BlackRock Continental European Income: August 2022 fund update

• Andreas Zoellinger has built a strong track record investing in Europe and is supported by experienced co-manager Brian Hall.
• The fund adopts a more defensive, blended investment approach which could help limit volatility compared to peers in times of uncertainty.
• Since launch in 2011, the fund’s paid an attractive income to investors. Though yields and income aren’t guaranteed and change over time.
• The fund was recently added to the Wealth Shortlist of funds chosen by our analysts for their long-term performance potential.

How it fits in a portfolio

The BlackRock Continental European Income fund aims to provide investors with an attractive income alongside growth in their investment. The managers mainly invest in larger, more established European businesses, but have the flexibility to invest in higher-risk small and medium-sized businesses as well.

We think the fund could work well in an investment portfolio focused on income, or provide diversification to European or other global funds focused on growth. The managers also aim to provide some resilience during turbulent times for markets, which could provide some balance alongside other European equity funds in a more adventurous income-focused portfolio.

Manager

Andreas Zoellinger has managed the fund since launch in May 2011. He boasts over 22 years’ experience in the investment industry and is the longest standing member on the BlackRock European team. Zoellinger worked for Merrill Lynch Investment Managers from 2001, which then merged with BlackRock in 2006.

Brian Hall became co-manager in March 2021. He’s been with BlackRock since 2007 and has worked with Zoellinger on the European team ever since. He brings a strong background and track record of investing in European value, which complements Zoellinger’s skillset.

Both managers run other funds and investment strategies. Zoellinger co-manages the Pan European Equity Income fund, as well as the Eurozone and Euro Markets funds. Hall has run the BGF European Value fund since December 2010 and co-manages the Pan-European fund alongside Zoellinger. We think this is a reasonable workload given each strategy is managed with a similar investment process, and there’s a high level of overlap.

They can also draw on the support of the wider European team at BlackRock, where idea sharing, challenge and debate are encouraged. Both managers can lean on the expertise of other long-standing team members, including Stefan Gries, who runs the European fund and Nigel Bolton, the current Head of European Equities. From the end of September 2022, Gries will take over as Head of European Equities, and Bolton will become co-Chief Investment Officer of Equities. They can also draw on the expertise of Alister Hibbert, who is currently running global funds but has previously managed European funds.

It’s currently one of the largest teams covering European investments, and we hold the team in high regard. There have been a few changes to the team over the years, which we will continue to monitor.

Process

The main aim of the fund is to deliver a growing income, with the potential for long-term growth. The managers want to achieve this while experiencing less volatility than peers in the European sector, providing some resilience in tough markets. A blended balance of quality, income, and growth opportunities across a market cycle is crucial.

The managers have the flexibility to invest in both ‘growth’ and ‘value’ stocks, but their approach is quality orientated. They balance quality dividend-paying companies which have the potential for dividend growth over time, with companies that pay a higher income now, but perhaps have less potential for growth. Some of these companies may be in more economically sensitive sectors.

The investment process is based on individual company analysis. The managers like companies with a competitive advantage or brand that others struggle to replicate, strong balance sheets, and high-quality management teams.

Achieving lower volatility than other European funds is important too, so the team considers how cash generative a business is, and how resilient they think it’ll be in a market downturn. Because of this, they typically avoid parts of the market like autos and airlines.

To help achieve a blend of quality, income, and growth opportunities, the fund is split into three buckets – high yield, steady dividend growth and structural growth.

• High yield companies currently make up roughly half of the fund and typically offer an average yield above 4%. These must be run by high quality management teams and tend to be very cash generative.
• Steady dividend growth companies are considered the more resilient investments. They form the backbone of the fund due to their more resilient income streams. They typically yield 2-4% and currently make up around 30% of the fund.
• Structural growth companies have lower yields but offer greater potential for capital and dividend growth. The stocks in this bucket tend to be ‘unique franchises’, which the team view as world leading companies, like luxury goods provider LVMH or semiconductor manufacturer ASML. It makes up around 20% of the fund.

The amount invested in each bucket is driven by the opportunities in the market. The managers invest in 40-70 companies, and there’s currently 41 held in the fund. The amount invested in each company depends on their conviction, its prospects for dividend growth, its ability to be bought or sold quickly (also known as liquidity) and its growth potential. Individual investments tend to make up no more than 4% and no less than 1%. The fund can be quite concentrated, which means each investment could have a big impact on performance, which increases risk.

More recently, the team has invested more in banks. Historically, they’ve been cautious in this area due to low interest rates and ever-increasing competition. They feel the highest quality banks, like Nordea, BNP Paribas and KBC Groupe, are now in good positions, at more attractive share prices, and that the financials sector offers some diversification.

The managers sell an investment when there is risk to the dividend, a significant change in conviction or if the investment gets close to a level of risk the team are not comfortable with. Valuation plays a part too, meaning if a stock price rises close to or above the team’s target level, they’ll reduce or sell the investment and use the cash to invest in other opportunities.

The team recently sold some investments in the structural growth section of the fund. They reduced ‘growth’ focused investments and added to some more resilient names to help deal with the increased economic uncertainty. Some consumer staples companies were also sold due to worries around inflationary pressures.

Culture

BlackRock is the largest asset manager in the world, with around $9.5 trillion of assets under management globally. The company was founded in 1988 by eight partners including current CEO Larry Fink and is known for both active and passive strategies across the world. Employees at BlackRock are encouraged to hold shares in the company so that they are engaged with helping the company perform well and grow.

The culture within the European investment team is also strong. At all levels, debate and challenge is encouraged, and the team works closely together daily. Managers and analysts both make good use of the overlap between other teams, which helps with idea generation.

BlackRock’s incentive structure rewards fund managers for good long-term performance. They’re also encouraged to invest in the funds they run. We think this aligns fund managers’ interests with those of investors.

ESG Integration

The team has always considered environmental, social and governance (ESG) factors in their research, particularly the strength of governance. This part of the process has evolved over time though. The developments have added to the depth of their analysis, their coverage of ESG considerations and their levels of engagement.

ESG is fully integrated into their risk analysis and features in the stock selection criteria. For example, the managers sold some investments in the energy sector in 2021, because they felt certain companies would find it difficult to decarbonise. On the other hand, the managers recently purchased an energy stock called TotalEnergies. Through their ESG analysis, they believe the company has upped its ESG credentials significantly, primarily through improving emission scores, setting carbon and emission targets and the impact it's having on certain types of renewable energy.

As the fund doesn’t specifically target an ESG score or outcome, managers are in charge of making investment decisions for their funds. They need to take ESG criteria into consideration but there are no limitations on what the fund can invest in.

In recent years, BlackRock has increased its focus on stewardship and expanded its range of ESG focused funds. BlackRock’s Investment Stewardship Team aims to vote at 100% of meetings where it has the authority to do so, meaning they vote at around 17,000 meetings on 165,000 proposals each year. The Investment Stewardship team engages with companies, in conjunction with fund managers, and the results of proxy votes can be found on the BlackRock website.

The firm has courted controversy in recent years for failing to put its significant weight behind shareholder resolutions aimed at tackling climate change. It responded by committing to be more transparent on its voting activity and providing rationales for key votes. The firm also outlines its work on voting and engagement in annual and quarterly Stewardship reports.

Cost

This fund is available at an annual ongoing fund charge of 0.91%. We think this is a reasonable price to access a team we hold in high regard. The HL platform fee of up to 0.45% per year also applies.

Please note the fund's charges can be taken from capital rather than income. This increases the yield but reduces the potential for capital growth.

Performance

Zoellinger has managed the fund since launch in May 2011. Over this period, the fund has returned 166.38%* versus the FTSE Developed Europe ex UK index’s gain of 116.58%*. Our analysis suggests this has been driven by the managers’ ability to select outstanding companies, regardless of their size or what sector they’re in.

The fund has also delivered this performance with far less ups and downs than the market and its peers in the IA Europe Excluding UK sector. The fund is more defensive, so we don’t expect it to fall as much as others in periods of uncertainty, but expect it to lag when markets rise. Remember past performance isn’t a guide to the future. Funds will rise and fall in value, so investors could get back less than they invest.

A key focus for the managers is to deliver a reliable and growing income. Over the long run, the fund has delivered an attractive yield for investors, above the one produced by the market. As of the end of July 2022 the fund yields 4.28%, though income is not guaranteed, and yields aren’t a reliable indicator of future income.

Performance has been mixed over the last 12 months. While the fund has held up better than peers and the benchmark, the end of 2021 and early 2022 were difficult periods. The managers were more exposed to structural growth companies, which were hit hard by the sharp rotation away from growth investing.

Some of the ‘unique franchises’ within this bucket are considered ‘growth’ investments, including the more innovative tech-based companies, and have fallen out of favour with investors. As a result, they detracted on performance and the fund didn’t provide as much shelter as expected. The team decided to readjust part of the portfolio, to make it more defensive, by investing more in the steady dividend growth bucket. The aim was to boost the fund’s resilience and since March this year the fund has performed better than the market.

All funds go through periods of good and bad performance, but the managers’ disciplined investment process and long-term track record gives us confidence in the fund’s long-term prospects.

Past performance is not a guide to the future. Source: *Lipper IM to 31/07/2022.

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