BlackRock Income & Growth (BRIG) targets growth in both income and capital over the long term. BRIG has been run by the extensive team at BlackRock since 2012 which also runs a successful open-ended UK equity income product. The open-ended fund has successfully increased its distribution every year for the past 30 years.
Whilst there is significant overlap between BRIG and its better-known open-ended counterpart, the managers of BRIG, Adam Avigdori and David Goldman, are keen to take advantage of the trust structure for this product.
BRIG seeks to balance income generation with growing distributions, by concentrating primarily on identifying attractive opportunities from bottom-up stock analysis. The managers tend to place stocks into one of three ‘buckets’, as we discuss under Portfolio. The trust structure, and this approach, allows them to invest in lower yielding names – which they believe to have significant growth or turnaround potential – and focus on generating yield at a portfolio level.
As we discuss under Dividend, the aim of generating a growing level of distribution is also supported by the board, who have looked to accrue additional revenue reserves in benign conditions whilst distributing these reserves in more challenging environments. This strategy has allowed BRIG to consistently grow its dividend, without placing excessive impediments on the managers to focus solely on dividend generation.
The current level of discount (of c. 5.9%, as of 24/07/2020) is wide relative the trust’s recent history, as we discuss in the Discount section.
BRIG’s dividend looks resilient, despite the headwinds to income investing in the UK and globally. It is backed by a substantial revenue reserve, with a board that has said it intends to use this reserve to maintain distribution levels. BRIG has seen its dividend grow steadily and has demonstrated a willingness to access revenue reserves in previous instances of shortfalls in income received. This approach should continue to allow the managers flexibility to access the best opportunities from a total return perspective, and it is positive to see them concentrating the portfolio further into their best ideas. While we note the excellent track record of dividend growth recorded by the same management team on the OEIC, we think during this crisis BRIG’s revenue reserves should allow them greater flexibility to input their best ideas whilst retaining the ability to maintain or raise the dividend.
Intervention from the board to try and ensure BRIG trades at close to NAV has been welcome. The strategy should be easily scalable if the board is able to grow the trust through issuance, without impeding the ability of the managers to take positions in less liquid holdings. This ability remains an attraction offered by the trust structure. Short-term fluctuations in line with wider sentiment towards the UK remain likely. But any downside in the wider market could potentially offer opportunities to initiate new positions in relatively illiquid stocks, which would likely suffer disproportionately.
|Reasonable yield which is very well supported by revenue reserves||Gearing can exacerbate downside as well as amplify upside|
|Has exhibited good adjustments to gearing and portfolio management thus far in 2020||Small size of trust|
|Relatively small size allows access to attractive mid and small cap opportunities without impinging on overall portfolio liquidity||Can lag in strongly reflationary environments driven by highly cyclical sectors|
BlackRock Income & Growth (BRIG) has twin aims of providing growth in both capital and income over the long term. The managers, Adam Avigdori and David Goldman, aim to achieve this through investment primarily in UK listed companies. Adam and David look to construct a high-conviction portfolio of around 40 companies, utilising the insights and processes of the similar BlackRock UK Income open-ended fund, for which they are also part of the management team.
Although there is significant crossover between the well-known OEIC product and BRIG, Adam and David seek to use the closed-ended structure to their advantage in portfolio construction. The closed-ended nature of BRIG and the relatively small pool of assets under management (c. £44m, as of 30/06/2020), allows them to allocate a greater proportion of their assets to small and mid-cap opportunities. The ability to retain earnings in benign or positive market conditions, means that they are able to focus on the best opportunities from a total return perspective in more challenging times – but with the cushion of a revenue reserve to offset any concomitant loss of income.
BRIG’s portfolio is constructed through a process which sees the team build exposure to three different kinds of stock:
- Income Generators: these companies will typically represent between 60-80% of the portfolio (currently c. 70%, as at 30/06/2020).
- Structural Growth Companies: these companies will generally comprise between 15-25% of the portfolio (currently c. 20%).
- Turnarounds: a maximum of 10% of the portfolio will be invested in these companies. This is an internal hard limit applied by BlackRock that the team will not exceed. (At present they have c. 10% invested in stocks meeting this classification).
Whilst the portfolio will be invested nearly wholly in UK equities, BRIG’s board has recently authorised the managers to invest up to 5% of assets overseas. This allowance is to enable them to access opportunities in sectors which, because they are dominated by companies not listed in the UK, are not readily accessible in the UK market. The increased opportunities available should also serve, in their view, to enhance the yield profile of BRIG going forward. Stocks considered within the ‘Turnarounds’ bucket, however, will continue to be solely UK listed companies.
The process itself is primarily driven by bottom-up stock analysis, using both quantitative and qualitative considerations including external research. Adam and David are also able to draw on the wider Blackrock UK equity analyst team. Consequently the resources available to them ensure there is a deep knowledge and database of the companies that comprise the investment universe.
A majority of the portfolio continues to be invested in the ‘Income Generators’ bucket: companies with stable revenue streams operating in industries with high barriers to entry. Strong capital allocation and free cash flow helps ensure these businesses are able to maintain competitive advantages through research & development. Adam and David note that, whilst the market-leading qualities of many of these businesses within their sectors are often appreciated by the wider market, the length and degree to which these companies can compound cash flow growth is often not understood, and that they are thus able to pick up assets at discounted valuations to their own expectations.
This has been seen, for instance, in their positions in BHP and Rio Tinto, which they have been adding to in recent months. As mining companies, there is often an assumption that cash flows within these businesses are hostage to the global economic cycle. Whilst there is an element of truth to this (for example, severe drops in commodity prices will likely impact the dividend paid), this does not account for the fact that both are amongst the leading mining companies and lowest cost producers of commodities in the world and are able to generate free cash flow even at significantly lower commodity prices. Adam and David’s stress testing of the companies suggests that Rio Tinto, for example, can still remain profitable even if the iron ore price were to fall by 50%. With the mining sector having endured a crisis earlier in the decade, capital allocation and supply discipline across the whole sector is much improved, whilst BHP and Rio Tinto both have very strong balance sheets to manage any short-term crisis.
Company meetings are considered a key input to better understanding the operational performance of a business, with Adam, David and the UK team undertaking over 1,000 meetings in an ordinary year. Meetings with management help provide colour to their assessments of the efficiency of capital allocation within a business.
In the wake of widespread disruption to business operations in recent months from the COVID-19 pandemic and related economic shutdown, the management team have been undertaking these meetings (albeit remotely) at an increased rate even relative to normal. When we spoke to them in late June 2020, they had participated in over 570 calls with management in the past month, and 943 company meetings in total thus far in 2020 (to the end of June).
Risk analysis on the stocks held, including scenario analysis, continues to be undertaken on an ongoing basis. Adam and David use this to help understand the portfolio’s exposure to different investment style factors and different macroeconomic variables, and use the output at any one time to try and ensure the portfolio is not skewed towards particular outcomes in the macroeconomic or market environment. They thus hope to ensure that stock-specific factors remain the primary drivers of relative returns over the long term, and will stress test BRIG’s portfolio against a variety of different outcomes (such as moves in the FX rate) regularly. A more detailed discussion of the investment process can be seen in our previous research note here.
These risk models and their output helped the team reconcile the portfolio to their market outlook earlier in 2020. Their bottom-up stock analysis suggested stocks were rerating higher, with price rises significantly exceeding likely gains in cash flows and sales. This valuation rerating, which became more acute after the 2019 UK General Election, led the managers to consider portfolio level risk. Observing global equity market and economic conditions, as well as the likelihood of increased headwinds to global trends from geopolitical developments, Adam and David increasingly came to regard low volatility conditions in markets as fragile.
Having developed a view in January that market conditions were likely to prove more volatile going forward, Adam and David opted to reduce risk in the portfolio through a reduction in gearing. While they typically target a low-turnover approach to portfolio management, this increased notably in January as they turned over around 10% of the portfolio. At this time they primarily sought to reduce exposure to more cyclically exposed sectors, such as chemicals and industrials. They also reduced their financials exposure, viewing the inherent leverage in this sector as likely to prove unhelpful in an increased volatility environment.
In the place of these positions, Adam and David introduced holdings in Reckitt Benckiser and Astrazeneca, viewing both as having resilient cash flows and dividends at attractive valuations. These investment decisions, buying and selling, were driven by their bottom-up observations of the market’s repricing of the outlook for the individual companies relative to their own views, which was able to account for their wider market observations.
As the market sell-off started to pick up pace in later February 2020, the significant analytical resources to BRIG and experience of the managers also meant they were able to revisit their portfolio activity in the market sell-off amidst 2008-09 financial crisis for comparative purposes. Whilst sell-offs do not repeat history, there are certain rhymes to investor behaviour in mass panics such as that seen in Q1 2020. Both Adam and David examined their portfolio activity during the 2008-09 financial crisis, looking to identify positive and negative behaviours they had exhibited in the midst of a market panic and seeking to understand how best to navigate the sell-off that was then ongoing.
From this they sought to guard against allowing the market sell-off to lead them to unduly pessimistic outlooks for the underlying businesses. They also noted, however, that markets in high-volatility environments often tend to feed on themselves, and they largely waited for confirmation that equity markets were treating the policy response as sufficient before opting to increase their exposure within BRIG to what they believe are the opportunities best placed to benefit from a market recovery.
This has led to them to increase portfolio concentration even as they added to new names, looking for their best ideas to drive returns in the durable market recovery they anticipate going forward. We can see how the portfolio has become more concentrated when we compare the current top-10 holdings with those when we last reviewed BRIG on 31/10/2019 in the table below.
top ten holdings
|AS AT 31/10/2019||as at 31/05/2020|
|Royal Dutch Shell 'B'||6.1||AstraZeneca
|AstraZeneca||5.2||British American Tobacco
|British American Tobacco||3.6||Reckitt Benckiser
|National Grid||3.4||Smith & Nephew
Source: BlackRock, as at 31/10/2019 and 31/05/2020
Whilst stock dispersion has been low in recent months, the managers believe this will rise again and markets will increasingly appreciate companies who remain operationally robust. In all of the positions the management team have introduced they have long-standing familiarity with the business, and believe long-term profits and operations to remain intact.
The sell-off and widespread derating gave the managers the opportunity to introduce some of these at discounted valuations, where previously it had been high valuation multiples which deterred them from owning the stock. This was the case for their holding in Next, which they reintroduced to the portfolio having previously held the stock before exiting primarily due to valuation concerns a couple of years ago. Operationally, they believed the management of Next to be excellent and note that capital and free cash flows are very well deployed to manage the interests of both the business and shareholders.
Although known as a high street retailer by much of the market, Next has a highly developed online business and is now even acting as a hub and distributor for other retailers. Having observed Next stock derate – to the point where it was displaying a double-digit free cash flow yield and a single digit P/E ratio – Adam and David opted to reintroduce this as a long-term holding within the ‘income generators’ bucket of their portfolio. It is worth noting that they believe the business can sustain free cash flow growth much longer and more sustainably than the market currently appreciates.
BRIG currently has gearing of c. 2.6% (as of 31/05/2020), having marginally increased this recently as the managers identified increased opportunities. The managers have the option to gear up to a maximum of 20% of net assets. Typically the managers generally avoid using gearing for short-term market timing, and instead aim to use it as a way of enhancing returns over the medium to long term.
However, the Adam and David have been active in their use of gearing in late 2019 and 2020 thus far. Having previously increased gearing levels in late 2020, they began to believe that increases in market prices were outpacing fundamental improvements, and their bottom-up stock focus suggested to them that increased valuations were commonly unjustified by improved earnings expectations. This was particularly true in the degree of market gains after the UK 2019 General Election.
Moving into January 2020, the absence of attractive opportunities at a stock level sounded a note of caution to the managers. Combined with their top-down assessment of general risks of slowing economic growth, they felt that market risk was elevated. Accordingly, they derisked the portfolio by reducing gearing and reducing exposure to particularly economic sensitive areas such as chemicals and industrials.
Subsequent to the significant market sell-off, they have started to put capital back to work in attractive stock opportunities, as detailed in the Portfolio section. However, overall use of gearing remains reasonably constrained at this time. Instead, the managers have primarily looked to focus and concentrate BRIG’s portfolio into the stocks offering, in their view, the strongest upside potential.
BRIG’s NAV has outperformed both the Morningstar UK Equity Income peer group and benchmark over the past twelve months to 26/06/2020, though a widening discount has impeded share price returns. In this twelve-month period, BRIG has produced NAV and share price returns of c. -9.8% and -13.1% respectively, whilst the peer group has produced average NAV and share price returns of c. -11.5% and -13.5% respectively. Over this same period, the benchmark FTSE All-Share (as represented by a passive index-tracker) has returned c. -13%.
12-month returns relative to peers and benchmark
Having reduced gearing and cyclicality within the portfolio, the managers were able to mitigate the impact of the market sell-off more successfully than the peer group average. Employing the lessons they learned from the 2008-09 financial crisis consequently helped the managers to make the dispassionate decision to start to build their ‘risk’ exposure to derated stocks, where they continued to see a bright outlook operationally, as we have discussed under Portfolio.
Longer-term returns have also been strong relative to the benchmark, though NAV returns have lagged the peer group average. Since the current management team took over running of BRIG on 1 April 2012, BRIG has produced NAV and share price returns of c. 61.6% and 65.5% respectively, against a benchmark return of c. 49.1%. While they have outperformed the benchmark, they have trailed the peer group average on a NAV basis, with an unweighted average peer group NAV return of c. 85.4% over this period.
We would suggest this underperformance to the peer group average is partially because the investment strategy tends to result in BRIG skewing slightly more towards large caps than many of their peers, with the FTSE 250 having outperformed over the same period. This tendency is not always a significant factor, but it does seem to impact returns at more acute moments of changes in the fortunes of the mid cap index to the All-Share.
cumulative relative returns to peer group, benchmark and ftse 250
BRIG’s outperformance in challenging market conditions is in line with previous experiences of market drawdowns, with rolling six-month NAV returns outperforming the benchmark on c. 68% of occasions under the current managers where market returns were negative (and outperforming on c. 54% of occasions when the market was positive).
discrete calendar year returns
Given the historic aversion that the managers have typically displayed towards stocks with highly cyclical earnings and by extension dividends, which tend to be vulnerable to swings in the economic cycle, they have tended to have significant underweight allocations to the basic materials and oil & gas sectors. This is inevitably a headwind at times when these stocks have rallied hard on expectations of improved global economic conditions, as we can see below from the allocation effects in FY 2016. Equally, however, this worked to their advantage in late 2015.
However, as we discuss in the Portfolio section, the managers now see more reliable cashflows and dividends from the mining sector, and their weighting to this sector is near to market weight now. Accordingly, any outperformance of this sector is less likely to be a headwind to the trust going forward than it has in the past.
Stock selection in the previous financial year (to 31/10/2019) was highly beneficial to relative returns, whilst sector allocations also provided a further net benefit.
Sector allocation and stock contribution to performance by financial year
|FY 2016||FY 2017||FY 2018||FY 2019|
|Oil & Gas||-1.09||0.07||-0.64||-0.45||-0.58||0.2||0.45||-0.06|
BRIG has a yield of c. 4.4% at present (as at 24/07/2020). Whilst this is slightly lower than the AIC UK Equity Income sector average yield of c. 4.9% (Source: AIC), BRIG’s focus is on ensuring it has the ability to continue to grow income over the long term while also paying reasonable yields. This is partially through a focus on identifying opportunities that offer the potential to sustainably grow and return free cash flow to investors (increasing the trust’s earnings per share), and partially through accrual and deployment of revenue reserves in favourable conditions to support the dividend in more adverse times.
Adam and David note that they believe the current situation in the UK dividend market, with swathes of reductions or suspensions as revenues are impaired by the COVID-19 pandemic related shutdown, can potentially serve as an opportunity for parts of the market to reset dividend expectations. The UK market has, for several years, exhibited a high payout ratio relative to global peers, but with many former dividend stalwarts in the UK corporate world having finally been compelled to cut dividends by the unprecedented backdrop seen thus far this year, the mangers of BRIG believes a more normalized payout environment is likely going forward. In this context, and with their bullish outlook on the market (as discussed under Portfolio), the substantial revenue reserve is likely to be utilised in the coming months and potentially years to support the dividend as the managers focus on ensuring they have sufficient exposure to the most attractive opportunities from a total return viewpoint.
BRIG has declared an interim dividend of 2.6p per share, which is static on the previous year’s interim dividend despite an 11% fall in reported income in the equivalent period as dividends struggle within the UK market in general. However, the board has announced its intention to support the dividend going forward using the substantial revenue reserves that have been accrued.
As can be seen below, the managers and board have been successful in growing the dividend every year. Since the trust’s 2012 financial year (FY) the dividend has grown at an annualised rate of c. 4.6% to the end of FY 2019. Over the same periods, revenue returns per share have grown at an annualised rate of c. 7.2%.
Prior to the payment of the interim dividend, the revenue reserve was equivalent to c. 1.5x the FY 2019 dividend. Even if the interim dividend was to be funded wholly from this, we estimate BRIG would retain revenue reserve cover equivalent to c. 1.15x the FY 2019 dividend.
The ability of the managers to allocate to the best total return opportunities without having to rigidly seek income is evinced by the variance in revenue returns per share relative to the relatively steady path of increases in distributions.
dividend and revenue per share
The portfolio is co-managed by Adam Avigdori and David Goldman, who lead the UK Income team at BlackRock. Their team is a subset of the UK Equity team, which currently numbers 13 investment professionals. Each of the team members has research responsibilities, with sectors rotated around the team over time. The UK team works closely with the European Equity team, comparing notes, valuations and stock ideas.
The team also runs the open-ended BlackRock UK Income fund using the same strategy. Adam Avigdori has been co-manager of the trust since 2012, and David Goldman since July 2017.
BRIG presently trades on a discount of c. 5.9% (as at 24/07/2020). This is anomalously wide compared to the trust’s history. Under the current managers, it has traded on a median discount of c. 2.4%, with the current level over one standard deviations below the median level.
Typically, the narrow discount range has been a product of intervention of the board, who have regularly stepped in to purchase shares when the trust has moved to a discount, and to issue them when it trades at a premium. Indeed, BRIG has a company policy in normal conditions of attempting ensuring the share price does not deviate significantly from NAV. Since the last financial year end (31/10/2019), a total of 352,500 shares have been bought back at a weighted average discount of c. 5.9%.
Although limited buybacks were conducted in Q1 2020, this was in keeping with the company policy for BRIG, with extended discount volatility during the months of February and March, as can be seen in the chart below. As conditions normalised, the board once again bought back shares, with a substantial purchase on 17/04/2020, but generally buyback activity has been muted in recent months.
one-month discount/premium volatility
BRIG has an ongoing charge figure (OCF) of 1.07%, which is greater than the sector average level of c. 0.62% (Source: JPMorgan Cazenove). There has been no performance fee attached to the trust since 2013. The Key Information Document Reduction in Yield figure is 1.7%, compared to a sector average of 1.22%, although we caution that methodologies vary. Fees are charged 25% to revenues, and 75% to capital.
Adam, David and the wider BlackRock team regard ESG as an important input into their investment process. This is especially the case for the key bucket – “Income Generators”- currently accounting for c. 70% of the portfolio, which has a strong focus on ensuring dividends are sustainable. However, ESG factors are considered for all stocks.
The team primarily look for efficiency, and whether this can be achieved by, for example, cutting out waste and reducing their environmental footprint. They are also looking to ensure that growth is sustainable; this could be by ensuring that optical growth rates are not the artificial results of buying revenue, but have stemmed from, for instance, ensuring good staff retention rates. Adam and David have noted that a company’s ability to attract and retain talent tends to boost firm productivity.
Governance is also considered important, with the team regularly engaging with companies in its purview. The significant passive business run by BlackRock ensures that they have good access and can bring significant weight to bear on management, and they are keen to ensure that firms are allocating capital efficiently and employing strong accounting practices, amongst other things.