Brexit bargains and dangerous dividends: we talk to BlackRock Throgmorton’s Dan Whitestone

BlackRock’s Dan Whitestone

The BlackRock Throgmorton investment trust (LSE: THRG)  has been among the best-performing investment trusts in the UK smaller companies sector, returning nearly 170% over the past five years (according to figures from the Association of Investment Companies).

BlackRock’s Dan Whitestone, who has managed the trust since March 2015, will be taking part in a panel discussion at the MoneyWeek Wealth Summit on 22 November. We caught up with him to get an overview of where he reckons the best opportunities are right now – and to discuss the dreaded ‘B’ word.

Q: Given that you run an investment trust focused on smaller UK companies, how – if at all – has Brexit affected your investment process? 

The reality is that Brexit does not really affect our investment philosophy or process; it is very much business as usual for the Throgmorton Trust. We continue to focus our attention on researching company and industry specific trends, where the financial outcomes are less correlated to macro political events and far more dependent on the success of the underlying businesses.

As such we haven’t made any changes to the positioning of the fund in the run up to Brexit.  Long-term secular trends driven by changes in regulation, distribution, consumer behaviour, manufacturing and technology are key areas of focus for us, both from a long and short perspective, and trends such as these are far more significant to the financial health of many companies and industry profit pools than any Brexit outcome.

Q: How well prepared do you think smaller companies in general are for Brexit? 

There is no simple answer to this, it really is a case by case basis. Preparing for the unknown isn’t easy. Of course, what most companies want is clarity, as do most consumers (!) and that lack of clarity can lead to deferral in decision making, especially when it comes to capital and operational expenditure.

Generally, companies with strong management teams, high profit margins and well capitalised balance sheets are able to absorb additional Brexit-related preparatory costs, whereas others don’t have the financial means necessary. Again a reason why we think it is better to own companies with strong financials for the long term. Sometimes being small can make you more nimble.

For us, rather than deliberating each week on what our domestic exposure should or shouldn’t be, or what the correct mix is between small caps versus large caps, we think the real opportunity for long term wealth creation for our investors is to concentrate our efforts on building a portfolio of compelling global-facing growth companies, with differentiated business models and/or companies driving industry change.  This is where we believe we have added the most value to our clients and where we believe we will continue to do so.

Q: Are there any specific areas where you feel Brexit concerns have created unjustifiably low valuations and good opportunities to buy? 

The general aversion to the UK stockmarket has presented many opportunities for investors like us, where global leading franchises have de-rated in the wider sell-off of UK listed equities.  This is where we see the most compelling opportunities, ie, buying global companies that dominate specific niches, or global facing companies driving industry change, and where the earnings power of these investments is increasingly under-appreciated by the stockmarket, and in some specific cases where these investments are trading at even bigger discounts to their internationally listed peers.

In recent weeks we have seen an increase in M&A activity, and with the ongoing weakness in sterling and low interest rates allowing international companies to purchase UK companies at a low cost, we expect to see more bids by the end of the year. Consequently, this reaffirms our generally optimistic outlook on UK listed equities.

Q: What do you look for in a company as a “long” investment?

Our focus will continue to be on two specific types of investments: firstly, differentiated long-term growth investments – those with strong management teams, strong and dominant market positions, with a compelling product offering that are exposed to positive industry trends.

Second are those companies that are leading industry change, the “disruptors”. By focusing on the underlying business fundamentals, we believe that we are able to find companies with strong business models that will be able to adapt and more importantly thrive, regardless of the wider macroeconomic environment.

Q: And given that it’s been a bit of a banner year for “surprise” profit warnings, what red flags scream “avoid” or “short”?

Companies that have a significant second-half weighting to achieve full-year profits merit closer inspection. More important, though, is clean accounting. One of the biggest red flags for us is the questionable accounting treatments we see employed, which often leads to a growing divergence between reported “adjusted earnings” and cash flow. Ultimately cash flow is the only metric that really matters, and is the hardest to manipulate.

Generally we believe that the first and real victims of any global slowdown will be companies we think have weak financial structures (ie, low margins, too much debt and weak cash flow) and/or facing structural pressures.

Q: Earlier in the year you registered concern that some companies were paying excessive dividends – do you think that’s still the case? 

Absolutely, and I think we have seen the evidence of this in recent months with many high profile over-indebted companies having to cut or suspend dividend payments. It is an alarming trend that has developed within the UK market.

We continue to believe that a number of companies are pressured by major shareholders to pay dividends that they can’t afford, and this has starved many businesses of investment required to keep pace with change and grow.  This has led some driving themselves into a brick wall, and the trust has benefitted from a number of these situations in the financial year.

Q: Your trust is able to go short as well as long – what’s been your most successful short position in recent years? (Or if you can’t tell us specifics, are there any industries or sectors that you feel are particularly good hunting grounds for short opportunities?)

The ability to go short is, we believe a key differentiator of Throgmorton versus other small & mid-cap investment trusts. This enables the trust to deliver both stock specific alpha, in combination with thematic shorts across a number of challenged industries facing structural pressures has been a strong contributor to performance. In the last financial year, two of our shorts fell to zero.

Q: You can also invest in some overseas companies – are there any specific sectors or companies that particularly interest you in that area?

When investing in non-UK listed businesses, the criteria for inclusion in our portfolio is no different to that of businesses listed in the UK. Industry disruption is not limited by geography and therefore we introduced the ability for the trust to invest up to 15% in companies not listed in the UK, to provide further opportunity to identify exciting growth companies that are driving change and disrupting their end markets.

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