Results analysis: BlackRock Sustainable American Income

• BlackRock Sustainable American Income (BRSA), previously known as BlackRock North American Income, has recently reported its annual results for the financial year ending 31 October 2021. Over this 12-month period BRSA has generated a NAV total return of 36.0% and a share price return of 42.4%, outperforming the 35.6% return of its benchmark, the Russell 1000 Value Index.
• The most substantial change to BRSA over its financial year has been the adoption of an explicit sustainability objective, approved on 29 July 2021; though it still maintains its dedication of investing in high-yielding value stocks. As part of the new strategy, BRSA will now be invested in a manner consistent with the principles of sustainable investing, with an explicit target of achieving certain sustainability metrics – and a new name.
• There have also been a number of operational changes to BRSA as a result of the change in objective. The BRSA team can now invest in mid-cap holdings (i.e. investing in the entire market cap range of the Russell 1000 value), and have also increased the concentration, aiming for a 30-60 stock portfolio. The board will also take a more active approach to gearing, with BRSA now having a natural level of 5% net gearing, with a 0% to 10% range. The board has also removed the use of option writing to enhance the trust’s income, and has cut the management fee by 0.05%.
• BRSA has announced a full year dividend of 8.0p per share, in line with last year’s payment. BRSA did however see a 38.9% decrease in its revenues over the 2020 financial year, reflecting the lingering effects of COVID-19 on dividend payments. We note that BRSA retains an enhanced dividend policy, and is able to fund its dividend though both revenue and capital.
• BRSA has largely traded on a discount since 2020, reflecting the headwinds for value investing following the outbreak of the COVID-19 pandemic. However it did briefly trade on a premium in April, reflecting a period of heightened demand for value stocks, with the board utilising the opportunity to issue 445,000 shares, having purchased 190,000 in November.
• Chairman Simon Miller commented: “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.”

Kepler View

The change in mandate of BlackRock Sustainable American Income (BRSA) should make it more appealing to those investors who value sustainability highly. Importantly though, the change in mandate will not fundamentally alter the investment style, as the portfolio will still have the same bias to high quality US value stocks with attractive and growing dividends. However, the addition of sustainability objectives will act as an additional source of alpha for the managers, and when presented with two equally attractive investment opportunities, the one with an ESG advantage will have the clear edge. Another potential source of extra alpha is the decision to make the portfolio more concentrated, which will allow it to be a better representation of the team’s ‘best ideas’.

The team’s new approach to sustainability and broader ESG investing is, in our view, comprehensive, targeting a range of different ESG-opportunities, including companies which have market-leading ESG practices as well as those which are fundamental in enabling a more sustainable America. The team is also taking a far more active approach to company engagement around ESG issues, which is one of the most onerous components of sustainable investing. We cover the granular details of BRSA’s new approach in our own research note. We do note that the change in mandate brought about a 60% turnover in BRSA’s portfolio, with the historic risk/return profile not fully reflecting the current mandate.

That said, over the 12 months to 31 October 2021, BRSA’s value bias allowed it to capitalise on many of the tailwinds which revitalised the style, as well as naturally benefitting from what has been a strong year for many US stocks. The greatest example of this is the financial sector, which is still BRSA’s largest sectoral position at 25.2%. Over the financial year, the Russell 1000 Financials Index returned 61.2%, beating both the Value Index and the wider Russell 1000, which returned 35.4%. The team point out that banks have benefitted from the improving credit cycles and loan growth, as well as the high-quality of many US financial institutions. Other major positions in the trust include a substantial overweight to Information technology, which is now 14.8% of the trust, and Consumer discretionary, which at an 11.3% weighting is the largest overweight within BRSA.

We believe BRSA is well positioned for the forthcoming economic environment, thanks to its focus on not just the value factor but also quality. US equity markets have become increasingly concerned with the impact of rising inflation and interest rates, which has historically been the catalyst for a rotation out of more highly valued companies and into cheaper companies or those which benefit from higher interest rates; aspects which perfectly describe many of BRSA’s holdings. Whether it is the team’s large allocation to banks, which directly profit from higher interest rates, or their allocation to cheaper healthcare stocks that benefit from sectoral trends while still trading on cheap valuations, BRSA offers investors a range of companies which are well primed to capitalise on the aforementioned tailwinds.

Yet BRSA’s quality factor could also be key given the ongoing supply chain issues, which are also a major source of global inflation. Restricted global supply chains could place pressure on low-quality business that cannot adapt to either rising input prices or an outright shortage of components, whereas high-quality business will be more likely to absorb these factors, be it through increasing their own prices or sourcing lower cost components elsewhere. The quality factor has already paid dividends for BRSA over the financial year, as many of their holdings have already been able to beat their earnings expectations, thanks to strong revenue growth. As can be seen by the below chart, BRSA’s recent performance (as of 08/02/2022) has shown the advantages of the quality-value style in the current environment, as it has easily outperformed the wider US equity market.

We believe that the addition of a sustainable element to BRSA may help to not only enhance returns but also differentiate the trust from many of its peers (be they open or closed-ended). This is because pursuing a sustainable approach to value investing is a particularly difficult task, given its inherently weaker ESG credentials than growth investing, as the value style has long been associated with either large polluters or inferior corporate governance. We think ESG investors may be attracted by the possibility that taking an ESG-conscious approach in a sector with a bad record could have a greater impact than elsewhere.

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