10,700
Often founders
who have a history of success.

00:01:11,000 --> 00:01:13,800
We're looking for businesses
that lead their markets, that dominate

00:01:13,800 --> 00:01:16,800
the niches or the markets
that they're in, because that lead

00:01:16,900 --> 00:01:18,266
that gives you pricing power,

00:01:18,266 --> 00:01:19,500
which is obviously so important

00:01:19,500 --> 00:01:22,500
in a world where we're seeing inflation
in the way we are today.

00:01:22,800 --> 00:01:24,700
We're looking for track records.

00:01:24,700 --> 00:01:27,900
This presentation is littered
with disclaimers that tell you past

00:01:27,900 --> 00:01:30,400
performance
isn't necessarily a guide to the future,

00:01:30,400 --> 00:01:32,866
but we tend to find when we're looking
at companies, businesses

00:01:32,866 --> 00:01:36,366
that have a long term
history of profitable growth

00:01:36,900 --> 00:01:40,233
tend to have a positive future
in front of them.

00:01:40,500 --> 00:01:43,066
That history tells you
there is something about that product,

00:01:43,066 --> 00:01:45,533
something about their service
that people require.

00:01:45,533 --> 00:01:47,066
And therefore, as long as they maintain

00:01:47,066 --> 00:01:49,600
their market leadership
through investment,

00:01:49,600 --> 00:01:52,266
there's a good reason to believe
those track records will continue.

00:01:52,266 --> 00:01:54,466
We look for well-capitalized businesses.

00:01:54,466 --> 00:01:57,800
We like businesses to have strong
balance sheets, minimal levels of debt.

00:01:58,300 --> 00:02:00,000
These are cyclical markets.

00:02:00,000 --> 00:02:01,733
These are unpredictable markets.

00:02:01,733 --> 00:02:05,200
Businesses in the small and mid-cap
have a habit of having near-term

00:02:05,233 --> 00:02:06,300
earnings problems.

00:02:06,300 --> 00:02:08,733
We want to know that
when that happens to our companies,

00:02:08,733 --> 00:02:10,433
they're not fundamentally at risk,

00:02:10,433 --> 00:02:13,400
they have the balance sheets that
carry them through those situations.

00:02:13,400 --> 00:02:15,000
And then finally, cash generation.

00:02:15,000 --> 00:02:18,733
We like our businesses to be able
to fund their own growth through cash

00:02:18,733 --> 00:02:22,233
generation, not to be constantly calling
on shareholders to fund that growth.

00:02:23,000 --> 00:02:25,600
And cash generation is important
because what it tends to tell you

00:02:25,600 --> 00:02:26,966
is that the stated profitability

00:02:26,966 --> 00:02:30,066
of those companies is real,
and it's not a fabrication of accounts.

00:02:30,066 --> 00:02:31,433
It generates true cash.

00:02:33,833 --> 00:02:37,133
Our research process, our idea
generation, comes from company meetings.

00:02:37,466 --> 00:02:41,200
We conduct somewhere between 7 and 800
company meetings a year, often

00:02:41,200 --> 00:02:46,233
on Blackrock property, at conferences
or on company sites themselves.

00:02:46,833 --> 00:02:49,333
And those meetings
form the bulk of our research.

00:02:49,333 --> 00:02:51,900
We think meeting management
teams is really important.

00:02:51,900 --> 00:02:53,900
It tells you a lot
about the culture of a company.

00:02:53,900 --> 00:02:55,800
It tells you a lot
about the culture of the management.

00:02:55,800 --> 00:02:59,000
It tells you about how well they can get
a strategy across to us,

00:02:59,000 --> 00:03:01,766
and therefore how well they get
the strategy across to their employees.

00:03:02,200 --> 00:03:03,933
But it also gives you an insight
into their nature,

00:03:03,933 --> 00:03:05,400
that conversation with them.

00:03:05,400 --> 00:03:08,600
Are they life's hopeful
optimists or terrible pessimists?

00:03:10,466 --> 00:03:12,666
We also believe that company research
meetings are important

00:03:12,666 --> 00:03:15,466
cause they give you color
on a whole different perspective.

00:03:15,733 --> 00:03:17,100
They tell you about markets,

00:03:17,100 --> 00:03:19,433
about supply chains,
about horizontals and verticals.

00:03:19,433 --> 00:03:21,800
I tell you about economies.
They tell you about people.

00:03:21,800 --> 00:03:25,600
They are just a rich source of further
ideas in and of themselves.

00:03:26,800 --> 00:03:27,700
And in terms of portfolio

00:03:27,700 --> 00:03:30,733
construction, stock
selection is our primary driver.

00:03:30,966 --> 00:03:34,333
We are looking for businesses that meet
those five criteria, and we are looking

00:03:34,333 --> 00:03:37,433
to build a portfolio
around those companies.

00:03:37,833 --> 00:03:39,766
We do think about sectors,

00:03:39,766 --> 00:03:42,400
but we're less concerned
about sector composition

00:03:42,400 --> 00:03:44,366
and building a portfolio
around overweights

00:03:44,366 --> 00:03:45,900
and underweights
and certain industries

00:03:45,900 --> 00:03:49,100
and much more about the fundamentals
of the companies themselves.

00:04:00,300 --> 00:04:03,600
So to start with performance,
I think it goes without saying that

00:04:03,600 --> 00:04:06,600
this is not the year that we hope
to deliver to you as investors.

00:04:08,300 --> 00:04:10,800
I think I can loosely split the year

00:04:10,800 --> 00:04:14,000
into two parts
characterized by black hole day.

00:04:14,800 --> 00:04:17,500
Up until Rachel Reeve's announcement
of the 22 billion black hole,

00:04:17,500 --> 00:04:19,900
the portfolio was performing
roughly in line with the benchmark.

00:04:20,833 --> 00:04:21,466
But the discovery of the

00:04:21,466 --> 00:04:23,600
black hole and the budget that followed

00:04:24,700 --> 00:04:28,166
changed the market perspective on the UK
and changed the market outlook

00:04:28,500 --> 00:04:31,833
and caused much of the underperformance
that you see now.

00:04:32,800 --> 00:04:36,100
When I stood on this stage last year,
I said to you that I hope

00:04:36,100 --> 00:04:38,333
that the new Labor government
will calm markets,

00:04:38,333 --> 00:04:42,200
that a government that had a significant
majority would be far better

00:04:42,466 --> 00:04:44,966
than the issues that we'd seen before,

00:04:44,966 --> 00:04:47,133
the in-fighting
of the Conservative Party, several prime

00:04:47,133 --> 00:04:50,633
ministers over a short period of time,
constant switching of ministerial seats,

00:04:51,033 --> 00:04:52,800
that the labor government
would bring the stability

00:04:52,800 --> 00:04:54,666
that the country needed,
and therefore the stability

00:04:54,666 --> 00:04:56,733
that the economic policy
would also need,

00:04:57,133 --> 00:05:00,566
and even up to the budget
that felt like it was roughly in line.

00:05:01,066 --> 00:05:03,800
And then obviously, the budget itself
and the impact that that had on

00:05:03,800 --> 00:05:07,100
National Insurance caused all sorts of all sorts
of issues for stock markets.

00:05:08,400 --> 00:05:09,900
And we'll go into those details.

00:05:13,066 --> 00:05:15,333
In the next section, we're going
to cover the market environment.

00:05:15,900 --> 00:05:18,133
And unprecedented is a word
that is often used.

00:05:18,133 --> 00:05:21,333
I think the last few years from 2020
certainly fit that bill.

00:05:21,833 --> 00:05:25,500
There have been seismic shifts in market
drivers and fundamental headwinds

00:05:25,500 --> 00:05:26,800
to our asset class.

00:05:30,300 --> 00:05:31,266
As a reminder,

00:05:31,266 --> 00:05:32,900
as we said about the investment process,

00:05:33,166 --> 00:05:36,133
BlackRock Smaller Companies,
is a quality growth portfolio.

00:05:37,100 --> 00:05:39,933
And the last five years
quality growth is absolutely not

00:05:39,933 --> 00:05:41,066
where you wanted to be.

00:05:41,633 --> 00:05:44,700
We have tried to stay true to our label
during this process.

00:05:45,400 --> 00:05:50,066
What you're seeing here
are two different style factors.

00:05:50,700 --> 00:05:53,900
The yellow line is the MSCI
Value Small Cap

00:05:54,066 --> 00:05:56,833
and the red line is the MSCI Growth
Small Cap.

00:05:57,266 --> 00:05:59,633
And over that period
there was roughly 20%

00:05:59,633 --> 00:06:02,000
underperformance of growth versus value.

00:06:02,633 --> 00:06:05,966
The market has just not been interested
in growth companies for some time.

00:06:10,933 --> 00:06:13,700
I ummed and ahhed about whether to
use this slide in the presentation deck.

00:06:13,966 --> 00:06:17,366
What this is showing
is the rolling five year

00:06:17,366 --> 00:06:20,233
value premium from our benchmark,
the Numis Smaller Companies (Deutche Numis Smaller Companies plus AIM (excluding Investment Companies) Index).

00:06:21,300 --> 00:06:24,733
Whenever the blue line is above
the X axis, that is value outperforming.

00:06:24,900 --> 00:06:28,200
Whenever the blue lines beneath
the X axis that is growth outperforming.

00:06:28,666 --> 00:06:30,766
And so what does that tell you?
It tells you a couple of things.

00:06:30,766 --> 00:06:35,166
One, it tells you that since 1960 value
has been the outperforming asset.

00:06:35,800 --> 00:06:38,300
And that actually it makes you question
why you're sitting here

00:06:38,300 --> 00:06:40,866
holding a growth orientated portfolio.

00:06:41,800 --> 00:06:44,033
But actually we think about this
in a very different way.

00:06:44,600 --> 00:06:48,066
When you look back over time, it's
absolutely true that for a long period

00:06:48,066 --> 00:06:49,133
value outperformed.

00:06:49,466 --> 00:06:52,533
But that assumes that all companies
stay the same,

00:06:52,533 --> 00:06:56,033
that markets stay the same, that the way
businesses operate stay the same.

00:06:57,000 --> 00:07:00,166
I think it's far more relevant
to look at the period from 2000 onwards.

00:07:00,166 --> 00:07:01,066
And clearly,

00:07:01,066 --> 00:07:02,633
the first part of that was characterized

00:07:02,633 --> 00:07:05,066
by a significant period
of value outperformance.

00:07:05,066 --> 00:07:07,466
But you have to remember what came
before that.

00:07:07,466 --> 00:07:09,133
That was the dot.com.

00:07:09,133 --> 00:07:12,566
That was when value shares became
incredibly unattractive

00:07:12,566 --> 00:07:14,566
to many, many market participants.

00:07:14,566 --> 00:07:17,133
That was when you could buy cigarette
companies for four times earnings.

00:07:17,133 --> 00:07:20,400
Pharmer companies for six times
earnings, pubs for five times earnings.

00:07:21,100 --> 00:07:24,100
The period that followed
was the inevitable

00:07:24,600 --> 00:07:28,100
return of that asset class as the growth
company started to disappoint.

00:07:29,233 --> 00:07:31,366
But what have we really seen
during that period?

00:07:31,366 --> 00:07:33,533
What has really happened to companies,

00:07:33,533 --> 00:07:36,533
to the way that companies are formed in
that period?

00:07:36,733 --> 00:07:38,866
Well firstly the capital allocation,

00:07:38,866 --> 00:07:41,866
the capital stock of these companies
is fundamentally changed.

00:07:41,933 --> 00:07:45,666
Even growth companies
back in the early 80s and 90s were heavy

00:07:45,666 --> 00:07:46,466
capital employed.

00:07:46,466 --> 00:07:47,333
The Microsoft

00:07:47,333 --> 00:07:50,766
20 years ago, 30 years ago is not
the same as the Microsoft of today.

00:07:51,466 --> 00:07:54,466
Now, today, you don't need to invest
in fixed assets.

00:07:54,733 --> 00:07:57,400
They can have flexible computing power
through the cloud.

00:07:57,400 --> 00:08:00,533
They can have short
term leases through WeWork if necessary.

00:08:00,533 --> 00:08:02,866
They can get their staff
through short term basis.

00:08:02,866 --> 00:08:06,133
The capital employed nature
of businesses is fundamentally changed,

00:08:06,500 --> 00:08:09,500
and therefore so has the growth profile
in return to growth.

00:08:09,600 --> 00:08:12,866
If we look at the likes of OpenAI today
and how quickly that has scaled

00:08:12,866 --> 00:08:16,833
in the current market, every iteration
of technology scales more quickly.

00:08:17,433 --> 00:08:20,433
Therefore, the ability
of growth companies to grow over time

00:08:20,600 --> 00:08:23,066
has also grown more quickly.

00:08:23,066 --> 00:08:25,566
It's why we're now more convinced
than ever about the outlook for

00:08:25,566 --> 00:08:26,266
growth companies.

00:08:30,500 --> 00:08:31,066
The second thing you

00:08:31,066 --> 00:08:34,066
can see from this chart,
on the right hand side,

00:08:34,100 --> 00:08:37,200
is the fact that value has outperformed
over the last few years.

00:08:37,233 --> 00:08:40,233
Again, the headwinds to our asset class
highlighted before.

00:08:43,266 --> 00:08:45,300
The next thing to show

00:08:45,300 --> 00:08:48,300
is the current mid-cap
and small cap versus large cap.

00:08:48,666 --> 00:08:51,666
And again,
I use this chart in the last year.

00:08:52,000 --> 00:08:55,400
And at that point, this was the record
underperformance of mid-cap

00:08:55,400 --> 00:08:57,766
versus large cap that we had ever seen.

00:08:57,766 --> 00:08:59,533
You can see every other cycle in here.

00:08:59,533 --> 00:09:02,833
You can see the 87,
you can see the late 90s, the tech

00:09:02,833 --> 00:09:05,833
boom, the global financial crisis,
Brexit, Covid,

00:09:05,900 --> 00:09:08,900
all of those periods of underperformance
were over by now.

00:09:09,600 --> 00:09:11,600
This cycle
has been completely different.

00:09:11,600 --> 00:09:14,700
And I stood here last year and told you
this was the longest and deepest

00:09:14,700 --> 00:09:15,633
period of underperformance

00:09:15,633 --> 00:09:18,633
of mid-cap and small cap
versus large cap that we had ever seen.

00:09:18,700 --> 00:09:22,033
I'm now standing here 12 months later
telling you this is the deepest

00:09:22,033 --> 00:09:22,933
and longest period

00:09:22,933 --> 00:09:25,933
of underperformance of small and mid-cap
that we have ever seen.

00:09:26,166 --> 00:09:29,300
Something has fundamentally disconnected
between mid-cap markets and large

00:09:29,300 --> 00:09:30,566
cap markets within the UK.

00:09:34,633 --> 00:09:35,233
And we believe

00:09:35,233 --> 00:09:38,233
this is one of the big reasons
for the fundamental disconnect.

00:09:38,233 --> 00:09:41,100
I think this is at the heart
of everything.

00:09:41,100 --> 00:09:44,100
This is the flow environment in UK
small and mid-cap portfolios.

00:09:45,900 --> 00:09:49,600
We haven't seen a month of inflow
since late 2021.

00:09:50,100 --> 00:09:54,000
There has been a persistent
and never ending pressure on UK

00:09:54,000 --> 00:09:58,000
small and mid-cap portfolios,
as these flows have had to be met.

00:09:59,133 --> 00:10:01,600
You're invested
in a closed end portfolio.

00:10:01,600 --> 00:10:05,166
You shouldn't be exposed to these flows,
but you're invested

00:10:05,166 --> 00:10:08,666
in a portfolio that these people
are also invested in as well.

00:10:08,900 --> 00:10:12,800
The same underlying companies, the same
underlying assets are in BlackRock

00:10:12,800 --> 00:10:16,400
Smaller Companies, as are in all these
open ended small and mid-cap portfolios.

00:10:17,000 --> 00:10:20,733
The selling pressure on UK small and mid
has been intense for a period

00:10:22,200 --> 00:10:25,200
and we may think, well, that's
only since 2021.

00:10:25,433 --> 00:10:28,600
The sad truth is,
those few lines above the x axis

00:10:28,600 --> 00:10:32,300
that feature in 21 were
those were the first lines since 2016.

00:10:33,433 --> 00:10:35,833
This phenomenon
stretches back to Brexit.

00:10:35,833 --> 00:10:39,000
The market has just got smaller
and so why does that matter?

00:10:39,900 --> 00:10:41,766
Well this flow,

00:10:41,766 --> 00:10:43,233
it causes certain behaviors.

00:10:43,533 --> 00:10:46,533
The first is it makes investors
focus on short term earnings.

00:10:47,366 --> 00:10:49,566
If an investor is presented
with a sell ticket

00:10:49,566 --> 00:10:51,233
and can either sell the company

00:10:51,233 --> 00:10:53,100
that's going to deliver earnings
in the next three months

00:10:53,100 --> 00:10:55,400
and deliver them
in line of expectations,

00:10:55,400 --> 00:10:59,200
or it's going to be at risk of missing
those and may look cheap on a mid

00:10:59,200 --> 00:11:00,133
to long term basis.

00:11:00,133 --> 00:11:02,266
But in the very near-term has a miss.

00:11:02,266 --> 00:11:03,566
They're going to sell the earnings

00:11:03,566 --> 00:11:07,666
- the business with the bigger earnings
risk, which means that the mid-term

00:11:07,666 --> 00:11:10,300
valuations of stocks
have really started to look attractive.

00:11:10,700 --> 00:11:14,366
We should be in a period right now
where stocks are trading on recovery -

00:11:14,400 --> 00:11:16,500
of recovered multiples
and recovered earnings,

00:11:16,500 --> 00:11:19,566
we should be seeing higher multiples
than we are, but we're not.

00:11:19,966 --> 00:11:23,666
The pressure has maintained on
valuations and multiples within stocks

00:11:23,866 --> 00:11:25,066
because of this flow pressure.

00:11:26,400 --> 00:11:29,100
The second is there's no IPO market.

00:11:29,100 --> 00:11:31,466
Investors don't have the money,

00:11:31,466 --> 00:11:34,300
spare capital right now to give to IPOs.

00:11:34,533 --> 00:11:38,166
And even if they did, if you are
a private equity company right now

00:11:38,400 --> 00:11:41,400
with a business on your books
that you're looking to IPO,

00:11:41,666 --> 00:11:44,666
you have to give it at a discount
to the current market valuations.

00:11:45,300 --> 00:11:48,266
And they're just not prepared
to accept the current market valuations

00:11:48,266 --> 00:11:49,366
as we see them.

00:11:51,433 --> 00:11:53,133
And the final thing is that those flows

00:11:53,133 --> 00:11:56,133
mean that the shares that tend to work
are those that have price momentum.

00:11:56,233 --> 00:11:58,166
The shares that were up
yesterday will be the people,

00:11:58,166 --> 00:11:59,733
the shares that people tend to buy today

00:11:59,733 --> 00:12:02,733
because they're going
for that near-term certainty.

00:12:04,533 --> 00:12:05,833
So when we look at valuations

00:12:05,833 --> 00:12:08,866
that point I have already made,
investors aren't looking through.

00:12:09,133 --> 00:12:10,800
We're not seeing recovered
multiples yet,

00:12:10,800 --> 00:12:13,733
despite the fact that we are
now 4 or 5 years into this downturn.

00:12:15,133 --> 00:12:16,566
Both small and mid-cap are

00:12:16,566 --> 00:12:19,333
trading at discounts
to their long-term averages.

00:12:20,400 --> 00:12:22,133
If you exclude the last

00:12:22,133 --> 00:12:25,133
few weeks, we've seen a slight increase
in the premium.

00:12:25,466 --> 00:12:28,200
Small and mid-cap
shares were trading at the same levels

00:12:28,200 --> 00:12:31,333
they were trading in 2008
during the global financial crisis,

00:12:31,333 --> 00:12:33,866
or 2011 during the European debt crisis.

00:12:34,333 --> 00:12:37,766
Put that in context, they are trading
at roughly the same valuation,

00:12:37,766 --> 00:12:40,066
when we thought the banking system
and capitalism

00:12:40,066 --> 00:12:42,433
were fundamentally broken,
or at the same time

00:12:42,433 --> 00:12:44,733
that we thought the European Union
was going to fall apart.

00:12:45,366 --> 00:12:47,566
The valuations right now,
because of that selling

00:12:47,566 --> 00:12:49,400
pressure,
have just reached attractive levels.

00:12:54,800 --> 00:12:57,600
But again, back to the issue with flow.

00:12:57,600 --> 00:13:00,600
Back to the issue with the market
we're in and how dislocated it's become.

00:13:00,766 --> 00:13:03,233
The UK small and mid-cap
universe continues to shrink.

00:13:03,866 --> 00:13:06,833
Last year
there were ten IPOs in our universe.

00:13:07,800 --> 00:13:08,366
Ten.

00:13:09,066 --> 00:13:13,300
Now, to put that into context,
that is the lowest level since 1987.

00:13:13,733 --> 00:13:17,400
There were more IPOs in the small
and mid-cap market in the depths

00:13:17,400 --> 00:13:20,400
of the global financial crisis
than they were last year.

00:13:20,933 --> 00:13:24,200
The universe just continues
to get smaller and to shrink.

00:13:24,600 --> 00:13:26,966
It's a logical economic reaction
to the valuations

00:13:26,966 --> 00:13:29,000
that we're seeing, back to that point
that businesses

00:13:29,000 --> 00:13:31,300
why would they want to IPO
when the valuations are so low?

00:13:31,300 --> 00:13:34,300
Why would they want to IPO
when there's no spare investor cash.

00:13:35,166 --> 00:13:37,633
So the market has these
very difficult backdrops

00:13:37,633 --> 00:13:38,733
sitting behind it.

00:13:41,966 --> 00:13:43,266
And then from a BlackRock
Smaller Companies

00:13:43,266 --> 00:13:46,533
perspective, there has been lots of M&A
in the last few years.

00:13:47,400 --> 00:13:52,100
Companies have continued to leave the UK
market, 50-60 companies every year.

00:13:53,066 --> 00:13:54,433
Unfortunately for us,

00:13:54,433 --> 00:13:57,366
we didn't own
the ones that really mattered last year.

00:13:57,366 --> 00:14:00,700
So M&A was nearly a 2% headwind
to the portfolio

00:14:00,700 --> 00:14:03,300
last year
in terms of relative performance.

00:14:03,300 --> 00:14:06,300
This, in essence, is a bit of a
random walk.

00:14:06,600 --> 00:14:08,766
It's very hard to analyze
a company and say,

00:14:08,766 --> 00:14:11,700
I think that one is definitely going
to get taken over next year.

00:14:11,700 --> 00:14:14,666
Typically speaking, it's
the sort of thing that helps

00:14:14,666 --> 00:14:17,666
aid the performance of a portfolio
as companies get taken over.

00:14:17,966 --> 00:14:20,633
It's unusual
to see such a significant headwind,

00:14:20,633 --> 00:14:23,366
but it reflects
the fact that companies are leaving

00:14:23,366 --> 00:14:26,366
and that the valuations
when they do leave already quite large.

00:14:27,166 --> 00:14:29,500
Spectris was bid for
(two bids for announced

00:14:29,500 --> 00:14:30,566
for Spectris).

00:14:31,466 --> 00:14:34,533
The price was 70% above
the market price.

00:14:35,100 --> 00:14:36,766
We've seen a number of companies

00:14:36,766 --> 00:14:40,600
where IPO premiums have been 70%,
80%, 90%, 100%, Alphawave,

00:14:40,600 --> 00:14:41,466
very recently.

00:14:42,533 --> 00:14:44,766
Outside investors recognize the value

00:14:44,766 --> 00:14:48,166
that sits within the UK market,
and they are prepared to pay for it

00:14:48,600 --> 00:14:52,133
in a way that UK equity market
participants are not right now.

00:14:56,066 --> 00:14:58,700
And in terms of outperformance,
we have to hold our hands up.

00:14:58,700 --> 00:15:00,533
We have had stock specific issues.

00:15:00,533 --> 00:15:03,666
We have had companies where we just got
the investment case wrong.

00:15:05,400 --> 00:15:08,400
Broadly speaking,
I think they split into three groups.

00:15:08,400 --> 00:15:10,766
There were those where we did
identify the problems,

00:15:10,766 --> 00:15:13,133
but because of liquidity
were unable to get the shares out.

00:15:13,133 --> 00:15:14,366
YouGov is an example of that.

00:15:15,200 --> 00:15:16,866
There were those
I would describe as the true,

00:15:16,866 --> 00:15:18,066
left-field profit warnings.

00:15:18,733 --> 00:15:22,900
CVS had an investigation from the CMA
in terms of the veterinary industry.

00:15:22,900 --> 00:15:24,400
And we couldn't have seen that coming.

00:15:24,700 --> 00:15:27,333
Secure Trust, a lender in the automotive

00:15:27,333 --> 00:15:30,000
space, has been caught out
by the FCA investigation

00:15:30,433 --> 00:15:33,900
and the government investigation
into automotive lending practices.

00:15:34,233 --> 00:15:37,233
That was a change of rules where
the Court of Appeal decided that the

00:15:38,100 --> 00:15:40,133
current regulation
wasn't actually appropriate.

00:15:40,900 --> 00:15:43,166
And then there are those
who misanalyzed where we either thought

00:15:43,166 --> 00:15:45,666
that the problems would be much shorter
in duration than they were,

00:15:45,666 --> 00:15:48,066
recruiter Robert
Walters is a prime example of that.

00:15:48,600 --> 00:15:49,600
Or miss some of the trends

00:15:49,600 --> 00:15:52,966
that were going on within the industry
that led to short-term profit hits.

00:15:53,266 --> 00:15:55,200
TT Electronics is an example of that.

00:15:56,500 --> 00:15:58,133
So those are ones where

00:15:58,133 --> 00:16:00,766
companies we have owned have disappointed
for one reason or another.

00:16:01,133 --> 00:16:02,200
On the other side,

00:16:03,333 --> 00:16:05,433
there is the relative loss
from companies that we haven't owned

00:16:05,433 --> 00:16:06,300
that have gone up.

00:16:06,600 --> 00:16:10,166
And again,
you can see within this analysis stocks

00:16:10,166 --> 00:16:12,933
like Keywords, like Essential,
those are some of the businesses

00:16:12,933 --> 00:16:15,200
that were taken over last year
where we didn't have a position

00:16:15,200 --> 00:16:17,300
and acted as
a relative headwind to the portfolio.

00:16:21,300 --> 00:16:24,566
So it's all awful, markets are
terrible, outflows are everywhere.

00:16:24,866 --> 00:16:28,900
Why would you possibly want to invest
in a growth small and mid-cap portfolio?

00:16:29,000 --> 00:16:31,433
Given that backdrop,
no-one values growth.

00:16:32,100 --> 00:16:33,266
Well, this is one reason.

00:16:33,900 --> 00:16:36,100
This is the valuation of large-cap

00:16:36,100 --> 00:16:38,133
versus small-cap growth within the UK.

00:16:39,100 --> 00:16:42,400
Data goes back to 2017,
we can draw it further, but

00:16:43,566 --> 00:16:46,466
this bit suits in terms
of the amplification that we've seen.

00:16:46,466 --> 00:16:47,766
For many years

00:16:47,766 --> 00:16:52,700
small-cap growth, mid-cap growth - trades
at a premium to large-cap growth.

00:16:53,433 --> 00:16:57,300
It has higher valuation multiples
than large-cap companies tend to have.

00:16:58,500 --> 00:17:01,200
They should do, in theory,

00:17:01,200 --> 00:17:04,066
a smaller growth company
can clearly grow at a higher rate

00:17:04,066 --> 00:17:06,300
than a bigger, more diverse
growth company.

00:17:06,300 --> 00:17:09,566
That's just the law of large numbers
or the law of small numbers.

00:17:10,200 --> 00:17:13,133
So it's economically rational
for a small and mid-cap company

00:17:13,133 --> 00:17:16,133
to trade at a higher premium
than a largecap company,

00:17:16,333 --> 00:17:18,566
all else being equal.

00:17:18,566 --> 00:17:20,500
Right now, that's not the case.

00:17:20,500 --> 00:17:23,100
Back to that selling pressure again.

00:17:23,100 --> 00:17:26,466
And if we look at the largest UK
growth companies

00:17:26,466 --> 00:17:30,000
just taking from market
cap, Rolls-Royce (37 times earnings),

00:17:30,000 --> 00:17:32,966
Relex (30 times earnings),
London Stock Exchange (28),

00:17:32,966 --> 00:17:35,966
Experian, (29), Sage (30), Alma (31).

00:17:36,666 --> 00:17:39,766
Let's call that 30 as a round average
across that subset.

00:17:40,600 --> 00:17:44,400
Then let's do the same for the small
mid-cap companies IG Group (10 times earnings),

00:17:45,466 --> 00:17:46,233
Spectris (21 times -

00:17:46,233 --> 00:17:49,933
but as I just said, that's been bid
for on the undisturbed price of 14 times).

00:17:50,066 --> 00:17:51,133
Cranswick (18),

00:17:51,133 --> 00:17:53,700
Rotork (19), QinetiQ (60).

00:17:53,700 --> 00:17:57,000
Roughly half the valuation
of their large-cap peers

00:17:57,366 --> 00:18:00,366
for no difference in growth rate.

00:18:00,400 --> 00:18:03,400
Businesses
historically have traded at a premium.

00:18:03,600 --> 00:18:06,800
This is the effect
that flows are having on this market.

00:18:06,800 --> 00:18:09,800
Now at some point,

00:18:09,900 --> 00:18:12,000
markets should get better,

00:18:12,000 --> 00:18:13,600
economy should stabilize.

00:18:13,600 --> 00:18:17,033
But most importantly the valuation
the outside investors

00:18:17,033 --> 00:18:19,666
that private capital is seeing
for these companies.

00:18:19,666 --> 00:18:22,933
Equity investors should start to realize
that as well and see the opportunity

00:18:23,200 --> 00:18:26,200
that sits within this asset class.

00:18:26,900 --> 00:18:29,900
As a reminder, this is what
small companies do historically.

00:18:31,366 --> 00:18:33,833
Chart goes back to 1955.

00:18:33,833 --> 00:18:36,366
The compounding nature of small
and mid-cap over

00:18:36,366 --> 00:18:39,466
large has been demonstrated
time over time, over history.

00:18:40,333 --> 00:18:42,600
But right now,
we are at a ten-year period

00:18:42,600 --> 00:18:45,400
where small-cap has not outperformed
large-cap.

00:18:45,400 --> 00:18:47,066
That just typically does not happen.

00:18:54,200 --> 00:18:55,800
This is where we are, in the outlook.

00:18:55,800 --> 00:18:58,500
And what do we think?

00:18:58,500 --> 00:19:00,833
You can see the current sector
allocation of the portfolio.

00:19:00,833 --> 00:19:03,400
And as I said we are bottom-up.
We are stocks specific.

00:19:03,400 --> 00:19:06,866
We think about things from a company
basis, not a sector allocation basis.

00:19:07,666 --> 00:19:09,900
But of course
the sector allocation does reveal

00:19:09,900 --> 00:19:13,600
what the combination of those bottom-up
investments has done.

00:19:14,233 --> 00:19:15,633
What are we feeling about the world?

00:19:15,633 --> 00:19:18,633
What is the amalgamation
of those investment ideas?

00:19:18,633 --> 00:19:21,633
I stood here last year and I told you
that we are positive on consumer,

00:19:21,700 --> 00:19:24,466
that swap rates were falling,
that savings ratios were high,

00:19:24,466 --> 00:19:27,466
the unemployment was stable,
the real wage growth was going up.

00:19:27,900 --> 00:19:31,166
And up until the point we got
the budget, that was absolutely correct.

00:19:31,866 --> 00:19:33,900
And then the budget hit
National Insurance.

00:19:33,900 --> 00:19:36,533
And what does that do?
Well, that does two things.

00:19:37,533 --> 00:19:39,900
One, is it

00:19:39,900 --> 00:19:41,333
just hits people.

00:19:41,333 --> 00:19:43,000
It drives a bit of inflation.

00:19:43,000 --> 00:19:46,000
People start to worry about what
the costs are going to be.

00:19:46,033 --> 00:19:48,166
Because it
drives inflation, it drives swap rates.

00:19:48,166 --> 00:19:49,066
Mortgage rates go up.

00:19:49,066 --> 00:19:51,733
People have a bit less cash
in their pocket.

00:19:51,733 --> 00:19:54,266
From the point of view
of the investments that we liked, that

00:19:54,266 --> 00:19:58,766
we focused on, that were pointed towards
the consumer, retailers, pub stocks.

00:19:59,733 --> 00:20:03,000
They are companies
that are exposed to short-term labour.

00:20:03,533 --> 00:20:05,466
which were most hit
by National Insurance.

00:20:05,800 --> 00:20:07,266
So not only was the demand side

00:20:07,266 --> 00:20:10,366
slightly impacted by National Insurance,
people delayed their decisions.

00:20:10,633 --> 00:20:12,833
The costs for these companies
went up significantly.

00:20:12,833 --> 00:20:15,333
National Insurance
was a hit for us last year.

00:20:15,833 --> 00:20:18,833
But we still fundamentally believe
that the consumer is in good place.

00:20:19,200 --> 00:20:22,800
Unemployment is rising, but it’s rising
in a controlled and contained fashion.

00:20:22,800 --> 00:20:25,300
Real wage growth is continuing to go up.

00:20:25,300 --> 00:20:28,600
The savings
ratio is still at multi-year highs.

00:20:28,800 --> 00:20:32,100
People still have the capacity to spend
if they have confidence.

00:20:32,400 --> 00:20:34,000
And swap rates are falling.

00:20:34,000 --> 00:20:35,333
Mortgage rates are falling.

00:20:35,333 --> 00:20:37,933
There is competition
between banks for mortgages.

00:20:37,933 --> 00:20:40,500
The housing market is slowly recovering.

00:20:40,500 --> 00:20:44,100
So we still think the consumer,
emphasized here through construction

00:20:44,100 --> 00:20:47,633
materials,
but also through, through other sectors.

00:20:47,933 --> 00:20:50,666
We think consumer from here
still has a positive outlook.

00:20:50,666 --> 00:20:53,233
It just needs that confidence
to unlock it.

00:20:53,233 --> 00:20:56,066
And we think the valuations of
the companies that sit within that space

00:20:56,066 --> 00:20:57,133
have moved to reflect.

00:20:59,800 --> 00:21:01,800
The second is the

00:21:01,800 --> 00:21:03,533
investment banking and
brokerage services.

00:21:04,933 --> 00:21:08,133
We do believe in the companies
that sit within this sector.

00:21:08,133 --> 00:21:11,133
We don't necessarily believe
in straight asset management.

00:21:11,500 --> 00:21:12,633
It's a terrible thing to say

00:21:12,633 --> 00:21:13,900
working at BlackRock.

00:21:14,900 --> 00:21:18,066
But the asset managers listed on the UK
market, they're small,

00:21:18,066 --> 00:21:22,100
they're niche, they're very exposed to
single strategies and single services.

00:21:22,466 --> 00:21:25,800
What we do like are the businesses
that serve that industry

00:21:25,800 --> 00:21:28,800
that do benefit
from the market movements.

00:21:29,233 --> 00:21:32,133
And so it's a wide range of companies
that sit within that.

00:21:32,700 --> 00:21:37,233
Ultimately, we continue to look
for advantage players that have growth

00:21:37,233 --> 00:21:40,233
characteristics
that we think will persevere

00:21:40,233 --> 00:21:41,600
for the mid to long-term.

00:21:45,000 --> 00:21:45,833
So I'll leave you there.

00:21:46,833 --> 00:21:48,300
Reminder of the trust.

00:21:48,833 --> 00:21:50,600
A reminder of the long-term performance.

00:21:50,600 --> 00:21:53,366
A reminder of why we do what we do.

00:21:53,366 --> 00:21:56,133
We do think that the growth outlook

00:21:56,133 --> 00:21:59,133
for the UK is starting to improve.

00:21:59,166 --> 00:22:01,666
We do think that the valuations
of growth

00:22:01,666 --> 00:22:04,666
companies have reached levels
where fundamentally they're attractive.

00:22:04,833 --> 00:22:08,200
We do not believe that
these companies are broken

00:22:08,466 --> 00:22:11,900
and we fundamentally still believe as UK
small-cap, small and mid-cap

00:22:11,900 --> 00:22:14,900
investors, growth is the outcome
that you should get

00:22:14,900 --> 00:22:16,166
from that investment process.