BlackRock North American Income Trust

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Horace Wiggins
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1 1 BlackRock North American Income Trust is a client of Kepler Trust Intelligence. Material produced by Kepler Trust Intelligence should be considered a marketing communication, and is not independent research. Please see the important information at the bottom of the page. BlackRock North American Income Trust Summary BlackRock North American Income Trust (BRNA) has a diversified portfolio comprised mainly of US equities, focused on the 5 largest stocks by market cap. The company s objective is to provide an attractive and growing level of income return with capital appreciation over the long term. The managers have a low-turnover approach, and a strong focus on valuation, aiming for well-established cash generative companies with clear revenue streams and the potential for dividend growth. The board announced plans in December 217 to boost the dividend the trust pays by paying a small proportion from capital, and have specified a quarterly dividend of 2p per share for the current financial year. As such the trust currently offers a yield of 5.2, putting it comfortably ahead of all of its comparable peers in the AIC North America sector on yield terms. The trust was launched in September 212 and, because of its focus on quality and valuations, had a rocky start, underperforming the index in 213 and 214 as bond proxies and financials raced ahead. Stock selection also played a part. Since then, Tony DeSpirito, David Zhao and Franco Tapia have changed the investment process. This has involved increasing the number of staff in the team, as well as developing a new quant screen with the aim of ensuring opportunities are flagged up more rigorously. The team now consists of 21 investment professionals, with on average over a decade s worth of experience. The trust outperformed the index in 215 and then kept pace with it in 216. More latterly, BRNA produced almost double the return in NAV terms of the Russell 1 Value index in 217. The team has a clear preference for high-quality businesses both in terms of management, but also franchises and balance sheet strength. The team aims to invest in businesses that have shown a disciplined approach to paying dividends, but more importantly, that it thinks offer significant prospects of dividend growth in years to come. The team believes that (relatively long) holding periods which are commensurate with business strategy horizons will serve them well. Turnover in the team s portfolios is generally very low (c.1), with an investment horizon of typically three-to-five years. With this having been said, it is not constrained in its holding time, and if a stock performs particularly well, breaks the investment thesis or stops being compelling, it will sell regardless. TOP TEN HOLDINGS HOLDING JPMorgan Chase 4.3 Bank of America 4.2 Pfizer 3.7 Citigroup 3.4 Wells Fargo 2.9 Oracle 2.9 Microsoft 2.5 Anthem 2.4 Verizon Communications 2.4 Royal Dutch Shell 2.3 Over the past year the discount has been relatively volatile, ranging between c.-1 and At the time of writing, the discount is Portfolio The managers start with an investment universe of the 5 largest US stocks by market cap, and use a quant screen to ensure that all potentially interesting equity income opportunities are on the radar. The 21-strong investment team then performs bottom-up fundamental research trying to identify attractively valued, high-quality companies with prospects for dividend growth. Source: BlackRock (31/3/18) The trust is benchmarked against the Russell 1 Value index but the managers are willing to take positions against the benchmark where they think it is appropriate to do so, and are open to investing up to 25 of the portfolio overseas if they identify a company that replicates a US business or fits their investment criteria. Around 18 of the portfolio is currently invested outside the US an increase from the 1 when we reviewed the trust in May 217. The managers have increased their offshore exposure having seen certain domestic stocks race ahead in the wake of Donald Trump s election as US president, leaving overseas equivalents like AstraZeneca and Total relatively attractive on valuation grounds.

2 2 Cons Discretionary Utilities Industrials Cons Staples Info Tech BlackRock North American Income Materials Telecom Energy Cash Equity Exposure Financials Health Care Powered by Highcharts Cloud Stocks in the portfolio generally fall into two buckets: the stability bucket and the cyclical bucket. The stability bucket could include companies in sectors like consumer staples and real estate investment trusts (REITs), but the managers do not currently favour the former because they see the impact of technology and changing consumer habits putting pressure on traditional business models here. There are exceptions, though, such as Diageo, which they see benefiting from its foothold in emerging markets. For the stability bucket they prefer healthcare and large cap pharmaceuticals, among the trust s largest sector overweights, which they say are benefiting from demographic change and positive impacts from technology. AstraZeneca (1.92) sits in this section of the portfolio alongside Pfizer (3.73), Anthem (2.39) and Merck (1.72) all of them among the trust s 2 largest individual holdings. An interesting development is that the trust s exposure to technology has grown dramatically as more and more technology companies in the US move from being purely growth companies to steady, cash generative income plays. The managers say companies like Microsoft (2.1) look increasingly like high quality industrial companies, generating solid cashflows year after year where previously they would have been reinvesting for growth. Gearing We understand that the managers do not anticipate using gearing in the near term. Returns The trust has seen performance improve since the appointment of BlackRock s Equity Dividend team led by Tony DeSpirito, coming at the same time as the overhaul of the investment process which began in October 214. Over three years to the end of March 218 the trust has generated 37.3 in NAV total return terms, outperforming the Russell 1 Value index (32.9) and only narrowly trailing the average trust in the Morningstar North America sector (38.6) BlackRock North American Income: Performance versus indices from to For the cyclical bucket the team is particularly keen on companies which it believes should be relatively resilient (in stock price terms) in a rising interest rate environment. There is a particular tilt towards banks, a preference evidenced by the portfolio s largest overweight, which is towards financials. To the end of March, the financials weighting had not made a major contribution to performance, but the managers remain positive on the outlook. They believe that improved leverage ratios and better balance sheets that exceed capital requirements offer an attractive entry point. Additionally, President Trump s lighter regulatory touch and tax reforms also have the ability to benefit many of these companies. Energy continues to be another significant overweight in the portfolio, again sitting on the cyclical side of things. The managers point to the cyclical nature of capital investment among energy companies, and claim that at this point as the global economy gathers pace the sector has seen the taps turned off on capex for three years. This leaves supply constrained, they say, and, given how long it takes to bring resources back onstream in this area, that is good news for profits in the sector as demand picks up, driving prices up Jul '15 Jan '16 Jul '16 Jan '17 Jul '17 Jan '18 BlackRock North American (Cum Fair NAV) Russell 1 Value IA OE North America Prior to appointing the Equity Dividend management team, the trust had underperformed the index in 212, 213 and 214, hit by a combination of a style which didn t suit the market and a focus on analyst-led research which, without the rigour of a quant screen, the managers believe, resulted in a number of missed opportunities. Since then the trust has fared better, outperforming the index in 215 and then keeping pace with it in 216. The trust produced almost double the return in NAV terms of the Russell 1 Value index in 217. The biggest positive contributions to performance during 217 came from the trust s technology and healthcare positions and also, notably, included its exposures to companies outside the US, like AstraZeneca and Royal Dutch Shell.

3 The managers have allowed a small cash position (5) to build up. Rather than reflecting a bearish position, the managers view this an opportunistic cash pile which will allow them to take advantage of any opportunities that arise from the quantitative tapering process and/or market setbacks. Dividend BlackRock North American Income: Calendar year performance (to ) BlackRock North American (Cum Fair NAV) Russell 1 Value IA OE North America As well as the income stemming from the portfolio, the team also makes extensive use of option writing to generate option premium and thereby boost dividend income. The managers write covered options, taking the premium upfront, and forgoing any upside beyond the strike-price in return. No more than 2 of the company s portfolio will be under option at any given time. Over the last financial year (to November 217), option writing generated just under 4 of all income generated during the year. This element of the strategy can deliver a boost to income, but during strongly rising markets can be a drag on performance. The trust pays dividends quarterly, and this is meant to be very much part of the attraction of the trust. Since launch in 212, the quarterly dividend had increased by 25 from 1p per share to 1.25p per share. However, the strong capital growth of the portfolio during the same period meant a lower dividend yield for newer investors. As a result, the board announced plans in December 217 to improve the trust s yield by paying a quarterly dividend of 2p per share in the 218 financial year, equating to a 5.2 dividend yield based on the company s share price at the time of writing. Some of the money used to support this yield will be drawn from capital. Management The portfolio is managed by three co-managers; Tony Despiritio, Franco Tapia and David Zhao. Tony typically has the final say within the team, having lead-managed the trust since October 214. The managers have a long-term relationship with each other, having all previously worked together at Pzena Investment Management. They believe this helps in their investment decisions in particular when conducting honest and open debates during the stock selection process. The co-managers are supported by a 21-strong investment team, all of whom act as analysts, performing bottom-up fundamental research trying to identify attractively valued, high-quality companies with prospects for dividend growth. The team has a preference for high-quality businesses both in terms of their management, but also their franchises and their balance sheet strength. They aim to invest in businesses which have shown a disciplined approach to paying dividends, but which in their view offer significant prospects of dividend growth in years to come. Discount The trust was launched in September 212 and, because of its focus on quality and valuations, had a rocky start underperforming the index in 213 and 214 as bond proxies and financials raced ahead. The trust languished on a discount as a result. However, following a change in the manager in late 214, performance picked up in 215. At that time, the trust was trading on a discount of 8 putting it in the seventh percentile of cheapness relative to its own history and in the months that followed we saw the discount narrow to reach a premium of around 1.5 in January 217. Since then the trust drifted back out to a discount of around 7, before reaching a relatively stable level close to -5. The discount has in recent times narrowed, now at BRNA still remains relatively small with net assets of c. 11m. 1 5 BlackRock North American Income: Discount / premium From 2/4/213 to 3/3/218 The trust aims to grow the dividend over time. Dividends have remained the same or grown every year since launch and the trust has developed a small revenue reserve, equivalent to around 3 of last year s total dividend BlackRock North American

4 4 Charges The management fee is.75 pa, and the majority of charges (75) are allocated to the capital account. The KID RIY cost is 1.4, which compares to the peer group average of 1.28.

5 5 BlackRock North American Income Trust is a client of Kepler Trust Intelligence. Material produced by Kepler Trust Intelligence should be considered a marketing communication, and is not independent research. Please see the important information at the bottom of the page. Important Information Kepler Partners is not authorised to make recommendations to Retail Clients. This report is based on factual information only, and is solely for information purposes only and any views contained in it must not be construed as investment or tax advice or a recommendation to buy, sell or take any action in relation to any investment. This report has been issued by Kepler Partners LLP solely for information purposes only and the views contained in it must not be construed as investment or tax advice or a recommendation to buy, sell or take any action in relation to any investment. If you are unclear about any of the information on this website or its suitability for you, please contact your financial or tax adviser, or an independent financial or tax adviser before making any investment or financial decisions. The information provided on this website is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation or which would subject Kepler Partners LLP to any registration requirement within such jurisdiction or country. Persons who access this information are required to inform themselves and to comply with any such restrictions. In particular, this website is exclusively for non-us Persons. The information in this website is not for distribution to and does not constitute an offer to sell or the solicitation of any offer to buy any securities in the United States of America to or for the benefit of US Persons. This is a marketing document, should be considered non-independent research and is subject to the rules in COBS 12.3 relating to such research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research. No representation or warranty, express or implied, is given by any person as to the accuracy or completeness of the information and no responsibility or liability is accepted for the accuracy or sufficiency of any of the information, for any errors, omissions or misstatements, negligent or otherwise. Any views and opinions, whilst given in good faith, are subject to change without notice. This is not an official confirmation of terms and is not to be taken as advice to take any action in relation to any investment mentioned herein. Any prices or quotations contained herein are indicative only. Kepler Partners LLP (including its partners, employees and representatives) or a connected person may have positions in or options on the securities detailed in this report, and may buy, sell or offer to purchase or sell such securities from time to time, but will at all times be subject to restrictions imposed by the firm s internal rules. A copy of the firm s conflict of interest policy is available on request. Past performance is not necessarily a guide to the future. The value of investments can fall as well as rise and you may get back less than you invested when you decide to sell your investments. It is strongly recommended that Independent financial advice should be taken before entering into any financial transaction. PLEASE SEE ALSO OUR TERMS AND CONDITIONS Kepler Partners LLP is a limited liability partnership registered in England and Wales at 9/1 Savile Row, London W1S 3PF with registered number OC Kepler Partners LLP is authorised and regulated by the Financial Conduct Authority.

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