19 March 2014

BlackRock Hedge Selector Ltd is a research client of Edison Investment Research Limited

BlackRock Hedge Selector currently has one class of share (BHUE) acting

as a feeder for the BlackRock UK Emerging Companies Hedge Fund. After

the strong run enjoyed by small- and mid-cap companies over the last

three years, investors may now appreciate the merits of a fund focused on

taking advantage of differentiation between companies in this area,

through a long/short strategy. Ralph Cox will assume sole responsibility

for management of the fund while co-manager Richard Plackett completes

a six-month sabbatical from April this year.

12 months ending

Total share price return

Total NAV return

Numis Smaller Cos + AIM (ex-ICs)

FTSE All-Share

HFRI Equity Hedge

28/02/11 34.7 25.4 31.7 17.0 5.6

29/02/12 (11.6) (0.2) (1.2) 1.5 (2.0)

28/02/13 8.3 5.9 15.3 14.1 9.6

28/02/14 10.3 6.3 27.4 13.3 1.5

Note: All figures % total returns on a sterling-adjusted basis.

Investment strategy: Seeking quality and growth The managers of the UK Emerging Companies Hedge Fund follow a fundamental,

bottom-up approach to selecting positions. For long positions they look for

companies with sustainable market positions, good cash generation, healthy

balance sheets and strong management. They have a bias against turnaround

stories and a preference for companies with a record of delivering EPS growth. The

criteria for short positions are a mirror image of the long criteria, with the managers

indicating that they have had a number of successes when identifying financially

vulnerable companies. Close attention is paid to holding size, with long positions

typically in the 0.3% to 3.0% range, while risk/liquidity considerations mean short

positions normally fall in the 0.5% to 1.0% range.

Market outlook: Good time to think alternatively The Numis Smaller Companies plus AIM (ex-investment companies) Index was up

27% in the year to end January and has outperformed the FTSE All-Share Index by

50% over three years. While the recent positive surprises on UK GDP growth

suggest scope for small-cap earnings growth to follow suit, some investors,

particularly those whose time horizon is uncertain, may feel uncomfortable initiating

or adding to straight small-cap exposure at this point. Through its long/short

positions, BHUE offers selected exposures to individual companies and relatively

low correlation with the equity market; this could be an attractive option in this

climate, particularly if, as the managers expect, individual company performance

becomes more differentiated.

Valuation: Marginal premium Implementation of a quarterly redemption facility has seen BHUE shares move to a

marginal premium to NAV. The most recent redemption opportunity (for March

2014) only attracted applications for 0.4% of the shares, suggesting any selling

pressure may have abated.

BlackRock Hedge Selector

Long/short expertise in UK small- and mid-caps

Price 140.25p

Market cap £36m

AUM £36m

NAV* 139.03p

Premium to NAV 0.9%

Yield Nil

*Including income, as at 7 March 2014.

Ordinary shares in issue 25.9m

Code BHUE

Primary exchange LSE

AIC sector Hedge Funds

Share price/discount performance*

Three-year cumulative perf. Graph

52-week high/low 142.0p 127.3p

NAV* high/low 141.17p 131.10p

*Including income.

Gearing (at BlackRock Hedge Selector level)

Gross 0.0%

Net 0.0%

Analysts

Andrew Mitchell +44 (0)20 3681 2500

Martyn King +44 (0)20 3077 5745 investmenttrusts@edisongroup.com

Edison profile page

Investment companies

-4

-2

0

2

4

6

115

120

125

130

135

140

145

Feb/

13M

ar/1

3Ap

r/13

May

/13

Jun/

13Ju

l/13

Aug/

13Se

p/13

Oct

/13

Nov

/13

Dec

/13

Jan/

14Fe

b/14

Discount (%

)Shar

e Pr

ice

BHUE Equity Discount

50

75

100

125

150

175

Feb/

11

May

/11

Aug/

11

Nov

/11

Feb/

12

May

/12

Aug/

12

Nov

/12

Feb/

13

May

/13

Aug/

13

Nov

/13

Feb/

14BHUE Equity Numis Smllr. Cos. + AIM (x-ICs)

BlackRock Hedge Selector Ltd | 19 March 2014 2

Exhibit 1: BlackRock Hedge Selector at a glance

Investment objective and fund background Recent developments BlackRock Hedge Selector is structured to issue a range of classes of feeder fund shares, each providing exposure to an investment fund managed by BlackRock. At present, only one class is in issue, which invests directly in the BlackRock UK Emerging Companies Hedge Fund. This fund’s investment objective is to seek to maximise total returns by investing primarily in mid- and small-cap UK equities, while limiting correlation with the UK equity market.

3 March 2014 – Ralph Cox, to assume full responsibility for UK Emerging Cos. Hedge Fund while Richard Plackett completes a six-month sabbatical from April. 20 January 2014 – 112,277 (0.4%) shares to be redeemed in March 2014 redemption. 16 January 2014 – 3,005,454 (10.4%) shares redeemed at 140.22p and cancelled. 25,937,505 now remaining.

Forthcoming Capital structure Fund details AGM June 2014 Ongoing charge 0.54% Group BlackRock Investment Management Ltd Preliminary results April 2014 Gross/net exposure 158%/44% Managers Richard Plackett, Ralph Cox Year end 31 December Annual mgmt fee 1.75% of total net assets Address 12 Throgmorton Avenue,

London, EC2N 2DL Dividend paid N/A Performance fee 20% of net assets Launch date September 2009 Trust life Indefinite Phone +44 (0)20 7743 3000 Continuation vote N/A Loan facilities £5.65m overdraft Website www.blackrock.co.uk/BRHS Distribution of hedge fund holdings by market capital (December 2013) Share buyback policy and history Over 75% of long exposure (% of NAV) was accounted for by companies with market caps of £0.25-3bn.

BlackRock Hedge Selector is authorised both to repurchase up to 14.99% of its ordinary shares and to issue shares from treasury. A discretionary quarterly redemption mechanism allows redemption of up to 20% of BHUE shares.

BHUE shareholder base (as at 7 February 2014) Hedge fund sector long exposures (% of NAV; as at 31 December 2013)

BlackRock UK Emerging Companies Hedge Fund, top 10 long holdings (as at 31 December 2013)

Portfolio weight %

Company Country Sector 31 December 2013

Xaar UK Industrials 3.1

Bellway UK Consumer Goods 2.9

Howden Joinery UK Industrials 2.9

Ashtead Group UK Industrials 2.9

Victrex UK Basic Materials 2.8

Senior UK Industrials 2.8

Spirax-Sarco UK Industrials 2.7

Bovis Homes UK Consumer Goods 2.7

Spectris UK Industrials 2.6

ITE Group UK Consumer Services 2.5

Top 10 27.9

Source: BlackRock Hedge Selector, Bloomberg, Edison Investment Research

Index (0%)

>£3bn (10%)

£1-3bn (39%)

£0.5-1bn (24%)

£0.25-0.5bn (13%)

£0.1-0.25bn (11%)

<£0.1bn (5%)

-25

-20

-15

-10

-5

0

5

-25

-20

-15

-10

-5

0

5

2010

2011

2012

2013

2014

Cost/proceeds (£m

)

No

of s

hare

s (m

)

Repurchased AllotmentsTotal cost (RHS) Total proceeds (RHS)

Investec Wealth & Inv. (19.7%)

Close Brothers AM (13.5%)

Schroder IM (10.5%)

Henderson Global Inv. (9.8%)

Legal & General IM (9.7%)

North Investment (5.2%)

Waverton IM (5.1%)

BlackRock IM (3.6%)

Heartwood Wealth (2.3%)

Other (31.6%)

Industrials (33.9%)

Consumer Services (20.0%)

Financials (17.1%)

Technology (9.2%)

Consumer Goods (8.4%)

Basic Materials (6.2%)

Healthcare (3.3%)

Oil & Gas (2.9%)

BlackRock Hedge Selector Ltd | 19 March 2014 3

Market outlook: An interesting time for hedge exposure

The attractions of small-cap investing include the opportunity to benefit from the high growth

potential of these businesses in comparison to larger companies, the scope to identify less well-

known shares that are conservatively valued, and the opportunity to earn a premium return in

exchange for the lower liquidity that tends to characterise smaller company shares.

As Exhibit 2 illustrates, the small-cap sector in the UK (represented here by the Numis Small

Companies plus AIM (ex-investment companies) Index) has outperformed the FTSE All-Share

Index over 10 years. However, at 11% or 1.1% pa, the difference is moderate rather than

substantial. Further, as the chart shows, there are marked periods of underperformance and

outperformance. Outperformance is most evident in the period following the financial crisis, which is

shown separately in Exhibit 3, with outperformance of 41% or 7.2% pa.

Exhibit 2: Small caps versus All-Share – 10 years Exhibit 3: Small caps versus All-Share – five years

Source: Thomson Datastream Source: Thomson Datastream

With this recent history in mind, the near-term prospects for UK small-cap equities are uncertain.

Economic recovery has surprised positively, and this may feed through to a greater or lesser extent

to small-cap equity earnings, but the strong performance has left the valuation of the FTSE Small

Cap Index at an increased premium to the broader market (forward P/E 15.9x versus 13.4x for the

Datastream UK market) and 27% above its three-year average.

Another feature of small and mid-cap investing to consider is the tendency for volatility to be higher

than for larger-cap stocks. Figures for returns and volatility for the FTSE 100, FTSE 250 and Numis

Small Companies plus AIM (ex-investment companies) are set out in Exhibit 4. Here, for periods of

over one year, the volatilities for the FTSE 250 and Numis indices are higher, although, reflecting

the recent outperformance shown earlier, returns have also been significantly higher.

For longer-term investors, the potential for outperformance from the small-cap area of the market is

appealing but, following a period of marked relative strength, an unqualified investment in this area

may not be appropriate for all. In addition to using an actively managed fund as a means of

accessing attractive but under-researched ideas among small- and mid-cap companies, one option

is to gain hedged exposure to the sector. This is the approach offered by the BlackRock UK

Emerging Companies Hedge Fund in which the managers’ company knowledge is applied to

identifying opportunities for both long and short positions.

We conclude that the continued improvement in the UK economy should provide a gradually

improving background for small- and mid-cap companies, which, as a group, tend to be more

economically sensitive. After the strong absolute and relative run the sector has enjoyed, however,

some investors seeking lower volatility and returns that are less market correlated may prefer the

50

100

150

200

250

300

Feb-04 Feb-06 Feb-08 Feb-10 Feb-12 Feb-14

Numis Smll. Co. + AIM (ex ICs) FTSE All-Share

50

100

150

200

250

300

350

Feb/09 Feb/10 Feb/11 Feb/12 Feb/13 Feb/14

Numis Smll. Co. + AIM (ex ICs) FTSE All-Share

BlackRock Hedge Selector Ltd | 19 March 2014 4

potentially less volatile hedged exposure offered by a long/short fund such as BlackRock Hedge

Selector and its UK Emerging Companies share class.

Exhibit 4: Large- and small-cap annualised returns and volatility compared (%)

Source: Thomson Datastream, Edison Investment Research

Fund profile: Small-cap stock picker

Launched in 2009, BlackRock Hedge Selector Ltd was structured to enable it to issue a range of

feeder fund shares to give exposure to different investment funds managed by BlackRock. In practice

only two were initially issued: the UK Emerging Companies shares (BHUE) and Cash Fund shares.

Given the availability of appropriate strategies and the market environment, no further share classes

were added subsequently. The Cash Fund shares were delisted in February 2013 leaving only BHUE

shares in issue. Given the potential benefits of increasing the scale of the company and/or choice

available to investors, we would not rule out share issuance at some point if the circumstances are

appropriate.

The UK Emerging Companies Hedge Fund has the objective of maximising returns by investing in

small- and mid-cap UK equities while limiting correlation with the UK market. While BlackRock Hedge

Selector does not itself employ gearing, the underlying hedge fund for BHUE does have a leveraged

gross position, with short positions currently established through the use of contracts for difference.

Looking at the record since the launch of BlackRock Hedge Selector, the average net long position

has been 34% of NAV and the gross exposure 127%.

The company has in place a quarterly redemption facility for up to 20% of the BlackRock UK

Emerging Companies shares at NAV less associated costs (see page 9). This operates at the

discretion of the board if the shares trade at an average discount during a quarter.

The company states that it conducts its affairs in a way that would not result in it being considered a

non-mainstream pooled investment, and intends to continue to do so for the foreseeable future. This,

and the shares’ listing on the London Stock Exchange, means they provide more widely accessible

exposure to the strategy than direct investment in the Caymans-domiciled hedge fund itself.

The fund managers: Richard Plackett and Ralph Cox

The managers’ view: Expecting greater focus on fundamentals Richard Plackett and Ralph Cox explain that, with a background as long-only managers, they

started the hedge fund strategy after they saw an opportunity to exploit the relative volatility of the

small- and mid-cap area (see Exhibit 4). The aim then, as now, was to harness the potential for

returns from this area while controlling the risks, thereby providing steady returns from small- and

mid-cap stocks. They investigated the approach in 2003 and launched the UK Emerging

8.510.4

7.511.1

18.114.8

21.0

12.115.9

14.0

36.1

17.2

23.5

9.512.7 13.1

38.0

17.1

0

5

10

15

20

25

30

35

40

1 year return 1 year volatility 3 year return 3 year volatility 5 year return 5 year volatility

FTSE 100 FTSE 250 Numis Smaller Companies + AIM (ex-inv. cos.)

BlackRock Hedge Selector Ltd | 19 March 2014 5

Companies Hedge Fund a year later. With performance meeting the objective of limiting market

correlation and providing positive returns through periods of substantial market volatility, the only

change the managers have made to their process since then has been to pay greater attention to

position sizes.

In terms of market view, the managers highlight the conclusion of the BlackRock Investment

Institute that although equities have performed strongly over the last year they are fairly valued,

rather than overvalued. Plackett and Cox see the potential for performance to be more

differentiated in 2014 with earnings growth being more influential than in 2013. While the market

correction in January 2014 saw correlation within the market briefly spike (as indicated in the US,

for example, by the CBOE Implied Correlation Index – Exhibit 5), in a relatively slow growth world,

the managers expect greater differentiation between fundamentally weaker and stronger

companies.

Exhibit 5: The CBOE S&P 500 Implied Correlation Index*

Source: CBOE, Edison Investment Research. Note: *The index compares the implied volatility for derivatives of the S&P 500 and its constituents to derive an index of expected correlation of index constituents.

The managers are very much focused on individual stocks with stock-specific factors outweighing

the macro view, although, thematically, they invested in a number of stocks with emerging market

exposure in 2010, a balance that subsequently changed in favour of domestic US and UK

exposure. The portfolio currently includes a number of stocks that benefit from the strengthening

UK housing market with the December top 10 long positions including Bellway, Howden Joinery

and Bovis Homes. In each case, however, stock selection reflects the specific attributes of the

companies.

Three examples of stocks that have made positive contributions to the fund are highlighted by the

managers: Victrex, Rotork and Aveva. These companies illustrate the variety of the businesses in

the portfolio, but each has strong market positions in its field driven by technical expertise and

investment.

Victrex is a leading manufacturer of high performance polymer for the transport, industrial and

device sectors. It has a strong global position in its areas of expertise, has maintained gross

margins of over 65% and in its latest, February, update indicated that its second quarter had

started strongly.

Rotork is the world leader in production of electric, pneumatic and hydraulic valve actuators

and associated systems. Rotork has maintained its leading position in selected market

segments for many years through investment in new products and acquisitions.

Aveva’s technology was originally spun out of Cambridge University. It is engaged in the

marketing and development of computer software used in providing engineering solutions for

companies in the oil and gas, power and marine industries, for example.

40

50

60

70

80

Nov/12 Jan/13 Mar/13 May/13 Jul/13 Sep/13 Nov/13 Jan/14

BlackRock Hedge Selector Ltd | 19 March 2014 6

Asset allocation

Investment process: Fundamental long/short stock selection BlackRock UK Emerging Companies Hedge Fund managers Richard Plackett and Ralph Cox have

substantial experience in the small- and mid-cap area, and are supported in running the fund by

Daniel Whitestone, who joined BlackRock last year as a director and analyst (see Exhibit 6). Ralph

Cox is to take full responsibility for managing the Hedge Fund for six months this year while Richard

Plackett completes a six-month sabbatical (April-September). The investment team has two team

meetings and one portfolio construction meeting a week. They do not divide sector responsibilities,

which helps maintain healthy debate within the team on the opportunities under consideration. They

work on the basis that a decision to take a position should be agreed between the three team

members.

The hedge fund investment team is part of the broader BlackRock Small & Mid Cap Team, headed

by Richard Plackett and also including Roland Arnold, Lucy Marmion and Mike Prentis. In addition,

the team has access to the rest of the BlackRock UK research capability (an additional 15

managers/analysts) and the wider resources at BlackRock, including the risk management and

investment strategy teams.

Exhibit 6: BlackRock UK Emerging Companies Hedge Fund investment team

Team Title Role/background Richard Plackett Managing Director, Head

of UK Small/Mid Cap Team Co-manager of UK Emerging Companies Hedge Fund and UK Special Situations Fund. Began career at 3i before joining M&G and then MLIM in 2002.

Ralph Cox Managing Director, in UK Small/Mid Cap Team

Co-manager of UK Emerging Companies Hedge Fund since inception. Manager of UK Smaller Companies Fund. Began career at MLIM in 1999 as a graduate.

Daniel Whitestone

Director and analyst in UK Small/Mid Cap Team

Focuses on hedge fund research with responsibility for travel and leisure sector. Joined BlackRock in 2013 from UBS where he was head of UK small/mid-cap sales.

Source: BlackRock Hedge Selector Ltd. Note: Merrill Lynch Investment Management (MLIM) was purchased by BlackRock in 2006.

For their long positions the managers are primarily looking for companies with quality and growth

characteristics. Ideas are generated through fundamental bottom-up analysis and discussion within

the team. While they use models, building these is not regarded as a priority, in view of the danger

of spurious accuracy; understanding the drivers of a business is the key task.

The team holds at least 700 company meetings a year and they are looking for management to

display salesmanship, strategic vision and control. They are trying to judge if they are capable of

growing the business, putting in place appropriate control and other systems ahead of expansion.

When they talk about vision they want to know where the company aims to be in three or five years’

time and whether growth is expected to be primarily organic or acquired.

Investments are made with a medium- to long-term horizon and, given this, they like to see

management with a stake in the business and experience of more than one cycle in the market.

Strong market positions are preferred and the managers have a bias against more indebted

companies. Other liabilities such as pensions and leases are taken into account.

Short positions are selected based on a reversal of the long criteria. In particular the managers note

that they have had a number of successes when selecting vulnerable stocks with weak cash flows

and poor balance sheets. Companies lacking strategic vision with weak market positions and short

track records are liable to be candidates for a short position. Currently all short positions are

established through the use of contracts for difference.

Turning to portfolio construction, the managers seek to control risk primarily through diversification.

They pay close attention to position sizes with long positions ranging from c 0.3% to 3%. The upper

end of the range would represent high conviction, long-term holdings. If positions move much

BlackRock Hedge Selector Ltd | 19 March 2014 7

above 3% then the fund managers are disciplined in taking profits in order to maintain appropriate

exposures.

Short positions are typically smaller in size, reflecting liquidity and risk considerations, with the

largest holding being 1% and most positions in the 0.5% to 0.75% range. The overall portfolio

turnover was 51% last year with activity typically greater in the short book. While some short

positions are held for longer periods, when catalysts for a realisation of overvaluation fail to evoke

the expected response, then the managers may decide to close a position.

The underlying hedge fund’s gross (the total of long and short positions) and net exposures (long

positions less short positions) since inception are illustrated in Exhibit 7 below. The gross exposure

has ranged between 23% and 172% but, excluding the low values in the first year of operation,

gross exposure has generally been between 100% and 150%, averaging 127% since September

2009, when the BHUE share class was issued. The level of gross exposure is a reflection of the

(long and short) opportunities available and in the 2008/09 period gross exposure was relatively

low, reflecting high levels of correlation within the market and the managers’ view that there were

therefore fewer attractive opportunities for their approach. The end December 2013 level of 158% is

indicative of the managers’ expectation of greater differentiation in performance and hence

opportunities to exploit.

Net exposure has been between -9% and +46% of NAV with an average of 34% since September

2009, when the BHUE share class was issued. As Exhibit 7 shows, net exposure was reduced in

2007/08, but not significantly below a neutral position. Subsequently the managers moved to a

higher net long position. The net long position is not subject to frequent substantial changes, and is

a reflection of broader strategic views, taking into account both top-down perspectives and insights

they gain at a company level. The managers note that, if adjusted for the relatively low beta of their

quality-biased holdings, the end-December 2013 net exposure of 44% could be as much as 10

percentage points lower.

Exhibit 7: BlackRock UK Emerging Companies Hedge Fund gross and net exposure

Source: BlackRock Hedge Selector Ltd

Portfolio positioning At the end of December 2013, the BlackRock UK Emerging Companies Hedge Fund had 82 long

and 90 short positions with an overall gross exposure of 158% and a net positive exposure of 44%.

As illustrated in Exhibit 8, net sector exposures were within a range from +12.2% to -1.0%, with the

largest net exposures being to industrials, financials and consumer services. These accounted for

over 30 percentage points of the net exposure and 109 points of the gross exposure for the fund.

-50%

0%

50%

100%

150%

200%

May04

Oct04

Mar05

Aug05

Jan06

Jun06

Nov06

Apr07

Sep07

Feb08

Jul08

Dec08

May09

Oct09

Mar10

Aug10

Jan11

Jun11

Nov11

Apr12

Sep12

Feb13

Jul13

Dec13

Gross % of NAV Net % of NAV

BlackRock Hedge Selector Ltd | 19 March 2014 8

Exhibit 8: Sector exposure (31 December 2013)

Long exposure Short exposure Net exposure Gross exposure Industrials 33.9% -21.7% 12.2% 55.6% Consumer Services 20.0% -10.6% 9.4% 30.6% Financials 17.1% -5.2% 11.9% 22.3% Technology 9.2% -2.5% 6.7% 11.7% Consumer Goods 8.4% -5.8% 2.6% 14.2% Basic Materials 6.2% -3.1% 3.1% 9.3% Healthcare 3.3% -1.7% 1.6% 5.0% Oil & Gas 2.9% -2.3% 0.6% 5.2% Telecommunications 0.0% -1.0% -1.0% 1.0% Utilities 0.0% -1.0% -1.0% 1.0% Index 0.0% -2.3% -2.3% 2.3% 101.0% -57.1% 43.9% 158.2%

Source: BlackRock Hedge Selector Ltd. Note: Rounding errors mean short and net exposures do not sum.

The managers adjust the gross and net positions in the fund reflecting their view of the market

outlook and the potential they see for differentiated individual stock performance (short and long). A

higher gross exposure is adopted when they expect greater stock differentiation and the position at

end December of 158% was at the upper end of the range since the hedge fund’s initiation in 2004

(see Exhibit 7); since then the gross exposure has averaged 127% with a maximum of 159% and a

minimum of 97%.

Similarly, the net position of 44% was close to the maximum level of 46% since BlackRock Hedge

Selector’s launch and compares with the average of 34% over that period, indicating a relatively

positive view on the long ideas available on the part of the managers.

Exhibit 9 shows the distribution of long and short exposures analysed by market capital. Points to

note here are that nearly 80% of gross exposures are below £3bn market cap with the smaller-cap

bias being more pronounced among the long positions (nearly 90% sub £3bn). This fits with the

managers’ requirement for sufficient liquidity for short positions.

Exhibit 9: Market capital analysis of exposures (31 December 2013)

Long Short Net Gross Index 0.0% -2.3% -2.3% 2.3% >£3bn 10.2% -21.4% -11.2% 31.5% £1-3bn 38.8% -14.5% 24.2% 53.3% £0.5-1bn 24.1% -10.9% 13.1% 35.0% £0.25-0.5bn 12.5% -6.2% 6.3% 18.7% £0.1-0.25bn 11.0% -1.4% 9.5% 12.4% <£0.1bn 4.6% -0.4% 4.2% 5.0%

101.0% -57.1% 43.9% 158.2%

Source: BlackRock Hedge Selector Ltd. Note: Rounding errors mean some rows and columns do not sum.

Performance: Differentiated, low volatility

The performance information shown in Exhibits 10 and 11 relates to the UK Emerging Companies

share class (BHUE). It is worth underlining here that the hedge fund has no formal benchmark and

targets an absolute rather than relative return. Exhibit 10 shows that the fund has underperformed

the Numis Smaller Companies plus AIM (ex-investment companies) Index over most of the period,

although with considerably lower volatility. This was during a period of particular strength in small

and mid-cap company indices, and is unsurprising in the context of the fund’s long/short strategy

and objective of limited correlation with the UK equity market.

BlackRock Hedge Selector Ltd | 19 March 2014 9

Exhibit 10: Investment trust performance

Price, NAV and benchmark total return performance, one-year rebased Price, NAV and benchmark total return performance (%)

Source: Thomson Datastream, Edison Investment Research. Note: SI = Since Blackrock Hedge Selector inception – data from end September 2009. Three and five year returns annualised.

The difference in performance versus the FTSE All-Share Index is significantly smaller (Exhibit 11).

While hedge fund equity long/short strategies and net market exposures will differ substantially, it is

interesting to make a further comparison with the HFRI Equity Hedge Index. Here the fund NAV

performance is ahead of the index over all the periods shown.

Exhibit 11: Share price and NAV total return performance, versus benchmarks

1 month 3 months 6 months 1 year 3 years SI Price versus Numis Smaller Cos + AIM (ex-ICs) (3.2) (4.4) (12.6) (17.1) (39.5) (56.6) NAV versus Numis Smaller Cos + AIM (ex-ICs) (3.7) (6.9) (13.2) (20.5) (32.1) (53.6) Price versus FTSE All-Share (3.9) 0.6 (3.7) (3.0) (25.6) (21.2) NAV versus FTSE All-Share (4.3) (2.0) (4.3) (6.4) (18.3) (18.2) Price versus HFRI Equity Hedge 0.7 3.7 4.2 8.8 (3.5) 16.1 NAV versus HFRI Equity Hedge 0.3 1.2 3.7 5.4 3.9 19.2

Source: Thomson Datastream, Edison Investment Research. Note: Data to end-February 2013 and indices £ adjusted. SI = since BRHS inception – data from end September 2009.

The UK Emerging Companies risk-adjusted NAV performance as measured by Sharpe ratios

shows values of 0.9 over one year and 0.6 over three years. These ratios are below the average for

AIC hedge funds but comfortably above the low end of a wide range. Taking a longer view, Exhibit

12 shows the figures for the underlying hedge fund since its inception on 4 May 2004 to end

December 2013. This underlines the relatively low volatility (6% versus annualised return of 14%)

and a correspondingly favourable Sharpe ratio of 1.8%. Correlation with the Numis Smaller

Companies plus AIM (ex-investment companies) Index is relatively low, while the worst peak to

valley drawdown of under 6% looks modest in the context of market moves during the financial

crisis.

Exhibit 12: Underlying hedge fund returns and risk statistics since inception to 31/12/13

Returns since inception Risk statistics Cumulative 263.22% Annualised volatility 6.00% Annualised 14.27% Beta 0.14 Worst month % drawdown -3.26% Correlation 0.43 Worst peak to valley drawdown -5.41% Sharpe ratio 1.75

Source: BlackRock Hedge Selector. Note: Inception of hedge fund 4 May 2004. Beta and correlation are calculated relative to the Numis Smaller Companies plus AIM (ex-investment companies) Index.

The resilience during the financial crisis is underlined if we compare the performance of the hedge

fund and the Numis index from inception to end-2013 (Exhibit 13). Here the substantial

outperformance in 2008 is a prominent feature and, not shown, the fund also outperformed the

HRFI Equity Hedge index with a return of 19% versus 1.6%. The mirror image of this strength in

adversity was the muted relative performance as the market as whole and the Numis index

bounced back in 2009 and 2010. Understandably, again given its hedged position and the objective

80

90

100

110

120

130

140

Feb/

13

Mar

/13

Apr/1

3

May

/13

Jun/

13

Jul/1

3

Aug/

13

Sep/

13

Oct

/13

Nov

/13

Dec

/13

Jan/

14

Feb/

14

BHUE Equity BHUE NAV Numis Smllr. Cos. + AIM (x-ICs)

0.0

5.0

10.0

15.0

20.0

25.0

30.0

1 m 3 m 6 m 1 y 3 y SI

Perfo

rman

ce

BHUE Equity BHUE NAV Numis Smllr. Cos. + AIM (x-ICs)

BlackRock Hedge Selector Ltd | 19 March 2014 10

of limiting correlation with the UK equity market, the fund also underperformed as small- and mid-

cap companies performed particularly strongly in 2012/13.

Exhibit 13: Underlying hedge fund returns since inception to end December 2013

Source: BlackRock Hedge Selector. Note: Inception of hedge fund 4 May 2004.

Discount: Has moved to a small premium

In order to control any share price discount to NAV, the company has put in place a quarterly

redemption facility for up to 20% of the UK Emerging Companies shares at NAV less associated

costs. The facility is operated at the directors’ discretion, and they intend to make it available if the

shares have been trading at an average discount during a quarter. Since the introduction of the

facility, 12.9m shares have been redeemed at a cost of £17.4m (see Exhibit 1). Prior to this, cash

fund shares were in issue, which had the effect of providing an exit route for shareholders, and

since the company’s launch the premium/discount range has been between ±8%. Over the last

year, with the control mechanism in place for most of the period, the shares have traded in a

narrower range: between a discount of 3.8% and a premium of 2.6%.

Exhibit 14: BHUE percentage share price discount/premium to NAV over three years

Source: Thomson Datastream, Edison Investment Research. Note: Positive values indicate a discount, negative values a premium.

Capital structure and fees

BlackRock Hedge Selector is structured to have different share classes, each providing exposure to

a specific investment mandate. Currently, there is only one such class with 25.9m UK Emerging

Companies shares in issue at the end of January 2014. As noted in the previous section, while the

redemption facility has limited discount volatility it has also resulted in a significant reduction in the

share count (end January 2014 58% of the end 2012 level). The initial three redemptions, in June,

26%18% 18% 13% 19%

6%

25%

0%

5% 10%21% 25% 22%

-6%

-48%

61%

32%

-13%

22%31%

-60%

-40%

-20%

0%

20%

40%

60%

80%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

BlackRock UK Emerging Cos. Hedge Fund Numis Smaller Cos + AIM (ex-investment cos.) Index

-8

-4

0

4

8

Feb/

11

Jun/

11

Oct

/11

Feb/

12

Jun/

12

Oct

/12

Feb/

13

Jun/

13

Oct

/13

Feb/

14

BlackRock Hedge Selector Ltd | 19 March 2014 11

September and December 2012, were equivalent to 16.9%, 17.1% and 10.4% of the outstanding

shares, with a small number of holders accounting for the majority of the redemptions. In contrast

the latest redemption, to be implemented in March this year, is equivalent to just 0.4% of the shares

in issue. This suggests the appetite for redemption may have been satisfied, while maintenance of

a premium to NAV would be expected to limit further use of the facility and hence contraction of the

company.

We assume the board is likely to be sensitive to the relatively small size of the company and would

probably be keen to be in a position to issue shares, thereby increasing liquidity and allowing for a

more efficient spreading of costs. A return to the original plan to offer different share classes cannot

be ruled out, assuming an appropriate fund could be identified. The company has an unlimited life

and is not subject to a continuation vote.

BlackRock Hedge Selector itself does not employ gearing, but the UK Emerging Companies Hedge

Fund is leveraged and may employ borrowing of cash or securities and derivative transactions.

Leverage is limited to 300% of the net asset value of the fund, but in practice has never approached

this level, with the maximum gross exposure being just over 170%.

The company does not pay any investment management or performance fees directly to the

manager or investment manager. The underlying investment manager receives a management fee

of 1.75% pa of the net asset value of the share class and a 20% performance fee (on a share-by-

share basis), calculated on the annual performance to end September from a base net asset value

(at the time the share was issued) or the (end September) high watermark. The company pays fees

to the sub-administrator and custodian, and has other operational expenses that, together, are

estimated to be 0.5% of the net asset value (as stated in the 2012 accounts).

Dividend policy

The directors do not expect to declare dividends with respect to the UK Emerging Companies

shares. Historically, dividend distributions were made to holders of the separate Cash Fund share

class prior to its redemption/conversion.

The board

The board (five members, all non-executive) are Howard Myles (chairman), Angus Spencer-Nairn,

Frank Le Feuvre, Gregor Allan and Jonathan Ruck Keene. All were appointed to the board in 2009.

Frank Le Feuvre and Jonathan Ruck Keene are employees of BlackRock and considered non-

independent.

BlackRock Hedge Selector Ltd | 19 March 2014 12

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