Adapting to a new normal

These are changing times. We believe investors need to retain the flexibility to look as broadly as possible for areas of structural growth and resilient income.

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.

The global economy is likely to emerge from the COVID-19 crisis laden with debt and with some structural weaknesses that will be slow to resolve. As a result, slower growth overall appears inevitable as economies rebuild. Nevertheless, some areas will thrive in the ‘new normal’. In this environment, it will be more important than ever to find, where possible, areas of structural growth and income, rather than relying on a rising market to support investment returns.

To our mind, the pandemic has exposed the problems of a lack of selectivity. While ‘buying the market’ provides exposure to the largest and most liquid stocks, it has not necessarily provided investors with any protection in the current crisis, particularly in the UK. Many of the largest dividend payers in the UK market have cut their dividends and it is difficult to see them delivering compelling capital growth opportunities in the tough environment we see ahead1.

Instead, we believe it is important to look carefully at where the most exciting opportunities are emerging. We would argue that starting with the largest capitalisation stocks is the wrong way around. These are companies whose growth is behind them. Large companies, with legacy business lines, significant internal infrastructure and incumbent technology, take time to make changes; some will struggle to make the adjustment they need to a new environment.

How agile is your portfolio?

The companies that can take advantage of a new climate are likely to be those that are nimbler. They don’t have vast legacy systems to convert or business models to re-engineer. Across our trusts, we want to hold companies that are already on the right side of change or have the agility to pivot their businesses to new models.

It is also worth noting that since the late 1990s, there has been a significant fall in the number of publicly listed companies2. This is happening across the globe. In the UK, 2019 was the London Stock Exchange’s quietest year for IPOs since 2009. Just 36 companies listed their shares and the number of companies on AIM ended the year at a 15-year low2. It is clear that some of the UK’s most exciting technology companies are staying in private hands for longer.

Equally, that there are exciting opportunities to be found amid illiquid holdings. While in the short term, share prices can get blown about by liquidity considerations, but this can give rise to opportunities. If an investor needs to limit themselves to just the most liquid parts of the market, they may miss out on early growth opportunities.

“…we believe it is important to look carefully at where the most exciting opportunities are emerging.”

Right opportunities, right time

This is not to say that everyone needs to be rushing to snap up early-stage technology companies in private markets or illiquid assets elsewhere, but simply that investors should retain the flexibility to invest in good companies wherever they may be found and at the right time. The investment trust structure, by removing the need to manage inflows and outflows gives managers the flexibility to invest in the right opportunities at the right time.

The same is true for income. Income investors have had a shock as previously reliable dividend-paying companies have slashed their payouts. With bond yields low and dividend cover stretched in many of the largest companies, we believe investors will need to be more nuanced in the way they approach income generation in future.

This means not just drawing revenues from the same handful of dividend-paying stocks, but looking at other ways to generate income – through less liquid markets, through alternative assets such as debentures ((medium- to long-term debt instruments used by large companies to borrow money, at a fixed rate of interest), through call-writing strategies and through reserving income in good times to sustain the dividend in weaker moments. This agility is only available in an investment trust structure.

This is an environment that requires flexibility and an ability to look beyond the conventional. We believe the investment trust structure is a better way to capitalise on the changing environment in which we find ourselves.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are from BlackRock as of October 2020 and may change as subsequent conditions vary.

  1. Link Asset Services, July 2020
  2. Institutional asset manager, January 2020