BlackRock North American Income (BRNA) annual results to 31 October 2020 brought total NAV and market returns of -8.9% and -17.9%. By comparison, the benchmark Russell 1000 value index returned -7.5%.
Performance – stock selection in utilities weighs
BRNA’s underperformance of the benchmark was a reflection of stock selection, allocation decisions in utilities, and a negative contribution from option writing. BRNA’s managers, Tony Despirito, Franco Tapia, and David Zhao had this to say: “Stock selection in the electric utilities industry accounted for the majority of underperformance within the sector, although underweight exposure to the industry proved costly as well. In financials, an overweight exposure and stock selection among banks weighed on relative returns. Stock selection in the pharmaceuticals and health care equipment and supplies industries within health care proved detrimental, although our overweight exposure to the sector was beneficial. Lastly, stock selection and allocation decisions in consumer staples, industrials, materials and energy hampered relative performance.
The largest positive contributor to relative performance was allocation decisions in information technology. Within the sector, an overweight exposure to software and stock selection in technology hardware, storage and peripherals and IT services accounted for the majority of relative outperformance. A lack of exposure to real estate, most notably equity real estate investment trusts (REITs), also benefited relative performance during the year. Further, stock selection and allocation decisions in consumer discretionary boosted relative returns. Most notably, selection decisions in the household durables industry and a combination of overweight exposure and stock selection in multi-line retail positively impacted relative performance. Lastly, an elevated cash balance, which we have maintained as our preferred method of defensive exposure, contributed to relative performance during the year.”
Manager views on the economy and valuation
Macro Regime: “The COVID-19 pandemic, through mass social distancing and the transition to working from home, has supercharged secular growth trends towards e-commerce, digitisation and enterprise spending on cloud infrastructure. A narrow subset of U.S. stocks has reaped the lion’s share of financial gains from this sudden shift. Many of these high growth companies have also benefited from a world characterised by lower nominal growth, lower interest rates and low inflation. First, a scarcity of growth has increased demand, and valuation multiples, for stocks that can potentially deliver high growth to investors. A collapse in interest rates has also pushed valuations higher, to the benefit of longer duration growth companies. A case in point, in financial models the net present value of future cash flows increases when the cost of debt financing (i.e. the discount rate) decreases. Finally, low inflation gives policymakers flexibility to keep the current macro regime intact (i.e. lower interest rates for longer). These factors have culminated in vastly different year-to-date investment returns across sectors, industries and investment styles. The bifurcation between COVID-19 winners and losers has also resulted in wide valuation spreads, which suggests there are ample stock-picking opportunities for investors.”
Valuations: “A glance at traditional valuation metrics, such as the price/ earnings (P/E) ratio, suggests U.S. stocks are richly priced versus history. However, U.S. stocks appear to be cheaply valued versus bonds in a low interest rate world, as measured by the equity risk premium. Further, as businesses are increasingly asset-light today, a company’s value is less determined by its tangible assets and more determined by its cash flows. This can make traditional valuation metrics less relevant. So, are stocks expensively valued or cheap today? We argue stock valuations can be both high and attractive, with the caveat that high valuations offer less of a buffer versus downside risks. With interest rates at historic lows and poised to stay there for some time, equities are a relative bargain and can be a compelling option for growth, value and income seekers.”
BRNA: Utilities weigh on BlackRock North American Income’s annual returns