BlackRock Sustainable American Income Trust plc (LON:BRSA) has announced its final results for the year ended 31 October 2021.
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PERFORMANCE RECORD
| As at 31 October 2021 | As at 31 October 2020 | |
| Net assets (£’000)1 | 165,334 | 126,410 |
| Net asset value per ordinary share (pence) | 206.08 | 158.06 |
| Ordinary share price (mid-market) (pence) | 198.25 | 145.50 |
| Discount to cum income net asset value2 | 3.8% | 7.9% |
| Russell 1000 Value Index | 1647.89 | 1215.24 |
| ————— | ————— | |
| Performance (with dividends reinvested) | ||
| Net asset value per share2 | 36.0% | (8.9%) |
| Ordinary share price2 | 42.4% | (17.9%) |
| Russell 1000 Value Index | 35.6% | (7.5%) |
| ========= | ========= |
| Year ended 31 October 2021 | Year ended 31 October 2020 | Change % | |
| Revenue | |||
| Net profit after taxation (£’000) | 3,248 | 5,367 | -39.5 |
| Revenue earnings per ordinary share (pence)3 | 4.06 | 6.65 | -38.9 |
| ————— | ————— | ————— | |
| Interim dividends (pence) | |||
| 1st interim | 2.00 | 2.00 | – |
| 2nd interim | 2.00 | 2.00 | – |
| 3rd interim | 2.00 | 2.00 | – |
| 4th interim | 2.00 | 2.00 | – |
| ————— | ————— | ————— | |
| Total dividends paid/payable | 8.00 | 8.00 | – |
| ========= | ========= | ========= |
1 The change in net assets reflects market movements, shares reissued/bought back and dividends paid during the year.
2 Alternative Performance Measures, see Glossary in the Company’s Annual Report for the year ended 31 October 2021.
3 Further details are given in the Glossary in the Company’s Annual Report for the year ended 31 October 2021.
CHAIRMAN’S STATEMENT
CHANGES TO INVESTMENT OBJECTIVE AND POLICY
As reported in my statement in the Half Yearly Financial Report, the Board proposed in June that the Company’s investment mandate be altered to incorporate explicit Environmental, Social and Governance (ESG) objectives.
I am delighted to report that shareholders overwhelmingly approved the proposals and the Company is now embarking on an exciting new chapter in its development, one your Board is convinced will bring strong investment returns over the long run and broaden its appeal to a wider audience.
The Board believed that this change in strategy was appropriate in order for the Company to remain a relevant and attractive investment opportunity for its shareholders. Approval was obtained at a General Meeting held on 29 July 2021, and since this date the Company’s portfolio has changed to reflect the new objective of investing in a manner consistent with the principles of sustainable investing. The exposure to mid-cap companies has also increased and the number of portfolio holdings has reduced.
Following the policy to adopt a more active approach to gearing, with a range of 0% to 10% and a neutral level of 5% of net asset value, the Company reduced its cash holdings to become substantially fully invested and has therefore been at the lower bound of this new range. However, since the financial year-end and market uncertainty brought on by the emergence of the Omicron COVID-19 variant, the opportunity has been taken to increase the Company’s gearing which at 4 February 2022 stood at 2.9%.
PERFORMANCE OVERVIEW
Following the COVID-19 pandemic outbreak and subsequent ramifications in 2020, the restart of economic recovery has gathered pace and Europe and other major regions are catching up with the more advanced recovery in the U.S. At the time of writing, however, the full impact of the Omicron variant remains unclear. Strong company earnings helped the stock market reach new highs early in the calendar year. Overall, companies have beaten analyst expectations on both earnings per share and revenue growth, with the latter having been particularly strong.
Against this backdrop, over the year to 31 October 2021, the Company’s net asset value per share (NAV) returned 36.0%1 and the share price returned 42.4%1. This compares with a rise of 35.6%1 in the Russell 1000 Value Index. At the close of business on 4 February 2022, the Company’s NAV had increased by 2.8% (with dividends reinvested) since the year end.
REVENUE EARNINGS AND DIVIDENDS
The Company’s revenue earnings per share (EPS), based on the weighted average number of shares in issue for the year, amounted to 4.06p (2020: 6.65p), a decrease of 38.9%. Four quarterly interim dividends of 2.00p per share were paid on 29 April 2021, 2 July 2021, 1 October 2021 and 4 January 2022. This is in line with the payments made in the previous financial year. The dividend paid represents a yield of 4.0% on the share price at the year end.
Whilst the Company continues to retain a bias to high yielding value stocks, the changes to the mandate and the fact that we have stopped writing covered calls will both impact the Company’s underlying income level. However, your Board considers that it remains appropriate to continue with the current enhanced dividend policy for the new financial year which will be supported through both revenue and other distributable reserves. Consequently, the Board will be seeking shareholder authority at the forthcoming Annual General Meeting to cancel the Company’s share premium reserve, effectively converting it into a distributable reserve. The Board continues to believe that this dividend policy provides an attractive option for current and prospective shareholders who wish to achieve exposure to the U.S. equity market whilst at the same time receiving a competitive dividend.
SHARE ISSUES AND DISCOUNT CONTROL
As at 4 February 2022, the Company was trading on a 5.9% discount and has largely done so since the start of 2020, reflecting the headwinds for value investing following the outbreak of the COVID-19 pandemic. However, in April 2021 the Company’s shares traded at a premium, reflecting the rally in value stocks following the announcement of the success in vaccine trials and their subsequent rollout. Since this time, the discount has widened a little as growth stocks returned to favour for a time.
In November 2020, the Company purchased 190,000 ordinary shares at an average discount of 6.8% for a total cost of £295,000 including expenses. All shares purchased have been placed in treasury. Whilst the shares were trading at a premium in April 2021, the Company reissued 445,000 shares from treasury at a premium to NAV for a total gross consideration of £888,000 at an average price of 199.58p per share and an average 1.7% premium to NAV. Subsequent to the year end and up to the date of this report, no further shares have been bought back or reissued.
The Board will continue to use its authorities to issue and buy back shares when it considers it is in shareholders’ interests to do so. Resolutions to renew the authorities to issue and buy back shares will be put to shareholders at the forthcoming Annual General Meeting.
ENGAGEMENT ON GOVERNANCE ISSUES
An important element of our approach to sustainable investing is an active engagement with the companies in which your Company invests.
During the year under review, the Investment Manager voted on 1,277 proposals at 85 general meetings on behalf of the Company. At these meetings the Investment Manager voted in favour of most resolutions, as should be expected when investing in well run companies, but voted against 90 (6.9%) resolutions, abstained on 2 (0.2%) and withheld 7 votes (0.5%). Most of the votes against were in respect of resolutions relating to Directors’ remuneration arrangements, independence and time commitments, or to elect or remove directors, and to amend articles, which were deemed by the Investment Manager as not being in the best interests of shareholders.
BOARD COMPOSITION
Andrew Irvine has announced his intention to retire as a Director of the Company following the Annual General Meeting in March 2022 and, accordingly, will not be seeking re-election. His contribution to the Board over the nine years since the formation of the Company has been outstanding and on behalf of both shareholders and the Board, I would like to express our appreciation.
The Board, having carefully considered its composition and need to ensure that a suitable balance of skills, knowledge, experience, independence and diversity was maintained, commenced a search and selection process at the end of 2021 to identify a new Director which is now nearing completion. It is my intention to retire at the end of the Company’s financial year in October and I am delighted that Alice Ryder will succeed me as Chairman.
OUTLOOK
The Board believes that following the changes implemented last year the Company now offers an even more attractive investment opportunity and the incorporation of explicit ESG objectives underpins this.
The outlook for U.S. equities remains uncertain, although we continue to believe that the economy will normalise during the course of the year. The year will not be without its risks and returns are expected to be lower than 2021 (the S&P 500 Index has more than doubled since 2019) with decelerating economic growth and if current inflation turns out to be more persistent than envisaged, the likelihood of further interest rate rises.
The Portfolio Managers also consider that US value investing remains a compelling opportunity given the current inflationary environment, as value stocks are likely to show much greater resilience than their more expensive growth counterparts in an environment when inflation and interest rates are rising.
ANNUAL GENERAL MEETING (AGM)
The AGM of the Company will be held at the offices of BlackRock at 12 Throgmorton Avenue, London EC2N 2DL on Tuesday, 22 March 2022 at 12 noon. Details of the business of the meeting and attendance at the meeting are set out in the Directors’ Report. In light of the ongoing COVID-19 pandemic, shareholders are strongly encouraged to submit a proxy vote in advance of the AGM, either by completing the hard copy Form of Proxy or online by following the instructions set out in the Notice of Annual General Meeting.
SIMON MILLER
Chairman
8 February 2022
1 All percentages calculated in Sterling terms with dividends reinvested.
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INVESTMENT MANAGER’S REPORT
A NEW INVESTMENT APPROACH
The year under review was marked by important changes in how the Company will be managed in the future. The Company adopted several changes to its investment strategy and was renamed the BlackRock Sustainable American Income Trust plc following shareholder approval on 29 July 2021.
We are excited by the opportunities afforded by the adoption of the new investment strategy and we moved quickly to reposition the portfolio to reflect the changes. Given the liquidity of the portfolio we were able to execute the transactions necessary very swiftly and the new portfolio is set out below.
These changes are intended to enhance the experience of existing shareholders and to increase the Company’s appeal to new investors. The enhancements include evolving the Company’s mandate to pursue specific sustainability objectives, expanding the Company’s investment universe to include meaningful exposure to mid-cap companies, narrowing the range of portfolio holdings to 30-60 stocks, utilising structural portfolio gearing (a 5% of NAV neutral level typically with a range of 0% to 10%), and ceasing the Company’s systematic use of an active options overlay strategy. Meanwhile, the Company is maintaining its primary exposure to North American equities, preserving its value investment style and focus on dividend-paying stocks and will continue to target an attractive level of income with long-term capital appreciation.
The Company’s investment objective is to provide an attractive level of income with capital appreciation over the long term in a manner consistent with the principles of sustainable investing. We believe these dual objectives are best achieved through an investment approach driven by fundamental research and ESG analysis. Philosophically, we seek to build a high conviction portfolio of attractively priced, high-quality dividend-paying companies that are classified as either ESG Leaders, ESG Improvers or Sustainability Enablers. ESG Leaders are best-in-class companies that effectively manage environmental, social and governance factors to benefit all stakeholders. ESG Improvers are companies showing demonstratable progress on their ESG journey, where active engagements may lead to improving ESG practices and more sustainable outcomes. Finally, Sustainability Enablers are companies advancing the transition to sustainable solutions. For example, companies contributing to greater energy efficiency and a lower carbon footprint. A fuller explanation of our investment process is set out in the Company’s Annual Report for the year ended 31 October 2021.
MARKET OVERVIEW
U.S. large-cap stocks, as represented by the S&P 500® Index, advanced by 42.9% in US Dollar terms for the year ended 31 October 2021. In Sterling terms, the S&P 500 appreciated by 34.8% during the year.
U.S. large-cap stocks rallied in the fourth quarter of 2020 as election clarity and the emergence of viable COVID-19 vaccines boosted investor optimism. Cyclical value stocks, those most beaten down in the COVID-19 crisis, staged a particularly strong late-year rally as financial markets anticipated an end to global lockdowns and a positive inflection in economic growth. Policymakers also continued to provide accommodative measures to combat the effects of the pandemic. This included passing the US$900 billion COVID-19 Relief Bill, an aid package signed into law in late December 2020, that provided new direct payments to Americans, as well as additional paycheck protection programme loans and unemployment benefits.
Markets encountered bouts of volatility in the early stages of 2021 but ended the first quarter on an upbeat tone, reaching all-time highs. The U.S. economy was fuelled on multiple fronts. Firstly, monetary policy support continued to persist with the Federal Reserve (the Fed) signalling its intention to keep the federal funds rate (i.e. the target interest rate for commercial bank overnight lending) near zero through at least 2023. Secondly, fiscal policy remained stimulative with the signing into law in March 2021 of the American Rescue Plan, a US$1.9 trillion fiscal stimulus package. Thirdly, further progress on vaccine supply and distribution aided a rebound in economic activity levels. These elements stayed in place for the duration of the annual reporting period and functioned as a notable tailwind for financial markets.
U.S. stocks extended their rally in the second and third quarters despite bouts of volatility and investor concerns related to rising inflation, supply chain bottlenecks and the emergence of new COVID-19 variants. For example, broad market indices traded lower in September as investors focused on potential systemic risks in China related to Evergrande, a debt-challenged real estate developer, before posting their strongest month of the year in October. Stronger corporate earnings were the primary driver of rising stock prices, as companies beat consensus expectations on both earnings and revenues, albeit versus easy year-on-year comparisons. Revenue growth was particularly strong, as companies flexed their pricing power in passing through higher input costs to end customers via higher prices.
PORTFOLIO OVERVIEW
For the annual period ended 31 October 2021, the Company returned 36.0% and 42.4% on a net asset value and share price basis, respectively. This compares to a 35.6% return for the reference index, the Russell 1000 Value Index. Following the adoption of the new investment strategy on 29 July the sector composition of the portfolio shifted to reflect the new approach. The table below provides a comparison of the sector split immediately prior to the changes and at the calendar year end.
GICS Sector | 29 July 2021 Portfolio Weight | 31 October 2021 Portfolio Weight | Change |
| Consumer Discretionary | 7.1% | 11.3% | 4.2% |
| Information Technology | 10.9% | 14.8% | 3.9% |
| Materials | 1.9% | 3.8% | 1.9% |
| Real Estate | 0.0% | 0.9% | 0.9% |
| Utilities | 4.4% | 5.2% | 0.8% |
| Financials | 24.8% | 25.2% | 0.4% |
| Health Care | 18.1% | 18.4% | 0.3% |
| Communication Services | 6.0% | 5.7% | -0.3% |
| Energy | 6.3% | 5.3% | -1.0% |
| Consumer Staples | 6.5% | 4.0% | -2.5% |
| Industrials | 8.0% | 4.9% | -3.1% |
| Cash | 6.0% | 0.5% | -0.5% |
| ========= | ========= | ========= |
The largest contributor to relative performance was stock selection and allocation decisions in financials. Notably, stock selection and an overweight to the banks and insurance industries proved beneficial during the period. In consumer discretionary, stock selection in the specialty retail and textiles, apparel and luxury goods industries boosted relative returns. Furthermore, stock selection and allocation decisions in industrials proved beneficial, including a combination of stock selection and allocation decisions in the industrial conglomerates and aerospace and defence industries.
The largest detractor from relative performance was stock selection and allocation decisions in real estate. Our large underweight to the sector accounted for the majority of underperformance, although stock selection in the equity real estate investment trusts (REITs) industry proved costly as well. In health care, stock selection and an overweight to the health care equipment and supplies industry proved detrimental, as did selection decisions among health care providers and services companies. Another modest detractor from relative results was stock selection among metals and mining companies within the materials sector. Lastly, the portfolio’s cash allocation, which is our preferred method of defensive exposure, hurt relative performance amid sharply rising U.S. stock prices.
Writing covered call options in the portfolio enhanced the Company’s income generation for the annual period. Within the context of rising U.S. stock prices, the covered call options also capped the portfolio’s upside participation and ultimately weighed on absolute and relative performance. In conjunction with the changes to the Company’s investment strategy at the end of July 2021, portfolio management has discontinued its use of an options overlay strategy.
Below is a comprehensive overview of our allocations (in Sterling) at the end of the period.
Consumer Discretionary: 5.7% overweight (11.3% of the portfolio)
The portfolio’s largest overweight allocation is to the consumer discretionary sector and we are finding ample investment opportunities due to the strength of the U.S. consumer. The current market environment is unique as U.S. household balance sheets are strong, while consumers have historically exited recessions with limited capacity for spending due to depressed household savings and high levels of unemployment. The catalyst for this set-up is a combination of exceptionally low interest rates, direct stimulus payments, bonus unemployment, and strong stock and housing markets over the past 12 plus months. Within the sector, our preferred areas of investment include apparel, retail and firms with auto-related exposure. Disruption risks persist in the sector and we believe these risks are best mitigated through identifying stock-specific investment opportunities that either trade at discounted valuations or have business models that are somewhat insulated from disruptive pressures. For example, we believe companies such as General Motors (autos: 2.2% of the portfolio) and Ralph Lauren (apparel: 2.5% of the portfolio) offer investors exposure to underappreciated franchises at discounted valuations. Furthermore, retailers such as Lowe’s Companies (home improvement: 2.3% of the portfolio) and Dollar General (dollar store: 1.0% of the portfolio) provide us access to businesses that can potentially compound earnings and are more immune to disruptive forces. From a sustainability standpoint, our selection of companies includes a mix of Environmental, Social and Governance (ESG) leaders such as Gildan Activewear (1.0% of the portfolio) and Panasonic (1.8% of the portfolio), as well as ESG improvers with clear roadmaps for better ESG adherence and disclosures (i.e. General Motors’ commitment to electric vehicles and Ralph Lauren’s Global Citizen initiative).
Information Technology (IT): 5.0% overweight (14.8% of the portfolio)
An increasing number of companies in the technology sector are what we refer to as ‘industrial tech’. These firms are competitively insulated from disruptors, well-positioned to take advantage of long-term secular tailwinds and exhibit growth in earnings and free cash flow. Strong earnings growth and free cash flow generation is also translating to an increasing number of companies paying growing dividends to shareholders. This is in stark contrast to the dot-com era where growth was often prioritised over shareholder returns. We believe this trend is poised to continue. Our preferred exposures in the sector include communications equipment and IT services companies with sticky revenue streams such as Cisco Systems (4.0% of the portfolio), Cognizant Technology Solutions (3.2% of the portfolio) and Fidelity National Information Services (1.9% of the portfolio). We also continue to invest in software companies with capital-light business models such as Microsoft (1.7% of the portfolio) and SS&C Technologies Holdings (2.8% of the portfolio). IT broadly scores well on ESG metrics given the generally lower environmental impact than other sectors, with our selection of companies including a mix of ESG leaders (Microsoft and Cisco Systems) and ESG improvers (Fidelity National Information Services and SS&C Technologies Holdings).
Financials: 3.3% overweight (25.2% of the portfolio)
Financials represent our portfolio’s largest absolute sector allocation and we remain particularly bullish on companies in the banks, insurance and wealth management industries. The U.S. banks offer investors a combination of strong balance sheets (their capital levels are meaningfully higher post financial crisis), attractive valuations and the potential for relative upside versus the broader market from inflation and higher interest rates. We believe the current credit cycle is in its early stages as loan growth is starting to pick up and consumer balance sheets remain quite healthy. In our view this set-up could result in upside surprise versus consensus expectations on both growth and credit expectations over the next several years. Secondly, we continue to like insurers and insurance brokers as these companies operate relatively stable businesses and trade at attractive valuations. We categorise most of our holdings in this space as ESG improvers, with opportunities for company managements to enact stronger corporate governance and human capital development policies. Lastly, we have also identified stock specific investments in wealth management as companies such as Morgan Stanley (2.1% of the portfolio) and Charles Schwab (1.6% of the portfolio) stand out from peers due to their differentiated investment platforms, proximity to end customers and runways for long-term growth.
Health Care: 1.0% overweight (18.4% of the portfolio)
Secular growth opportunities in health care are a byproduct of demographic trends. Older populations spend more on health care than younger populations. In the United States, a combination of greater demand for health care services and rising costs, facilitates a need for increased efficiency within the health care ecosystem. We believe innovation and strong cost control can work together to address this need and companies that can contribute to this outcome may be poised to benefit. On the innovation front, we are finding opportunities in pharmaceuticals and among companies in the health care equipment and supplies industry. We prefer to invest in pharmaceutical companies with a proven ability to generate high research and development productivity versus those that focus on one or two key drugs and rely upon raising their prices to drive growth. Outside of pharma, our search for attractively priced innovators is more stock specific as we like Alcon (1.9% of the portfolio), a leading eye care company that serves more than 140 countries, and Zimmer Biomet (2.9% of the portfolio), a manufacturer of orthopaedic implants (primarily hips and knees) that provide relief for patients with debilitating health conditions. From a cost perspective, health maintenance organisations (HMOs) have an economic incentive to drive down costs as they provide health insurance coverage to constituents. These efforts ultimately help to make health care insurance affordable to more people and the HMOs also play a substantial role in improving the access to and quality of health care its members receive. Fundamentally, we believe our holdings in the space can benefit from downward pressure on cost-trend, new membership growth and further industry consolidation over time. Furthermore, they trade at meaningfully discounted valuations versus peers, offering us an attractive risk versus reward opportunity.
Utilities: 0.3% overweight (5.2% of the portfolio)
Relative valuations for regulated utilities have become more attractive over the last year and this shift has contributed to our modest overweight in the sector. Portfolio exposures are stock specific as we are finding pockets of investment opportunity among U.S. regulated utilities, which add a level of stability and defensiveness to the portfolio through their durable earnings and dividend profiles. Our investments in the sector primarily focus on ESG leaders that have specific targets for reduction in carbon emissions and maintain significant exposure to renewables or generate power through cleaner means such as natural gas.
Materials: 0.1% overweight (3.8% of the portfolio)
Our exposure to the materials sector is stock specific. In the metals and mining industry we have positions in Steel Dynamics (1.6% of the portfolio), the fifth largest U.S. steel producer, and Newmont Corporation (1.2% of the portfolio), an advantaged gold miner that operates on the lower end of the cost curve. Both are ESG leaders in their respective disciplines. Steel Dynamics is an EAF (electric arc furnace) ‘clean’ steel producer and EAF mills use a lower-cost, less carbon-intensive process for manufacturing steel than conventional blast furnaces. Meanwhile, Newmont Corporation stands above its gold mining peers due to its strong governance, safety record and environmental management commitments. We also recently initiated a position in Sealed Air, a manufacturer of film packaging for perishable food and industrials/e-commerce. Sealed Air operates a high return business, has good pricing power and in our view offers a relatively stable growth outlook. From a sustainability standpoint, plastic packagers generally score poorly on waste and water stress. The key issue for plastic is how to improve circularity and management has pledged to have 100% recyclable/reusable solutions and 50% average recycled/renewable content by 2025, which is well ahead of peers.
Energy: 0.1% underweight (5.3% of the portfolio)
The Company currently invests in four energy stocks and we have a neutral weight in the sector relative to the reference index. Our focus on sustainability places a high hurdle for energy companies to be included in the portfolio, but we believe the sector remains investable, as more traditional oil & gas operators are critical in the energy transition towards less carbon intensive sources. For example, natural gas is 40% to 60% less carbon-intensive to produce and combust versus coal and oil. We view natural gas as a key ‘bridge fuel’ and like companies such as Woodside Petroleum (1.3% of the portfolio) and EQT (0.9% of the portfolio). Fundamentally, we generally seek to invest in attractively priced operators with good resource assets that have opportunities to improve upon environmental issues or demonstrate clear leadership in sustainability (i.e. through their exposure to renewables or commitments to net zero/carbon neutral outcomes). We also prefer to target companies with experienced management teams, low financial leverage and disciplined capex spending plans as these elements can contribute to positive free cash flow generation over time.
Communication Services: 2.1% underweight (5.7% of the portfolio)
The portfolio has an underweight to communication services. Our underweight is driven by expensive valuations and a lack of dividend payers in the entertainment and interactive media and services industries. Meanwhile, the portfolio is overweight to the diversified telecommunication services and wireless telecom services industries. Notable portfolio holdings include Verizon Communications (diversified telecom: 2.2% of the portfolio), Rogers Communications (wireless telecom: 1.7% of the portfolio), and Fox Corp (media: 1.8% of the portfolio). Verizon Communications and Rogers Communications trade at reasonable valuations, boast strong competitive positions and rank well on ESG metrics versus peers. We also like that their core businesses, operating telecom networks, can be a key enabler of smart cities of the future, with potential to reduce energy consumption and provide other social benefits. Fox Corp, meanwhile, is a leading cable news company that we believe has an underappreciated portfolio of assets. We classify the business as an ESG improver and like that management has upgraded the firm’s data security controls and taken steps to improve the working environment for employees through implementation of both non-discriminatory and whistleblower policies.
Consumer Staples: 3.0% underweight (4.0% of the portfolio)
The consumer staples sector is a common destination for the conservative equity income investor. Historically, many of these companies have offered investors recognisable brands, diverse revenue streams, exposure to growing end markets and the ability to garner pricing power. These characteristics, in turn, have translated into strong and often stable free cash flow and growing dividends for shareholders. In recent years some of these secular advantages have become challenged, in our view, due to changing consumer preferences, greater end market competition from local brands and disruption from the rapid adoption of online shopping. These challenges, combined with higher than historical valuations, have facilitated our underweight positioning in the sector. Notable portfolio holdings include PepsiCo (2.1% of the portfolio), Lamb Weston Holdings (0.9% of the portfolio) and Danone (0.9% of the portfolio). We view each of these businesses as ESG leaders: PepsiCo stands out for reducing its water usage and product carbon footprint; Lamb Weston Holdings is at the forefront of implementing strong corporate governance practices; and Danone is making strides in reducing its greenhouse gas emissions, reducing its water usage, and increasing its mix of recyclable and reusable packaging.
Real Estate: 3.9% underweight (0.9% of the portfolio)
The portfolio has an underweight allocation to real estate, as we are finding few companies in the sector with both attractive valuations and strong or improving fundamentals. For example, retail REITs are facing challenges due to e-commerce and its negative impact on traditional brick and mortar retailers. Meanwhile, data center and logistics companies have strong fundamentals, but we view their valuations as unattractive. Our lone portfolio holding is SL Green Realty (0.9% of the portfolio), an office REIT with a knowledgeable management team that has successfully navigated the New York City real estate cycle and, in our view, made astute capital allocation decisions over time. SL Green Realty is the largest NYC landlord and over 90% of its office footprint is Leadership in Energy and Environmental Design (LEED) Gold or Silver certified, well above the NYC and U.S. averages. LEED is a leading rating system for sustainable and ‘green’ buildings and the certification is administered by the U.S. Green Building Council, a private non-profit organisation. LEED ratings range across four tiers including LEED certification, LEED Silver certification, LEED Gold certification and LEED Platinum certification.
Industrials: 6.8% underweight (4.9% of the portfolio)
The portfolio is meaningfully underweight to the industrials sector. Our selectivity is driven by relative valuations, which we view as expensive in many cases, versus other cyclical value segments of the U.S. equity market. Notable positions include Komatsu (3.0% of the portfolio), a Japanese manufacturer of construction and mining equipment, and Norfolk Southern (1.9% of the portfolio), a major U.S. east coast railroad operator. We view both companies as ESG leaders in their respective domains. Komatsu has set meaningful targets for reduced CO2 emissions from its products by 2030 and to achieve carbon neutrality by 2050. Furthermore, Norfolk Southern provides us with exposure to a consolidated industry with pricing power that emits roughly one third as much CO2 as trucks (the main shipping alternative), in moving an equivalent amount of cargo.
Market outlook
‘Unprecedented’ fittingly describes the market environment over the past 18 months. The global pandemic, the intertwined monetary-fiscal policy collaboration and the post-lockdown economic restart are all unique relative to history. The performance of U.S. stocks has followed this tone as the S&P 500 has rallied at its fastest pace in the post-Second World War era. Notably, the index doubled in 354 trading days versus the average 1,000 required to achieve such a feat, according to an August 16 CNBC analysis. Amid noisy economic data that lacks relevant historical comparisons, we believe it is important to find useful anchors for our investment convictions.
A look at earnings, fundamentals and valuations offers some helpful clues. Firstly, the composition of recent quarterly earnings speaks to corporate resilience as companies have beaten analyst expectations on both earnings per share (EPS) and revenue growth. Secondly, fundamentals indicate corporate pricing power and pent-up demand. Why? Revenue growth has been particularly strong, suggesting companies have been able to raise prices and push higher costs on to the end consumer, a reflection of pent-up demand and the consumer’s willingness to pay. Thirdly, while U.S. stock valuations are high on a price-to-earnings (P/E) basis versus history, the equity risk premium1 indicates stocks are undervalued relative to the risk versus reward they offer. All told, we remain constructive on U.S. equities, but cautious that starting points matter, and more muted return expectations are sensible at this stage of the recovery. We continue to believe that companies which run their businesses in a sustainable way, and which take into account all important stakeholders, can provide superior returns in the long run. Moreover, we believe our focus on both ESG leaders and ESG improvers provides a useful framework in which to capture this feature. After an extended market rally, we also believe markets are exiting a period of ‘rising tides lifting all boats’. If true, selectivity could play a greater role in investment returns in the months ahead.
The biggest concern or risk to our market outlook is inflation, as inflation has proven to be more durable than first anticipated. Our concerns centre on inflation’s potential to squeeze corporate profit margins, particularly if consumers grow less willing to pay up for goods and services. Additionally, persistently high inflation presents a more difficult challenge for Fed policymakers and it increases the risk of a potential policy mistake. We also continue to view COVID-19 as a market risk worth monitoring. Although we view the risks from current variants as manageable, we recognise that further COVID-19 upsets are possible and require a necessary measure of humility.
TONY DESPIRITO, DAVID ZHAO AND LISA YANG
BLACKROCK INVESTMENT MANAGEMENT LLC
8 February 2022
1 The equity risk premium (ERP) gauges whether investors are compensated for the greater risk in equities versus ‘risk-free’ government bonds. The ERP has been well above its long-term average for the past ten years, suggesting stocks are undervalued for the relative risk/reward they offer.
TEN LARGEST INVESTMENTS
1 + Cisco Systems (2020: 41st)
Information Technology
Market value: £6,649,000
Share of investments: 4.0% (2020: 1.0%)
Cisco Systems is the world’s largest networking equipment vendor, with leading positions in most of its core end markets. As one of the largest suppliers of network security solutions, the company’s products help customers to enhance data security and privacy. Despite market concerns regarding competition and cloud migration, we believe they can still deliver sustainable revenue and earnings growth due to better than feared market positions, a diversified portfolio and a large existing installed base. Cisco Systems is also an ESG leader, ranking in the top quartile of its peers in terms of carbon emissions and water usage, and the company continues to push for emissions reductions including a targeted 30% decrease in supply chain-related scope 3 GHG emissions by 2030.
2 + AstraZeneca (2020: 29th)
Health Care
Market value: £5,716,000
Share of investments: 3.5% (2020: 1.4%)
AstraZeneca is a diversified pharmaceutical company that conducts research & development (R&D) in high growth areas including oncology, cardiovascular diseases and immunology. They are also a leader in increasing access to health care in the developing world and we are encouraged by the aggressive stance they have taken on addressing their carbon footprint. The company has improved its R&D productivity and cost control in recent years and we believe continued strong execution by management has the potential to deliver further revenue growth and cost savings.
3 + Comerica (2020: n/a)
Financials
Market value: £5,648,000
Share of investments: 3.4% (2020: n/a)
Comerica is one of the 20 largest U.S. banks and most of their business is in commercial loans. They have a strong independent risk management committee that focuses on detecting unethical behaviour and have established processes to attract and retain talent, including a focus on diversity. We see Comerica as offering us access to higher growth geographies in the U.S. and believe their significant excess capital above regulatory minimums can help them execute on their long-term goals.
4 + Wells Fargo (2020: 9th)
Financials
Market value: £5,374,000
Share of investments: 3.3% (2020: 2.3%)
Wells Fargo (WFC) is one of the largest U.S. banks and it operates in three segments including community banking, wholesale banking and wealth & investment management. The company has a strong deposit franchise and we like its history of strong investment returns and prudent credit risk management. While WFC has a chequered history, we believe its current management team, led by CEO Charlie Scharf (hired in October 2019), can restore the firm’s reputation as a premier community bank. Operational improvements require patience, but we believe that risk and control remediation, as well as time-passed, can ultimately improve WFC’s low social and governance scores. In summary, we view shares of the company as underappreciated today in an environment characterised by low credit losses and ample access to liquidity.
5 – Cognizant Technology Solutions (2020: 4th)
Information Technology
Market value: £5,235,000
Share of investments: 3.2% (2020: 2.5%)
Cognizant Technology Solutions is an IT Services company with a diversified revenue base across industry verticals and geographies. As a service provider, they help enterprise and small and medium business clients to transition to cloud infrastructure, which is more efficient versus sub-scale in-house data centers. The company also exhibits strong governance as evidenced by an independent chairman, an independent majority of directors and a gender diverse board. After a period of market share loss and earnings guide-downs, we do not believe the company is structurally impaired. Rather, we see an attractive turnaround opportunity under CEO Brian Humphries (who joined the firm in April 2019).
6 + Komatsu (2020: n/a)
Industrials
Market value: £4,941,000
Share of investments: 3.0% (2020: n/a)
Komatsu is a Japanese manufacturer of construction and mining equipment and a provider of aftermarket parts and services. Lax management as it relates to investment returns has left the company underperforming its potential, but we believe sales are at a cyclical trough and that forward estimates are too low (i.e. the sales recovery following the pandemic is underappreciated). From a sustainability standpoint, the company is a leader in incorporating a broad range of power sources (i.e. hybrids, hydrogen, trolley, battery-electric) in its product portfolio. Furthermore, company management has set targets to reduce CO2 emissions from its products by 50% by 2030 and to achieve carbon neutrality by 2050.
7 + Zimmer Biomet (2020: 56th)
Health Care
Market value: £4,836,000
Share of investments: 2.9% (2020: 0.7%)
Zimmer Biomet designs and manufactures implants focused on orthopaedic markets and the company’s products help to provide patient relief and rehabilitation for those with debilitating health conditions. Over 90% of total hip arthroplasty and total knee arthroplasty patients indicate satisfaction. We see potential for the company to drive market share gains in its hip and knee franchises, due in part to potentially strong placements of its ROSA robotics surgery platform.
8 – American International (2020: 6th)
Financials
Market value: £4,757,000
Share of investments: 2.9% (2020: 2.4%)
American International Group (AIG) is a diversified insurance company with exposure to both property casualty insurance and life insurance. AIG’s business model entails pooling and diversifying risk and this includes insuring against adverse events related to climate change such as floods, hurricanes, etc. New management at AIG has spent the past several years fixing a variety of operational issues at the firm. Notably, AIG has expanded margins, increased reserves, lowered expenses and better managed catastrophe losses via improved use of reinsurance. Despite these developments, the stock still trades at an underappreciated valuation.
9 + SS&C Technologies Holdings (2020: n/a)
Information Technology
Market value: £4,697,000
Share of investments: 2.8% (2020: n/a)
SS&C Technologies Holdings provides software-enabled mission critical services for the financial services industry including software for accounting, recordkeeping, regulatory reporting, investor services, etc. This is a good quality, low growth business with high levels of recurring revenue and customer retention. Regarding ESG issues, the company has begun to address some of its shortcomings including improvements in its pay practices (corporate governance).
10 + Ralph Lauren (2020: n/a)
Consumer Discretionary
Market value: £4,208,000
Share of investments: 2.5% (2020: n/a)
Ralph Lauren is a leading global apparel company with solid brand momentum that trades at an attractive valuation. We think the company is pulling the right levers to maintain profit margins and brand equity, and we believe the market underestimates the company’s potential for improved profit margins in the medium term. We also believe the company is poised to improve its ESG scores over time. Notably, company management recently shared an updated global citizenship and sustainability plan that includes a net zero greenhouse gas emissions target by 2040. The strategy also outlines goals for increasing racial diversity in leadership, increasing the sustainability of the clothing industry and increasing ESG disclosures. Moreover, ESG key performance indicators are now used as metrics for executive compensation, which we view as a positive step.
All percentages reflect the value of the holding as a percentage of total investments.
Percentages in brackets represent the value of the holding as of 31 October 2020.
Together, the ten largest investments represent 31.7% of the Company’s portfolio (31 October 2020: 26.8%).
INVESTMENTS AS AT 31 OCTOBER 2021
Company | Country | Sector | Securities | Market value £’000 | % of total portfolio |
| Cisco Systems | United States | Information Technology | Ordinary shares | 6,649 | 4.0 |
| AstraZeneca | United Kingdom | Health Care | Ordinary shares | 5,716 | 3.5 |
| Comerica | United States | Financials | Ordinary shares | 5,648 | 3.4 |
| Wells Fargo | United States | Financials | Ordinary shares | 5,374 | 3.3 |
| Cognizant Technology Solutions | United States | Information Technology | Ordinary shares | 5,235 | 3.2 |
| Komatsu | Japan | Industrials | Ordinary shares | 4,941 | 3.0 |
| Zimmer Biomet | United States | Health Care | Ordinary shares | 4,836 | 2.9 |
| American International | United States | Financials | Ordinary shares | 4,757 | 2.9 |
| SS&C Technologies Holdings | United States | Information Technology | Ordinary shares | 4,697 | 2.8 |
| Ralph Lauren | United States | Consumer Discretionary | Ordinary shares | 4,208 | 2.5 |
| Anthem | United States | Health Care | Ordinary shares | 4,054 | 2.5 |
| Sanofi | France | Health Care | Ordinary shares | 3,860 | 2.3 |
| Lowe’s Companies | United States | Consumer Discretionary | Ordinary shares | 3,772 | 2.3 |
| Verizon Communications | United States | Communication Services | Ordinary shares | 3,706 | 2.3 |
| Bank of America | United States | Financials | Ordinary shares | 3,669 | 2.2 |
| Cigna | United States | Health Care | Ordinary shares | 3,661 | 2.2 |
| General Motors | United States | Consumer Discretionary | Ordinary shares | 3,598 | 2.2 |
| PepsiCo | United States | Consumer Staples | Ordinary shares | 3,459 | 2.1 |
| Morgan Stanley | United States | Financials | Ordinary shares | 3,401 | 2.1 |
| Citigroup | United States | Financials | Ordinary shares | 3,370 | 2.0 |
| Quest Diagnostics | United States | Health Care | Ordinary shares | 3,308 | 2.0 |
| Fidelity National Information Services | United States | Information Technology | Ordinary shares | 3,174 | 1.9 |
| Alcon | Switzerland | Health Care | Ordinary shares | 3,116 | 1.9 |
| Norfolk Southern | United States | Industrials | Ordinary shares | 3,079 | 1.9 |
| Fox Corp | United States | Communication Services | Ordinary shares | 3,023 | 1.8 |
| Equinor | Norway | Energy | Ordinary shares | 2,995 | 1.8 |
| Panasonic | Japan | Consumer Discretionary | Ordinary shares | 2,938 | 1.8 |
| Invesco | United States | Financials | Ordinary shares | 2,918 | 1.8 |
| Willis Towers Watson | United States | Financials | Ordinary shares | 2,852 | 1.7 |
| Microsoft | United States | Information Technology | Ordinary shares | 2,775 | 1.7 |
| Rogers Communications | Canada | Communication Services | Ordinary shares | 2,734 | 1.7 |
| Arthur J. Gallagher & Co | United States | Financials | Ordinary shares | 2,703 | 1.6 |
| Steel Dynamics | United States | Materials | Ordinary shares | 2,640 | 1.6 |
| Charles Schwab | United States | Financials | Ordinary shares | 2,627 | 1.6 |
| Public Service Enterprise Group | United States | Utilities | Ordinary shares | 2,511 | 1.5 |
| CenterPoint Energy | United States | Utilities | Ordinary shares | 2,491 | 1.5 |
| Sempra | United States | Utilities | Ordinary shares | 2,344 | 1.4 |
| ConocoPhillips | United States | Energy | Ordinary shares | 2,108 | 1.3 |
| Woodside Petroleum | Australia | Energy | Ordinary shares | 2,099 | 1.3 |
| Novo Nordisk | Denmark | Health Care | Ordinary shares | 2,063 | 1.3 |
| CDK Global | United States | Information Technology | Ordinary shares | 2,042 | 1.3 |
| Newmont Corporation | United States | Materials | Ordinary shares | 2,034 | 1.2 |
| First American | United States | Financials | Ordinary shares | 1,848 | 1.1 |
| Sealed Air | United States | Materials | Ordinary shares | 1,690 | 1.0 |
| Dollar General | United States | Consumer Discretionary | Ordinary shares | 1,682 | 1.0 |
| Gildan Activewear | Canada | Consumer Discretionary | Ordinary shares | 1,668 | 1.0 |
| Danone | France | Consumer Staples | Ordinary shares | 1,555 | 0.9 |
| SL Green Realty | United States | Real Estate | Ordinary shares | 1,532 | 0.9 |
| EQT | United States | Energy | Ordinary shares | 1,511 | 0.9 |
| Lamb Weston Holdings | United States | Consumer Staples | Ordinary shares | 1,476 | 0.9 |
| Fidelity National | United States | Financials | Ordinary shares | 1,448 | 0.9 |
| Consolidated Edison | United States | Utilities | Ordinary shares | 1,269 | 0.8 |
| American Express | United States | Financials | Ordinary shares | 1,239 | 0.8 |
| Lear | United States | Consumer Discretionary | Ordinary shares | 868 | 0.5 |
| ————— | ————— | ||||
| Portfolio | 164,971 | 100.0 | |||
| ========= | ========= |
All investments are in ordinary shares unless otherwise stated. The number of holdings as at 31 October 2021 was 54 (31 October 2020: 78).
At 31 October 2021, the Company did not hold any equity interests comprising more than 3% of any company’s share capital.
DISTRIBUTION OF INVESTMENTS AS AT 31 OCTOBER 2021
| Total % | Benchmark % | |
| Communication Services | 5.7 | 7.8 |
| Consumer Discretionary | 11.3 | 5.6 |
| Consumer Staples | 4.0 | 7.0 |
| Energy | 5.3 | 5.4 |
| Financials | 25.2 | 21.9 |
| Health Care | 18.4 | 17.4 |
| Industrials | 4.9 | 11.7 |
| Information Technology | 14.8 | 9.8 |
| Materials | 3.8 | 3.7 |
| Real Estate | 0.9 | 4.8 |
| Utilities | 5.2 | 4.9 |
| Cash | 0.5 | 0.0 |
Sources: BlackRock and Datastream.
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