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What does ‘defensive investing’ mean today?

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As the economic cycle matures, investors may be looking for greater resilience in their portfolios. But co-manager of BlackRock North American Income Trust plc, Tony DeSpirito, discusses why traditional defensive investment strategies may not be the answer.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

There can be little doubt this economic cycle is reaching its later stages. We have had near uninterrupted expansion in the US stock market for more than a decade and the economy has seen a clean run of growth. While we see no imminent reason for a slowdown, it is best to be prepared.

But what does this look like today? This is not straightforward. Many of the old rules about how to invest more defensively do not apply. Moving into government bonds, for example, no longer looks like a particularly ‘safe’ strategy given the low yields on offer. The same is true for the stock market. Traditionally defensive areas look overpriced and may not provide the resilience a portfolio needs. In this environment, we believe it is vitally important to look at each company on its fundamentals, rather than succumb to broad-brush thinking on what should work in a maturing cycle.

The usual suspects

A natural choice for this stage in the market cycle, for example, might be areas such as real estate, consumer services and communications. But these areas have been caught up in the ‘bond proxy’ trade that has been so persistent for the past five years. Bond proxies are where companies with bond-like qualities have been adopted by investors moving out of fixed income into the stock market in search of higher yields. Prices are simply too high for these areas to act as a defensive option in a more difficult climate.

On the other hand, we are not tempted to compromise on quality in this environment, no matter how cheap share prices have become in certain segments of the market. Loose monetary policy and benign economic conditions have kept many companies afloat that might not otherwise have survived. They may finally see a downturn should the environment change. ‘Cheap’ may prove illusory, with cheap companies becoming even cheaper.

High quality

We want to be invested in those higher quality companies whose earnings we can reasonably forecast into the future. These companies are likely to be in a better position to weather any incoming storms. Today, we are finding more of those businesses in the energy and financial sectors, despite these being seen as more ‘cyclical’ areas. We can also find firms that meet our criteria in the technology sector – though, admittedly, in niche subsectors rather than some of the expensive global technology giants. While we are both value, quality and income investors and technology does not usually fit the bill, investors need to look beyond those labels in today’s environment.

For any income strategy, it is important to be invested in companies that are generating income organically in this environment. Too often, companies are paying out more than they can realistically afford based on their earnings. This tactic leaves them particularly vulnerable in a weaker economic and market environment.

ISAs have a role in almost all portfolios but are particularly useful for income seekers. Unlike a pension, ISAs do not offer tax relief on contributions made, but all income can be taken tax-free. This is a significant advantage at a time when interest rates are low and income scarce.

Growing dividends

For us, it is vitally important not only that a company can pay its dividends today, but that it can grow its dividends tomorrow. We base our judgment on cashflow – what is left for the shareholder when all a company’s other commitments have been paid. Good cashflow means the management team has been disciplined and the company is likely to have competitive resilience.

In terms of how this looks in the portfolio, it means that the companies we hold are diverse – from large US banks to Microsoft – and they do not fit the natural assumptions about ‘quality’, ‘defensive’ or ‘value’ stocks. It is what we see that is important, not the characteristics the market assigns to these stocks. This is a recognition that the world is changing – information technology can be the new consumer staple, for example. We believe this realistic appraisal of a company’s true merits will be vitally important as we move into a more challenging environment.

For more information on this Trust and how to access the potential opportunities presented by North American markets, please visit www.blackrock.com/uk/brna.

Reference to the names of each company mentioned in this communication is merely for explaining the investment strategy and should not be construed as investment advice or investment recommendation of those companies.

Unless otherwise stated all data is sourced from BlackRock as at March 2020.

Risk warnings

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Trust-specific risks

Exchange rate risk: The return of your investment may increase or decrease as a result of currency fluctuations.

Risk to capital through derivative use: The Fund may use derivatives to aim to generate more income. This may reduce the potential for capital growth.

Capital growth/Income variation risk: Investors in this Fund should understand that capital growth is not a priority and values may fluctuate and the level of income may vary from time to time and is not guaranteed.

Derivative risk: The Fund uses derivatives as part of its investment strategy. Compared to a fund which only invests in traditional instruments such as stocks and bonds, derivatives are potentially subject to a higher level of risk.

Gearing risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.

Important Information

Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.

The Company is managed by BlackRock Fund Managers Limited (BFM) as the AIFM. BFM has delegated certain investment management and other ancillary services to BlackRock Investment Management (UK) Limited. The Company’s shares are traded on the London Stock Exchange and dealing may only be through a member of the Exchange. The Company will not invest more than 15% of its gross assets in other listed investment trusts. SEDOL™ is a trademark of the London Stock Exchange plc and is used under licence.

Net Asset Value (NAV) performance is not the same as share price performance, and shareholders may realise returns that are lower or higher than NAV performance.

The BlackRock North American Income Trust plc currently conducts its affairs so that its securities can be recommended by IFAs to ordinary retail investors in accordance with the Financial Conduct Authority’s rules in relation to non-mainstream investment products and intends to continue to do so for the foreseeable future. The securities are excluded from the Financial Conduct Authority’s restrictions which apply to non-mainstream investment products because they are shares in an investment trust.

BlackRock has not considered the suitability of this investment against your individual needs and risk tolerance. To ensure you understand whether this product is suitable, please read the Key Investor Document (KID) and the current Annual and Half Yearly Financial Reports which are available on blackrock.com/uk/brna and which provide more information about the risk profile of the investment. If after reading this you have any questions or would like any additional information, please contact your financial adviser or speak to our Investor Services Team.

Any research in this material has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy.

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For more information on this Trust and how to access the potential opportunities presented by North American markets, please visit: www.blackrock.com/uk/brna

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