- BlackRock Energy And Resources Income was a traditional energy fund but has repositioned to have a greater focus on clean energy
- Its revenue position has been weakened by dividend cuts last year
Given the rate at which the world is shifting away from fossil fuels, a fund with a 20 per cent allocation to oil, gas and nuclear does not appear an attractive prospect. But presented as a fund focused on investing through the energy transition while paying a yield of 5 per cent adds to its appeal.
There’s no hiding from the fact the long-term performance of BlackRock Energy And Resources Income Trust (BERI) has been weak. Historically, it invested 50 per cent in traditional energy companies (mainly oil and gas) and 50 per cent in mining companies – two sectors which, while essential to our economies, face structural headwinds.
The fund, which was set up in 2005, has had a lot of changes in recent years. In May 2019 the fund changed its name from BlackRock Commodities Income Investment Trust, which marked the start of a process to reposition it to benefit from the global energy transition.
By May 2020, the repositioning of the fund was complete. Mark Hume, co-manager of BlackRock Energy and Resources Income Trust, says while the fund has never had a formal benchmark, its internal reference benchmark is now 40 per cent mining, 30 per cent traditional energy and 20 per cent energy transition. He says this will gradually increase to include more companies linked to clean energy.
The fund’s largest renewable energy holding is Danish wind turbine manufacturer Vestas (DK:VWS), which has grown in share price by 200 per cent over the year to 28 January. While the company is now on a high valuation and “not without risk”, Mr Hume says “on a 10 to 20 year trajectory the growth is phenomenal”.
Vestas has a huge global portfolio with a 20 per cent market share, and Mr Hume says growth is not just from new capacity added every year but also, critically, on installed capacity. He says that once they have built the turbines, they retain the service contract typically over 20 years, with a 25 to 30 per cent earnings before interest and taxes margin. This is in contrast to low single-digit margins on the manufacturing side.
Mr Hume also invests in utilities companies to play the energy transition theme, with Italian power company Enel (IT:ENEL) in the top 10 holdings. He says well managed utilities companies are beginning to enjoy something of a renaissance.
“For the last 10 or 20 years electricity demand growth in Europe has been 0.5 per cent a year, making utilities companies unexciting and ex-growth," he explains. "But because of the current electrification requirement, all of a sudden they are the darlings of the European stock market again."
Assessing the support packages announced as part of the European Green Deal, he thinks “you are probably looking at 7 to 10 per cent of growth in invested capital over the next 10 to 20 years to deliver on that electrification path”.
However, the majority of the fund is still focused primarily on oil and mining companies. A key attraction of these sectors is the dividends available, despite oil and gas and mining companies making significant cuts last year. The trust pays a dividend of 4p a share, which has continued to be paid out of revenue but Mr Hume says “there is not much wiggle room in it”. However, he adds that the trust has “plenty of reserves” and the board has agreed that if the need arises the dividend will be paid out of capital. This means that the trust does not exclude attractive investment opportunities on the basis of a low yield. The trust was yielding 5.1 per cent on 1 February, according to Winterflood.
Half of the fund invests in mining companies, which should prove resilient in coming years as companies around the world announce ambitious industrial campaigns to transition to a green global economy, which will require significant volumes of mined materials. BHP (BHP), Vale (BRA:VALE3), and Rio Tinto (RIO), the world’s three largest iron ore and copper producers, have benefited from rising metals prices despite forced closure of some mines. While the rebound in global economic activity remains robust, Mr Hume expects mined commodity prices to remain at supported at current levels.
Contrary to the fund’s long-term asset allocation target, Mr Hume increased its oil and gas exposure in November by about 10 per cent as positive vaccine news made it “game on” for traditional commodities.
“As we saw a rush of capital last year into any thinking that looked sustainable or ESG – it’s the zeitgeist – we felt that there was a lot of stuff getting left behind that looks very attractive,” he says.
Mr Hume says the team has had long discussions about whether they should be moving out of the oil sector completely, but have concluded that there is still value in the sector, which has been very heavily sold over the past decade. While the fund is slowly trying to reduce the carbon footprint of the companies it invests in, Mr Hume says he is focusing on companies that are making proper pledges to get on the path to decarbonisation, rather than having an exclusionary approach.
“I tend to think about ESG in much the same way as I do about bringing up my kids,” Mr Hume explains. “I’m not going to not take one of them to a birthday party because they are naughty. I want to help educate them and get the right behaviours, and I can’t do that unless I engage with them.”
He has been impressed by the efforts made at BlackRock to hold companies accountable. He says this process has taken three or four years to work through as they have to give them a chance to make changes. “We’re not going to run away from companies, but we are also not going to let them toddle along and not make any changes. We are resolutely focused on engagement.”
A number of companies in the trust have relatively low environmental, social and governance (ESG) scores, as measured by rating agencies such as Fitch Ratings and Moody's. However, Mr Hume says that these scores are backward looking and he thinks a number of them will be upgraded fairly soon.
“The process these guys use is very rigorous, but often you have at least a two year window where they won’t upgrade a company even if they have made the changes that have been requested of them.”
However, Mr Hume concedes that the oil industry is not just hated because of its carbon footprint but also because it has “destroyed a tonne of capital over the past 10 years through bad capital allocation”.
While that does nothing to improve the investment case for oil companies, Mr Hume thinks the number of investors fleeing the sector for climate change reasons has created a buying opportunity. Although within the next 10 years traditional hydrocarbon demand will peak, it will not switch off immediately. He says oil companies’ assets typically only have a reserve life of nine years, so drilling more oil can still be compatible with a reasonable attempt to get to net zero carbon emissions by 2050.
“You’re looking at 15 per cent underlying decline with no investment," he explains. "We think demand might fall off 1 to 2 per cent, and accelerate to 3 to 4 per cent over the longer term – that’s a huge gap that has to be filled."
Mr Hume favours companies that have pledged to reduce their carbon footprint and do not have ambitious growth plans, but instead focus on returning the maximum amount of cash they can to investors. He adds that some oil companies, particularly in Europe, are successfully investing in renewables and the US Energy Information Administration forecasts that renewables' market share will grow from 10 per cent to 50 per cent by 2050, making “ a lot of space for big old lazy oil companies to be involved too”.
While their long-term aim is to shift to clean energy, Mr Hume says parts of the market are very expensive and their focus is on risk-adjusted return. For example, “we’ve seen evidence of some of the solar auctions in Iberia coming in at an implied 3 per cent rate of return, whereas we can see projects in traditional energy and mining that have a 25 per cent rate of return," says Mr Hume. "On reasonable assumptions, is that enough of a gap in terms of the returns you would expect to get on a risk-adjusted basis? Well – frankly – yes."
Mark Hume CV
Mr Hume is co-manager of BlackRock Energy and Resources Income Trust and a member of BlackRock’s natural resources team.
Before joining BlackRock in 2017, he spent seven years as an energy portfolio manager at Colonial First State Global Asset Management.