1 BlackRock Commodities Income is a client of Kepler Trust Intelligence. Research produced by Kepler Trust Intelligence covering BlackRock Commodities Income should be considered a marketing communication, and is not independent research. Please see the important information by following this link or at the bottom of the page. BlackRock Commodities Income Summary BlackRock Commodities Income (BRCI) has a conviction-led portfolio, with the managers aiming to generate a high income from the global mining and energy sectors. The managers have flexibility to use fixed income and option writing to boost income when the opportunity arises. Managed by Olivia Markham and Tom Holl, BRCI has typically run with a quality bias thanks largely to the income mandate. This has meant that the trust has outperformed many of its peers over the medium term, as it protected capital more effectively during the severe down cycle for natural resources between 211 and 21. Latterly, this defensive positioning has meant that BRCI has struggled over the course of 217, generating a NAV total return of 1.9, relative to the HSBC Global Mining index return of 2.9 and the.6 from the reference benchmark of a / combination of the MSCI World Energy & MSCI World Metals & Mining Indices. Income has been (and continues to be) a key selling point for the trust. However, the past two years has seen the board reduce the dividend from 6p paid in 21 to the current level of 4p. The managers have previously stated that they expect a lower contribution from option writing going forward, and the recent results posted at the end of January show a modest improvement since last year, with the revenue return increasing to 4.84p from 4.43p per share. This translates into an increased revenue reserve, which at 2.96p now, translates into.74x the current 4p level of dividends. The board have stated that, if possible, they will look to protect any future shortfall in earnings with reserves. With the dividend yielding 4.9, the trust yields considerably more than many other areas of the equity market the global equity-income investment trust sector yields 3.8 for example. Portfolio BlackRock Commodities Income is a relatively concentrated portfolio and represents the best ideas of the team s energy and mining mandates, with the top 1 holdings accounting for roughly of NAV. As such, it is more prone to swings in sentiment in the mining and energy sectors than a more generalist global equity income fund. The portfolio is constructed from both a top-down and bottomup point of view. From a top-down perspective, Olivia and Tom regularly review their medium-term outlook on the market based on company meetings and fundamental analysis. In general, the managers want to own stocks that can grow profits in a flat market for commodities, but also benefit from upside to commodity prices. This higher quality preference is a reflection of the trust s income mandate, with the managers focusing on solid companies that are good allocators of capital and tend to have an attractive dividend policy. The managers argue that taking an income approach to such a cyclical area of the market makes sense, especially as dividends have been a major driver of total returns for the sector over the longer term. It is important to note that the managers are valuation aware rather than valuation driven and are happy to hold higher quality stocks for the long term rather than trying to benefit from timing in cheap, poorer quality, leveraged stocks. Though the portfolio is predominately made up of equities, the team also hold corporate bonds and write options to bolster and diversify their income stream. Option writing has been a profitable strategy given the highly volatile nature of the sector, and in the past premium income has formed a significant part of the trust s underlying income generation. Looking forward, the team expect option Portfolio breakdown by broad sector In summary, the trust aims to deliver a superior level of income whilst also generating attractive risk-adjusted total returns from a notoriously volatile area of the market. BlackRock Commodities Income is certainly more narrowly focussed than Global Equity Income peers (in being purely subject to sentiment in the mining and energy sectors), but the 3.3 discount and yield of 4.9 compares favourably to the global equity income sector average discount of.3 and yield of 3.8. Mining Energy
2 premiums to contribute less to portfolio income as underlying dividend growth within the portfolio increases. The managers typically split the portfolio between energy and mining stocks. Currently 46 of the portfolio is exposed to energy, while 4 is in mining (with c 1 of the mining exposure through fixed income). The team are allowed to hold up to 1 of NAV in stocks in the agriculture sector, though historically this has represented a small part of the portfolio. The team are currently positive on both energy and mining, although the reasoning behind each do differ. For a while now, they have had a constructive view on the oil price, reasoning that the lack of investment in supply will start to have a positive impact on the oil price. As a result, the team have held various exploration and production (E&P) names with a historically high beta to the oil price currently c 16 of NAV. Distribution Oil services Oil sands Energy exposure Exploration and Production and so not only can these stocks re-rate, but also offer attractive dividend growth. This has certainly started to feed through as the MSCI World Mining & Metals index has returned 1 since June (albeit with the usual odd bout of volatility). The trust is global in nature, and so whilst 8 of NAV is invested in companies listed in North America (and 28 in the UK) the large majority of holdings generate earnings from all around the world. Performance The team s focus on income and higher quality stocks has meant BlackRock Commodities Income has tended to generate its relative outperformance in flat or falling markets. Apart from a significant rebound last year that has continued into 217, commodity-related stocks have endured a torrid time since 211 as Chinese growth has slowed and commodity prices have fallen. Over seven years to the end of December 217, the trust has lost 19 in NAV terms. However, this compares to a loss of 3 from the Commodities & Natural Resources sector over that period. The trust has no defined benchmark, but it has underperformed a composite benchmark of the MSCI World Energy index and MSCI World Metals & Mining index (/ split) over that time however, this is largely due to the fact the trust has recovered less strongly in the recent rebound. Integrated The managers bullishness on mining, on the other hand, isn t down to commodity prices. We understand that they don t believe the prices of mined commodities will rise materially from here, given their central thesis is that growth in China will continue to slow. Instead, they believe 218 will see high levels of free cash flow in the mining industry translate into capital returns to shareholders rather than into increased capacity. In Olivia and Tom s view, the market has not yet caught on to the fact that these management teams are generally much more disciplined, Industrial Metals Gold Silver Copper Steel Mining Exposure Diamonds Diversified 2-2 - -7 BlackRock Commodities Income: Performance vs indices past five years 214 21 216 217 218 BRCI (Cum Fair NAV) Morningstar IT : Commods & Nat Res Euromoney Global Mining MSCI World Energy & MSCI World Metals & Mining / split TR in GB /FE Analytics The graph below shows trust s more conservative approach in performance terms, having beaten its peers in five of the past eight calendar years. In absolute terms, the risks inherent in relatively narrowly focussed funds (in terms of sector) are illustrated by the maximum drawdown over seven years to the end of December of -67. In the same way that the trust has outperformed peers on the way down, the trust s defensiveness relative to peers has meant that the trust underperformed the composite benchmark by a wide margin last year (NAV total returns of 68), following the very strong rebound by the index as commodity prices stabilised.
3 1 1 - BlackRock Commodities Income: Performance vs indices Dividend Generating an income is a key part of the strategy. The trust, up until recently, had a good track record of dividend growth, but given the widespread dividend cuts that affected the mining (and to a lesser extent) energy sectors, the board reduced its dividend target to p in 216 (down from 6p the year before) and have brought it down once again to 4p for 217, with 1p per share paid quarterly. This has obviously been frustrating for shareholders. The managers have previously stated that they expect a lower contribution from option writing going forward (which during 216 accounted for more than of the trusts income), and in the recent results posted at the end of January 18, the trust show a modest improvement to overall income earned since last year, with the revenue return increasing to 4.84p from 4.43p per share. The team retain the flexibility to step option writing activity up should dividend income disappoint or the environment for options become materially better again. 8 6 21-217 21 211 212 213 214 21 216 217 BlackRock Commodities Income Ord (Cumulative Fair NAV) BlackRock Commodities Income Ord (Price) Morningstar IT SS: Commod & NR NAV MSCI World Energy & MSCI World Metals & Mining / split TR in GB BlackRock Commodities Income: Dividend 26-216 yields considerably more than many other areas of the equity market, and compares with global equity income sector average yield of 3.8. 12. 1 7. Gearing The trust operates a flexible gearing policy which depends on prevailing market conditions. It is noteworthy that in the last year, the level of gearing increased at one point to c.9 - reflecting the greater level of fixed income exposure within the trust, as well as the managers more positive outlook for both the mining and energy sectors. The gearing includes the trust s derivatives based fixed income exposure, as well as a traditional overdraft facility. It has subsequently reduced to the current level of 3. Management BlackRock Commodities Income: Yield 1/12/27-31/12/217 2. 28 21 212 214 216 218 BlackRock Commodities Income Ord IA UK Equity Income sector Olivia Markham and Tom Holl have managed the trust since January 214 and both members of the Natural Resources team within the Fundamental Equity division of BlackRock s Alpha Strategies Group. The duo manage a variety of natural resources strategies for the group, with Oliva co-managing BlackRock World Mining and Tom running various open-ended funds such as BlackRock Gold & General and BlackRock Natural Resources Growth & Income. pence 4 2 26 28 21 212 214 216 Dividend per share Revenue return per share The increase in revenue return has translated into an increased revenue reserve, which now stands at 2.96p, and translates into.74x the current 4p level of dividends. The board have stated that they will, where possible, try to protect any future shortfall in earnings with reserves. With a dividend yield of 4.9, the trust Given the size of BlackRock as a group, Olivia and Tom have a huge amount of support and access to a wide range of resources. Not only do they work closely with the rest of the natural resources team and are supported by BlackRock s sizeable risk management team, the managers note that one of the major benefits has been working alongside the variety of other equity and credit teams with Tom and Olivia regularly attending company meetings with members of different desks from around the firm. Discount Despite commodity-related stocks being out of favour for many of the past few years, BlackRock Commodities Income had traded
4 on a premium over much of that period thanks to its dividend profile and the manager s more conservative approach to the market. The board issued shares consistently in 21 and 216, but its recent NAV underperformance and a lowered dividend target have weighed on sentiment, with the discount widening out to as far as 8 at points this year. The shares have recently recovered their ground and now trade at a discount of 3.4. 1 - -1 BlackRock Commodities Income: Discount 2/1/213-29/12/217-1 213 214 21 216 217 218 It is worth noting that the board has the discretion to make semiannual tender offers at the prevailing NAV, less 2, for up to 2 of the issued share capital in August and February of each year. However, the board decided not to proceed with a tender offer in August 217 or February 218 given the average discount over the 217 financial year of 4.2, relative to the tender level of NAV less 2. Charges The trust s management fee is equal to.9 of gross assets p.a. and will reduce to.9 p.a. for gross assets in excess of 2m. The trust s net assets are currently c 1m. The fee is levied quarterly, based on the gross assets on the last day of each quarter, and is charged 2 to the revenue account and 7 to the capital account. Overall, BlackRock Commodities Income has an ongoing charge of 1.36. There is no performance fee.
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