BlackRock Energy and Resources Income Trust plc (LON:BERI) Co-Manager Mark Hume caught up with DirectorsTalk for an exclusive interview to discuss the trust’s objective, opportunities & outlook for the three sub sectors, performing in an inflationary environment, moving towards a lower carbon economy, ESG factors, how BERI has evolved over time and why it’s an attractive option for investors.
Q1: What is the objective of the BlackRock Energy and Resources Income Trust?
A1: The objective is a fairly simple one i.e. an annual dividend target, which was recently increased from 4p per share to 4.4p per share, and then over the long term, capital growth.
It’s probably worth, for those in the audience looking at the video, understanding a quick potted history for the trust because it’s important to understand where it is today and what it is that perspective clients could be investing in.
So, cast, one’s mind back to late 2005 when the trust was launched, it was very much focused on a 50/50 blend of traditional mining and traditional energy stocks, and that was very simplistically capitalising on the resource intensive growth, particularly in China. If we fast forward to 2020, clearly that growth had changed, much more service driven rather than resource intensive and also, globally, a very clear need to decarbonise the world’s energy system.
In the second quarter of 2020, and with, I should add, very strong support from the Board of directors, we actually pivoted the trust from a 50/50 target benchmark to a 40% mining, 30% traditional energy and 30%, what we call, energy transition. So, really leading into that longer term growth in the replumbing of the world.
One of the key things about that of course, is that we wanted to maintain the ability to achieve an annual dividend target and capital growth at the same time so rather than leaning 100% into the energy transition, because a lot of those stocks have very high growth but very limited income, we felt much more strongly that there would be a multi decadal journey and therefore leaning in and maintaining fuel flexibility in the trust is really important.
The key thing that’s happened in the last while of course is the prospect of pretty seriously high inflation, partly through higher commodity prices and that flexibility has really helped the trust in the last two years or so.
Q2: Where are you seeing the most attractive opportunities today and what is the outlook like for the three sub sectors?
A2: I think particularly in light of the tragic events in Ukraine, there’s a lot happening so it may be worth just breaking it down into short term and longer term outlook and opportunity.
So, in the short term, clearly a lot of volatility in the system, we are, as per the most recent update that investors can see, overweight to these traditional mining and traditional energy sectors because we can see a real tightness in both markets. In fact, that tightness was already rearing its ugly head more than two years ago in fact, before the Russian invasion of Ukraine, exacerbating supplies of energy, in particular into Europe, but also exacerbating food supply and mine commodity supply as well into Europe and the rest of the world.
So, tactically right now, we’re still fairly constructive on the outlook for traditional energy and mining stocks, and as per the most recent public disclosure, we’ve got about 46% of the trust in mining, about 32% in traditional energy and the balance, a little over 20%, in energy transition.
I guess it’s worth just highlighting that on a longer term basis, clearly the recent moves by the European Union are very important from a policy perspective, they’re looking to accelerate harder into the energy transition, much of which will include significant investment into renewables. But the problem that we have with that in the short run is that there’s going to be a lot of inflationary pressures to still get through because a lot of the supply chains have been severely impacted, not just because of the COVID restart, but also because of the recent events in Ukraine as well, causing a lot of inflation pressures throughout the system and not least in the solar and wind supply chains.
So, although the longer term outlook looks perhaps better than it did say six months ago, there’s still a lot of inflation headwinds to get through before we get to the other side with better margin outlook for some of these energy transition companies. On a longer term basis too, I think it’s also worth pointing out that precisely because of the higher inflation that we’re seeing today through commodity prices, particularly the energy prices, energy efficiency is going to be a really important tool to drive down cost, particularly for industrial processes in Europe, and that’s an area that’s of particular interest to the trust in the coming months.
Q3: How is BERI likely to perform in an inflationary environment?
A3: Well, with the usual caveat that past performance is never a guide to future performance, there’s a lot of empirical evidence that we track that shows very clearly that resource sectors, mining and traditional energy, tend to do better in rising inflation rate environments. We still anticipate a rising inflation environment for the foreseeable future albeit there are some big pulses of inflation that we expect to ease off in the coming months but typically the resources sector will do very well in that rising inflation environment.
I think that’s important, again just to come back to what is the trust and why would an investor be interested, that’s precisely why we wanted to maintain the flexibility in the trust because the energy transition in our view was never going to be a simple on off switch or a journey that would be measured in weeks and months, a journey that’s measured in decades, and unfortunately, the events that we’ve seen in the Ukraine, for instance, have exacerbated some of those inflationary aspects.
Q4: How is the move towards a lower carbon economy impacting the natural resources sector?
A4: The short answer is in a multitude of ways.
I think the misconception, certainly by some a couple of years ago, was that the pivot towards a lower carbon economy would be a fairly smooth one but in fact, you need a lot of resources to build wind turbines, to build solar panels, including from traditional mine commodities, such as copper, but also paradoxically from coal as well, because you need a coal to produce photovoltaic cells that go into solar panels. So, there’s a lot of heavy lifting still to be done as we pivot towards a lot a carbon economy .
I think there’s also a mindset change as well that we’ve certainly been aware of, as regards to the traditional energy companies and the energy transition companies. It’ll be quite reasonable for instance to expect in 10 years’ time that many of the higher carbon intensity traditional energy companies will look a lot more like utility companies as they move from molecules to electrons in the coming 10 years. They are in fact aggressively investing into low and no carbon projects at a pace that would actually match many of the greener utility companies in Europe in particular.
So, there’s a lot happening and a lot of opportunity, frankly, in our humble opinion, not just in the energy transition piece but also the traditional energy piece where a lot of the companies, particularly in Europe, are leaning really hard into the energy transition.
Q5: Just looking more generally now, how has the trust evolved over time?
A5: At the outset, obviously giving that thumbnail sketch of where it came from and where it is today, just a reminder, it was a 50/50 target benchmark traditional mining and traditional energy, it’s now 40% mining, 30% traditional energy and 30% energy transition.
I think the key point again is that piece on flexibility but as we looks at a 10 years down the line, that energy transition and energy piece, which is notionally 60% of the trust at any given time, will begin to look a lot more similar than just traditional oil and gas and energy transition so we’d expect that evolution to continue. As I said at the outset, we don’t believe it’s a zero to one transition, it will be measured over a longer period of time and therefore we’d expect more of an evolution in that exposure, and equally, because, again as a reminder of what is the key objective of the trust, it’s to hit an annual dividend target and provide capital growth.
So, if one were to swing 100% into energy transition, you could put at risk that underlying dividend target that we feel is very attractive and important for clients. Just by way of illustration, if you look at the 10 year return on the trust, the price returns about 1% but the underlying total of returns is about 83% over that period, underlying the importance of the dividend as well, in fact the trust just hit the 10-year high of yesterday close.
So, quite a long journey, but quite pleasing to see, nevertheless.
Q6: In your opinion, why is BlackRock Energy and Resources Income Trust an attractive option for investors?
A6: At the risk of being too positive on the trust, Tom and I, started running the trust together back in early 2020 when we, along with the Board, elected to make that transition from, as I said, 50/50 to 40/30/30 today. When we look out over the next 10 years, we genuinely feel that our team, which I think the latest headcount is 22 in our team and over 100 years’ experience in mine commodities, traditional energy and critically in energy transition, we’ve got a really deep bench strength to avail of what we think, again, I can’t under promise on the severity of volatility, if you like, in this energy transition. It really is the important that we’re going to keep getting these pockets of opportunity appearing and we think we’ve got the skill set to really navigate clients through it whilst offering the traction of the dividend whilst offering some inflation protection, but also keeping an eye on that longer term prize on the energy transition.
Q7: Finally, I’m guessing ESG factors are incorporated in the process?
A7: That would be a very good guess, indeed. Again, for the purposes of clarity for clients, I think it’s really, really important for clients to understand that ESG is part of the process, but it doesn’t represent this beginning or the end of the process i.e. we don’t simply run some screen that says, look give me the best ESG scores or the worst ESG scores and let that influence the portfolio. It’s another risk tool that we’ve used for many, many years, partly because the resources sector’s always been front and centre from an environmental perspective but it’s a risk tool that we use to say, okay, this company may have a particularly poor score right now as per some of the third party analysis that will cause us to go in deeper and understand why. If we think that there’s a suitable risk reward in the stock price, that will be up for inclusion in the trust and critically, within that, we take very seriously this notion of constructive engagement so rather than simply dismissing a company because it’s had a poor score on any given ESG metric, we are really proactively encouraging companies to improve change and, and where we can, we would provide guidance on those areas and it wouldn’t take a rocket scientist to surmise that company improving from a very poor score to very good score could benefit from that, from a stock price perspective on a longer term basis.