The best of British opportunity

With high standards of corporate governance and a rich heritage of entrepreneurialism, the UK has an abundance of exciting investment opportunities for investors to consider within the small and mid cap space. The Schroder British Opportunities Trust (SBO) was launched in December 2020 to tap into this potential, facilitating and driving growth across both publicly-listed and privately-owned businesses.

The ability to invest across both public and private opportunities is a key differentiator for the trust. Normally, funds are restricted to investing in one or the other but, with its ability to access both public and private markets, for SBO, this means a broader universe of exceptional opportunities from which to select the best of Britain’s fastest-growing young businesses.

With its acknowledged expertise in both public market and private equity investing, Schroders is uniquely well-placed to capture this broad opportunity. It has a long and impressive track record of investing in public companies and is particularly well-known for its small and mid-cap expertise. Meanwhile, with more than £10bn in assets under management, Schroders Capital has been investing successfully in private companies for more than 25 years.

Quality growth characteristics

Irrespective of whether they are listed or not, the businesses SBO seeks to invest in have some common characteristics. The core focus is to invest in high quality companies that have strong balance sheets and a long runway for growth. Typically, these businesses will exhibit strong pricing power (which is particularly beneficial in these times of high inflation), robust management teams, and will already be delivering good revenue growth. There is a preference for investing in businesses that are already profitable, but if the team is investing in loss-making companies, it ensures they are well-funded and possess a clear, and near-term route towards profitability.

All of these characteristics should ensure relatively resilient revenue streams, even in a challenging economic environment and, on balance, that is precisely what the managers have seen from the portfolio over the last eighteen months.

An impressive portfolio

At its most recent financial results (30 September 2022), 64% of SBO’s portfolio was invested in private businesses, spread across nine businesses. The public part of the portfolio has more positions but at smaller weights. Stock turnover is low, although a series of takeovers in 2022 led to modestly higher activity than the team would normally expect. Euromoney, EMIS and Ideagen were all sold after receiving bids, with the proceeds recycled into other opportunities that have strong and sustainable growth prospects. Whilst it isn’t part of the strategy to explicitly target takeover candidates, this series of deals (including the acquisition of Waterlogic from the private equity portfolio) does suggest the team has been successful in identifying undervalued businesses. M&A activity has been the catalyst for realising that undervaluation and the portfolio managers believe the portfolio consists of attractive opportunities that could also be targets.

Whilst software and IT services represent the largest two sector weights in the portfolio, the fund is well diversified across a range of other sectors, including consumer services, healthcare, leisure and financial services. This reflects the breadth of the opportunities the managers have been able to identify, which also de-risks the portfolio from being too concentrated.

Performance from the portfolio so far has been modestly positive, despite the challenging backdrop in 2022. The trust’s net asset value (NAV) has increased by 2.4% since launch, at the time of writing. The private portfolio has delivered very positive progress, with an aggregate fair value increase of 48%, based on strong operational progress. Whilst this is encouraging, it has been offset by the public element of the portfolio, where the share prices of many small-to-mid sized UK growth businesses have struggled. This doesn’t necessarily reflect poor operational performance, but rather, negative market sentiment has held valuations back.

Representative case studies

Examples that reflect the quality of the opportunities the managers have invested in include Easypark and Mintec. Easypark is a leading parking technology business that helps drivers find, manage and pay for parking, as well as electric vehicles charging points, through their phones. The business model is already well-established, and it offers considerable growth potential as it rolls out its technology in new territories. Its ambitious management team is currently driving a geographical expansion which means that it can now help drivers in more than 25 countries across over 3,200 cities. The company is already profitable, and its technology is proven, which de-risks the next phase of its scaled development.

Meanwhile, Mintec is the world’s leading independent provider of commodity price data and market intelligence to global food and manufacturing brands. Its cutting-edge software platform delivers highly valued data and analysis on thousands of different commodities and other food ingredients, which enable its customers to implement more efficient and sustainable procurement strategies. With expertise developed over more than three decades, Mintec has capitalised on its superior data collection and analysis capabilities to build a formidable market position. A subscription-based business model provides excellent revenue visibility, and its continued global organic growth should deliver higher margins as it scales.

An exciting proposition

The SBO team (Co-Portfolio Managers Rory Bateman and Tim Creed, together with team members Uzo Ekwue and Pav Sriharan), view the portfolio as a very exciting proposition right now. They have found abundant opportunities to invest in high quality growth businesses that are able to thrive even in a challenging economic environment. Indeed, the current economic challenges add to SBO’s future potential because they mean the managers can access those opportunities at extremely attractive valuations.

Importantly, SBO’s private equity allocation is not focused on the pre-IPO or ‘crossover’ part of the market, where a considerable amount of capital has flowed in recent years leading to excess valuation risk. Nor is it targeting earlier-stage venture capital companies, where the recent market downturn has had a notably negative impact, putting some businesses under significant funding risk.

In contrast, SBO’s private allocation is focused on later-growth capital and small-to-mid market buyout stage companies. Here, valuations have in some cases contracted, but declines have been relatively modest. Meanwhile, robust operational performance has meant that the impact of earnings growth has more than offset the valuation contraction.

Double discount

The SBO investment case is currently enhanced by two forms of discount. Firstly, the UK is among the cheapest of any regional stock markets at present, with a 40% valuation discount to global peers. This provides investors with the opportunity to invest in UK assets at a discount to what they would be worth if they were listed on practically any other market.

Secondly, over the course of 2022, SBO’s share price slipped to a discount to net asset value. Prior to this, the shares had traded close to NAV, but investors can now buy the shares at a discount of more than 30% to NAV. This discount perhaps reflects concern that the private element of the portfolio may be vulnerable to valuation downgrades in the coming months. Other private equity investment trusts have also slipped to a discount but, in the case of SBO, the portfolio managers strongly believe those concerns are misplaced. As explained above, the operational performance of the private portfolio has been very positive in aggregate and momentum remains generally strong, suggesting the direction of travel for valuations may actually be up not down. This reflects the resilient characteristics the team is seeking to invest in and the maturity of its portfolio companies, which are already at or close to profitability, and growing revenues at a rapid pace.

Nevertheless, the combination of these two discounts provides a window of opportunity for investors to currently buy a high quality, fast-growing portfolio of UK businesses at a very attractive price.

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Fund risk considerations

Conflict of Interest Risk: The AIFM, the Portfolio Managers and their affiliates will provide services to other clients, which could compete directly or indirectly with the activities of the Company and may be subject to conflicts of interest in respect of their activities on behalf of the Company.

COVID-19 Risk: The long-term impacts of Covid-19 are unknown, rapidly-evolving and may be materially more severe and/or more permanent than anticipated. It is difficult to accurately predict the effects these factors may have on the investee companies within the Company’s portfolio and on the Company. The Company may invest in investee companies which do not meet the target returns anticipated by the Portfolio Managers (being Schroder Investment Management Limited and Schroders Capital Management (Switzerland) AG  (the “Portfolio Managers”)) due to the Portfolio Managers underestimating or failing to accurately predict or foresee the time scale, severity and/or impacts of the Covid-19 crisis, which could result in a material adverse impact on the performance of the Company, the NAV and the returns to Shareholders.

COVID-19 Strategy Risk: The Company’s strategy is to invest, initially, in companies impacted by the Covid-19 crisis in the approximately £50 million to £2 billion equity value range. These companies may not have the financial strength, diversity and resources which larger companies may have and there may be a higher risk that these companies will find it more difficult to operate during the Covid-19 crisis, as well as in periods of economic slowdown and recession. The risk of bankruptcy of such companies is also generally higher. Therefore, investment in such companies could be riskier than investments in larger companies and the deterioration in the financial condition or bankruptcy of such companies may result in greater volatility in the Company’s net asset value (“NAV”) and may materially and adversely affect the performance of the Company and returns to Shareholders.

Fixed-life Risk: The Company has a fixed life and in the event that no alternative proposals are put forward to Shareholders and approved by Shareholders ahead of the winding-up date, a winding-up resolution will be proposed at the winding-up date to voluntarily liquidate the Company. This could mean that certain investments, in particular, private equity investments, may not be able to be realised at an optimal price, or that the realisation of such investments may take longer than anticipated (as it could take several years after the commencement of the winding-up of the Company until all of the Company’s private equity investments could be disposed of and any final distribution of proceeds made to Shareholders).

Illiquid Market Risk: There may not necessarily be a liquid market for shares in investee companies in the approximately £50 million to £2 billion equity value range even if their shares are publicly traded.

Investment Trust Status Risk: Failure by the Company to maintain investment trust status, or changes in taxation legislation or practice, could result in the Company not being able to benefit from the current exemption for investment trusts from UK tax on chargeable gains and could affect the Company's ability to provide returns to Shareholders.

No Guarantee and Investment Objective Risk: The Company may not meet its investment objective and returns of the Company are not guaranteed.

Private Equity Exit Risk: It is difficult to accurately time the exit of private equity investments. Exits will take time and the Portfolio Managers may have very little influence on any decisions around the timing on exits.  Realisations of private equity investments may not occur on a regular straight line basis. Should an exit of a private equity investment be effected in such manner or time frame which is not compatible with the Company’s investment horizon, this could result in a material adverse impact on the Company’s NAV and on the return to Shareholders.

Private Equity Valuation Risk: Private equity investments are difficult to value. Information from underlying investee companies may be delayed, missing or restricted which would lead to valuations being made on incomplete information.

Tax and Operations Risk: Changes in tax legislation or practices or laws or regulations governing the Company's operations (in particular, the Listing Rules, the Prospectus Regulation, the Prospectus Regulation Rules, the Disclosure Guidance and Transparency Rules, the Market Abuse Regulation, the AIFMD and the PRIIPs Regulation) may adversely affect the Company's business.

Third Party Services Risk: The Company has no employees and the Directors have all been appointed on a non-executive basis.  Therefore, the Company is reliant upon the performance of third party service providers for its executive function. Failure by any of these or any other service provider to carry out its obligations to the Company in accordance with the terms of its appointment, together with a failure by the Company to enforce such terms, could have a materially detrimental impact on the operation of the Company.

Marketing material

Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.  Exchange rate changes may cause the value of any overseas investments to rise or fall.

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Issued in June 2023 by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registered No: 4191730 England. Authorised and regulated by the Financial Conduct Authority.