Hello. Thanks a lot for watching this video. I'm Dan Whitestone, the portfolio manager for BlackRock Throgmorton Investment Trust, and the purpose of this short video is really to talk about the performance of H1 of 2023, to talk about the current positioning, and then to leave you with some thoughts about the outlook going forward.
OK, so for the performance in hand, this, ultimately, has been another challenging period to navigate, which really sort of continues the theme of the last 18 or so months where, ultimately, this huge tension between macro, there are so many things to worry about in this world, versus the micro, which really, actually, is the ongoing resilience and strength of company reporting, particularly of the companies that are owned in Throgmorton. So with that in mind, over the six-month period, the company's NAV has returned a modest 0.1%. So a very, very small positive performance, but certainly better than our benchmark, which was negative 2.4%. So some relative outperformance of 2 and 1/2%.1Nothing to really shout from the rooftops, but it is a start. And it's somewhat frustrating, because I actually feel that the resilience and strength of the underlying trading of the companies has certainly not been captured in the NAV performance of the period. And clearly, it's my belief and hope that that will come in time.
And one only has to look at the top contributors- or even the detractors, by and large, for the period-- to make my case that actually, the company's earnings have actually been very, very strong. When you look at the top three contributors in the annual report, you'll see it's Games Workshop, Oxford Instruments, Decca Pharmaceuticals. And if you look at two of the biggest detractors, Watches of Switzerland and Ergomed, what these companies have all in common is they have continued to demonstrate this year-- as they have in previous years-- of very, very strong, year after year, year-over-year strong organic revenue growth and profit growth. And this, I think, reflects the uniqueness of their offering. It reflects the differentiated product position, the strength of their market positioning, and more importantly, I think, speaks to the genuine secular growth prospects for their industry. Now, in some cases, that's been rewarded in the rising share price. In other cases, the shares have continued to fall. And therefore, we've seen a compression in their valuation. But it's certainly my belief and the team's belief that that will correct upwards in time. And really, this is like the frustrating-- or the main frustration of the period, is that the strong results aren't translating, by and large, into an outperforming asset class. And when you look at the asset class of, let's say, UK small and medium-size companies, what we've seen is a large period of negative outflows as investors continue to allocate to other areas of the stock market. And I think this, in part, explains the chronic underperformance of small mid-caps versus large caps. Indeed, if you go back to when this underperformance started in 2021, we've seen the biggest underperformance of UK mid-caps, the FTSE 250, versus large caps, the FTSE 100, on record. And that underperformance is now over 30%.2So it's the biggest in terms of drawdown, but also in duration, and this is not something that we can think that can persist.
But before we get all too despondent, there are glimmers of hope. An outcome of this is the valuation that is now afforded by this asset class, with UK small-size, small and medium-sized companies, in the case of small caps, on about 9 and 1/2 times current year's earnings. In the case of mid-caps, it's just under 10 and 1/2 times current year's earnings- which I think is compelling in an absolute sense, but certainly very, very attractive in a relative sense when you look at the valuations ascribed to other developed markets. And again, we don't think this is something that is sustainable.
If we turn to portfolio positioning, one thing to remember is that the whole philosophy of this investment trust is really to try and focus on differentiated and advantaged companies. And one of the key things that we would like to find in companies are those that can win market share and manufacture their own growth. And two sectors where we see a lot of evidence of that, both from a sort of market share winner and market share donor perspective, are consumer services and industrials. And if I've learned anything in my career, it's that no two industrials are the same, and no two consumer companies are the same. And I guess a frustration of last year was that a lot of these companies were treated the same, but the financial results actually showed very, very different outcomes. And I think that's going to be an increasingly important theme going forward, is more dispersion when it comes to financial reporting. And what I mean by that is I think those are very strong market share stories, as evidenced by some of the contributors that you'll see in our interim report, can continue to win market share at elevated levels. And some of this goes back to pre-COVID, where they've worked with their suppliers, they've invested in digital offerings, they've invested in two-man delivery, they've invested in their product offering, and they're able to accelerate those market share gains that, really, were catalyzed through COVID, particularly in that sort of difficult supply-chain-constrained environment.
Other companies that haven't got differentiated offerings are often, coincidentally, are combined with financial leverage- are much more exposed to not only the twin pincer of falling demand, but more importantly the rising cost of debt- debt and those interest payments- which really further erodes their profitability. So more dispersion in financial outcomes, I think, will favour the positioning of this trust, both from a long and short perspective.
If we turn our attention to industrials, this is a complex sector with lots of individual sector trends going in. I mean, generally speaking, there is a period of destocking in sectors as inventory has worked through the chain. But it's very important to note that in some particular parts of industrials- notably aerospace and autos, where this trust has exposure- demand was significantly choked through COVID and coming out of COVID, really through the supply chain constraint period. And so we're not coming off elevated levels of demand, which is what you'd normally see in the industrial complex going into any sort of economic downturn. So I think that's significant protects the revenue line- or certainly reduces the amplitude of any volume drop that one might expect. In the case of aerospace, actually, there's other factors at play here, which is quite- make a very interesting time for these companies to prosper.
If I think about our US exposure, many of my companies in Throgmorton make no money in the UK whatsoever. And actually, the US is by far, if not their only, largest market. And I think about some of the bigger themes at play here. I'm sure many of you have heard buzzwords such as local for local, or reshoring, or onshoring. But this, clearly, is a growing and very important long-term trend as companies continue to seek to diversify their supply chain and rethink their manufacturing footprint. And I think that plays very well into the hands of lots of UK-based exporting industrials into that US market. We will need more valves, more actuators, in some cases more scientific instrumentation equipment, et cetera.
But there are other things at play here, too- the IRA, the Inflation Reduction Act, or the CHIPS act, as the US seeks to invest more in its semiconductor industry, which, again, really plays into certain UK industrials. We've mentioned, you know, Oxford Instruments as a top contributor in the H1 Interim Report.
Another sector that continues to get a lot of interest is what we call in the UK RMI. And this really is, in common parlance, repair, and maintenance, and improvement. And effectively, this is the spend that one makes on improving their home. And this is an industry that- we always think is interesting because it's so much more than just about demand. Actually, there's so many interesting market share stories within this. And there are new formats. They're changing the offering. They're changing the way people buy, both through builders or individual consumers. And we think we own many companies that actually have demonstrable market share-winning strategies, which has served them well in the years that have gone and we certainly think are serving them well in this year in being more resilient in a more challenged backdrop, and certainly will serve them well in the future. But again, we think that, in this particular area, yes, volumes are under pressure. But we think that already, that is embedded in forecasts, and a lot of negativity is being currently priced into these companies. And we think that will revert in due course.
Which brings me to the outlook. I guess the first point that we would make is that employment has continued to remain strong and has effectively underwritten the confidence and health of both the corporate and the consumer. And when we think about the consumer, they have accumulated large savings buffers through COVID. Corporates have very strong balance sheets as referenced by the sheer number of share buybacks that we're seeing right now and the large number of companies that we own in Throgmorton Investment Trust that have a net cash position. Banks are incredibly well-capitalized, so conditions are certainly nowhere near as stretched as they were say back in the GFC.3 But employment is clearly one of the key metrics that we are watching like a hawk.
As for inflation, my own view is that inflation has already started to fall, and the real declines will be witnessed in H2, where we will see the real benefit working through the numbers of the falls in utility bills, which will offer meaningful protection to many consumers.
The housing market today is nothing like the GFC. So of course, there's some attention on interest rates and the outlook for interest rates from here. But look, one needs to bear in mind that over 40% now of the housing market are owned outright.4 There are no mortgages. And when you look at the mortgage book, the vast majority of it now has been termed out on five-year fixed. So any incremental increase in rate rise from here actually affects a disproportionately smaller amount of the mortgage market. So it would impact, certainly, some of the lower socioeconomic parts of society. But ultimately, that isn't really where the consumer positioning of Throgmorton currently lies.
The main picture that we see is really one of gradual recovery. In many cases, a shadow recession is already embedded in the forecasts, the analyst community forecasts, of the companies that we own. And in many of the cases, the companies continue to deliver earnings that are actually ahead of those numbers. We must bear in mind that we've come out of a very, very weird, distorted period from COVID, and the legacy or the hangover supply chain constraints have really, actually, weighed down the demand or, ultimately, the sales of many consumer and industrial companies, which basically has stopped them from coming off periods of real excess which, again, offer some protection.
But when we step back from it all, we ultimately are optimistic because we think the valuation of the asset class is attractive in absolute and relative terms. I mentioned those price and earnings ratios to you earlier. We can see continued robust, resilient trading across the portfolio's holdings, which reflects not only the strength of their market position and years of good work that have led them to this point, but ultimately speaks to us about the excitement of the future that we think these companies can generally continue to take market share, capitalize on their position, expand into new territories, continue to take share from competitors, and ultimately are exposed to structurally attractive long-term growing markets where we think, therefore, their sales and profits can grow meaningfully over years. And that, in our view, is certainly not reflected in the valuation ascribed today.
So our process hasn't changed. Our philosophy hasn't changed. We're firm believers in what we do. We are firm believers in the Interactions asset class. We are firm believers that asset class will rise again in the future, and if history is any guide to the future in any periods of economic recovery it's generally a very good time for small and medium sized companies, whether you're based in the US, Europe, or the UK. And so what we need is patience and to keep the faith and believe in the companies that we have, where we generally think the outlook for their ability to grow organically both, their revenues, their profits, and their cash flows meaningfully in the coming years is very high. And we only ask you to do the same. And with that, thanks for listening. And if you want to reach out to myself or to your contact at BlackRock, then please do so. Thank you.
Sources:
1 As at 31 May 2023 and percentage comparisons are against 30 November 2022. The Benchmark Index is the Numis Smaller Companies plus AIM (excluding Investment Companies) Index.
2 Source: BlackRock Investment Management as at 31 May 2023
3 Global Financial Crisis
4https://www.uswitch.com/mortgages/mortgage-statistics/ as at 7 June 2023
