BlackRock Continental European Income: August 2023 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.
• This fund features on our 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 and other global portfolios focused on growth. The managers also aim to provide some resilience during turbulent market periods, which could provide some balance in a more adventurous portfolio.

Manager

Andreas Zoellinger has managed the fund since launch in May 2011. He boasts over two decades 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 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 style companies, 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 BlackRock GF European Value fund since December 2010 and has co-managed the Pan-European fund alongside Zoellinger since 2021. 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 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. To achieve this, the managers can invest in both ‘growth’ and ‘value’ stocks, but their overall approach is quality orientated. They believe balancing 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, is key to long term success.

They also want to achieve this while experiencing less volatility than peers in the European sector, providing some resilience during tough markets. They’ll seriously consider how cash generative a business is, and how resilient they think it’ll be in a market downturn. This typically leads them to avoid certain parts of the market, like autos and airlines.

Having a blend of quality, income, and growth opportunities across a market cycle is crucial in achieving these aims, so the managers split the fund into three buckets – high yield, steady dividend growth and structural growth.

• High yield companies typically make up half of the fund and 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 yield 2-4% and typically 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 semiconductor manufacturer ASML. Unique franchises make up around 20% of the fund.

The amount invested in each bucket is driven by the opportunities in the market, but typically, turnover in the fund is low, which means buying and selling is kept to a minimum. Though, there have been a few changes over the last 12 months.

The managers reduced their exposure to financials, primarily by reducing banks, given the issues the sector has experienced this year. They decided to sell Nordea and reduce their investment in KBC but have retained investments in UniCredit and BNP Paribas. Two industrial companies, Siemens and CRH, were added to the fund. Siemens is expected to see strong demand for its expertise in areas like electrification and CRH is set to benefit from the increased spend in global infrastructure and renovation.

Over time, the managers typically invest in 40-70 companies, so the fund can be quite concentrated. This means each investment could have a big impact on performance, which increases risk.

Culture

BlackRock is the largest asset manager in the world, with over $9 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 as well and features in the stock selection criteria.

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. They engage 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 it launched in May 2011. Over this period, it’s outperformed the broader European market and beaten the average return of the IA Europe excluding UK sector, by 49.12%, to 31 July 2023. The fund has also delivered this performance with fewer ups and downs than the market and its peers.

As the fund is more defensive, 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 and funds will rise and fall in value, so investors could get back less than they invest.

Over the last 12 months though, performance hasn’t been as impressive. It’s returned 9.70%, which is 4.60% behind the average return of peers in the Europe excluding UK sector.

The rotation in investment styles has been a driver of this underperformance. Over the course of 2022, growth and value investing came in and out of favour, value being the dominant style over the year. While the fund can invest in companies that fit both styles, the investments within the ‘structural growth’ section of the fund took a hit, detracting from performance.

Another factor of underperformance has been the managers investments in insurance companies. Coming into 2023, they reduced their weighting in banks and increased their exposure to insurance, amidst the worry around the banking collapse in the US spilling over into Europe. Most of the fund’s insurance picks haven’t performed well so far this year, with Tryg and Gjensidige Forsikring topping the table as the poorest performing insurance names.

While this level of underperformance is disappointing, in a strongly rising market, driven largely by stocks the fund would not invest in, the level of return is considered reasonable.

And it’s not all bad news. Inditex, a Spanish clothing company, was one of the funds top performers, following exceptionally strong trading reports. Two banking investments, UniCredit and BNP Paribas, also delivered good returns so far this year.

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 2023 the fund had a yield of 4.00%, though income is not guaranteed, and yields aren’t a reliable indicator of future income.

Past performance is not a guide to the future. Source: *Lipper IM to 31/07/2023.

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