Written by Nick Ackerman, co-produced by Stanford Chemist
BlackRock (BLK) has been busy launching new closed-end funds over the last several years. 2021 wasn't any different with a couple of newer funds from this sponsor. One of those launched was the BlackRock ESG Capital Allocation Trust (NYSE:ECAT).
ECAT is slightly different from its other funds since it is a multi-asset approach. This puts it more similar to the BlackRock Capital Allocation Trust (BCAT) that they launched in September 2020. The tickers of the funds seem to represent this link too. Interestingly, ECAT launched exactly a year later in 2021. The lead portfolio manager is the same as well, Rick Rieder.
One of the main differences here is that ECAT is an ESG (environmental, social, governance) focused fund. I think that is an area in the CEF space that is lacking. There are a large number of ESG focused exchange-traded funds, and that seemingly hasn't translated over into the CEF space.
That being said, a large number of holdings in the fund are names you'll see in just about any other diversified fund. Just about anything seems to be able to be classified as "ESG" these days as companies make a more significant corporate culture shift overall.
Since the launch, the fund has declined. For a brief period, though, the fund's NAV was higher while the fund's share price just continued to sink. Given the broader market trend of also declining in this same period, it really isn't too surprising. A bit more surprising is the pace at which the share price has fallen. It has now opened up an incredible opportunity to invest in this fund at a nearly 17% discount.
ECAT has a fairly basic investment objective; "to provide total return and income through a combination of current income, current gains and long-term capital appreciation." This is essentially copy-paste from most of their other funds.
To achieve this, the fund will "invest in a portfolio of equity and debt securities. Generally, The Trust's portfolio will include both equity and debt securities. At any given time, however, the Trust may emphasize either debt securities or equity securities. The Trust will invest at least 80% of its total assets in securities that, in the Advisor's assessment, meet the environmental, social and governance criteria as described in the Trust's Prospectus and shareholder reports."
Here is how they screen out holdings from their Prospectus, which underlines how broadly they can invest.
Such screening criteria principally includes: (i) issuers engaged in the production of controversial weapons; (ii) issuers engaged in the production of civilian firearms; (iii) issuers that produce tobacco-related products; (iv) issuers that derive more than twenty percent of revenue from thermal coal generation, unless the Trust is investing in green bonds of such issuers or the issuers have set certain targets to reduce climate impact, or more than five percent of revenue from thermal coal mining, unless the Trust is investing in green bonds of such issuers; (v) issuers that derive more than five percent of revenue from oil sands extraction, unless the Trust is investing in green bonds of such issuers or the issuers have set certain targets to reduce climate impact; (vi) issuers ranked in the bottom half of the applicable fossil fuel issuers peer group by internal or external ESG criteria; (vii) issuers identified by recognized third-party rating agencies as violators of the United Nations Global Compact, which are globally accepted principles covering corporate behavior in the areas of human rights, labor, environment, and anti-corruption; and (viii) issuers receiving an ESG rating of CCC or equivalent by recognized third-party rating agencies. The Trust’s screening criteria is measured at the time of investment and is dependent upon information and data that may be incomplete, inaccurate or unavailable. This screening criteria is subject to change over time at the Advisor’s discretion.
Then they mention what they are considering when they do invest. Bearing in mind, they aren't limited to this, and it's only a loose guide:
In evaluating potential investments, the Advisor considers certain criteria, including but not limited to: (i) whether, based on the Advisor’s proprietary methodologies using internal data sources and third-party data, the issuer provides positive environmental and social benefits to third parties relative to other companies in its sector; (ii) whether a bond is a green, social or sustainability bond (e.g., the proceeds of the bond issuance are used for environmental projects that benefit the entire planet by either directly or indirectly reducing carbon-emissions) as determined through the Advisor’s propriety methodology and in line with global norms; (iii) whether it has been determined, based on metrics provided by third parties, that the issuer has established a decarbonization strategy; and (iv) whether the issuer is aligned with the Advisor’s social and environmental criteria and/or generates revenue associated with the UN Sustainable Development goals. Some examples of third-party data and metrics utilized by the Trust include green revenue metrics, forward looking emissions reduction commitments, revenue from socially controversial business lines, exposure to biodiversity controversies, product mix and targeted populations.
On top of this, they also utilize an option writing strategy that is standard for their equity-focused funds. BCAT also has an options writing strategy, so that is the same as well. One difference here is that ECAT does not intend to utilize leverage. That's different from BCAT, which does employ a moderate amount of borrowings. However, similar to most other CEFs, that doesn't mean that they can't in the future.
The Trust currently does not intend to borrow money or issue debt securities or preferred shares. The Trust is, however, permitted to borrow money or issue debt securities in an amount up to 33 1/3% of its Managed Assets (50% of its net assets), and issue preferred shares in an amount up to 50% of its Managed Assets (100% of its net assets). “Managed Assets” means the total assets of the Trust (including any assets attributable to money borrowed for investment purposes) minus the sum of the Trust’s accrued liabilities (other than money borrowed for investment purposes). Although it has no present intention to do so, the Trust reserves the right to borrow money from banks or other financial institutions, or issue debt securities or preferred shares, in the future if it believes that market conditions would be conducive to the successful implementation of a leveraging strategy through borrowing money or issuing debt securities or preferred shares.
The fund is a significant size in the CEF space, which is typical for BlackRock. They have a vast network that they can raise capital through. In this case, with no leverage intended to be used, the size will only change through potential appreciation of the underlying portfolio.
The fund's expense ratio came to 1.30%, as of the last Annual Report. However, due to when the fund launched, we are only looking at a period of 9/27/21 to 12/31/21.
As is standard for launching a new CEF these days, the fund is a limited-term structure. That means they anticipate liquidating in the future at whatever the net asset value is at that time.
In this case, it is anticipated to be around September 27th, 2033. That puts it on the twelfth anniversary, which is also fairly standard.
They include that the Board may extend the dissolution date "once for up to one year, and once for up to an additional six months." That allows the fund flexibility to wait for a potential rebound if we are in a period of slumped investment prices, such as when a recession occurs.
The fund also has the standard way to go to a perpetual fund. That is through a tender offer that is at 100% of NAV for 100% of outstanding shares. If the fund has over $200 million in net assets remaining after such a tender offer, the Board may eliminate the dissolution date without shareholder approval.
Importantly, this is not a "target term" fund. Those aren't really launched anymore, but they are still out there. Target term funds are designed to provide inception NAV per share back to investors potentially. Though even then, it isn't a guarantee.
In my opinion, when sponsors launch a fund, they want it to grow and be successful so having the distinction seems a bit unnecessary. Though we would see with target term funds, they would slash their distributions dramatically to attempt to meet their target if they were short. On the other hand, they would start going to safer assets well before the liquidation date if they were coming in around their target.
Anyway, the tender offer means that investors that want to get out at the NAV per share at that future date can do so. Essentially, being able to participate in the biggest selling point of limited-term funds in the first place - being able to get out at NAV and not having a discount go on into perpetuity. If the fund does switch to perpetual, there isn't anything saying that it can't then go to trade at a discount for the entirety of existence.
ECAT launched with a monthly $0.10 distribution. That is pretty standard for funds that launch with a $20 price tag. This is because it puts it at a 6% distribution - an attractive level but a sustainable level with flexibility.
Given the massive declines since launch, the fund's distribution yield has now climbed to 7.86%. It has climbed only a bit to 6.54% on an NAV basis. This puts it at a fairly reasonable and sustainable level too, in my opinion.
At the end of January, ECAT had a significant allocation to cash still in their portfolio. I suspect that is why the fund's NAV has been holding up relatively well when compared to the broader market.
Looking at the fund's equity sector allocation, we have the largest weighting to tech. That isn't that uncommon for most CEFs. However, in this case, it seems to be a fairly overweight position considering the second-largest allocation to healthcare. It will be interesting to see how this might shift going forward as they continue to put this capital to work diligently.
I don't see having so much cash as a negative at this time. I generally wouldn't want to carry this much cash, but it seems appropriate since they are getting started. This is on top of the current economic conditions with uncertainties all around due to interest rates and Russia's invasion.
The credit quality of the underlying fixed-income sleeve is fairly well split between investment grade and non-investment grade; even the not-rated category is evenly represented. Not-rated debt is generally debt holdings that they carry that are issued to institutions. Typically, qualified institutional buyers can buy these private holdings, and the companies can forgo the costs and time associated with getting a rating. Since these larger investors often have internal research divisions that can come up with their own ratings.
At this time, the fixed-income sleeve of their portfolio is relatively small. It will be interesting to see how this plays out going forward - noting that CEFs, even ones that are as flexible as ECAT and BCAT, often don't make drastic changes over short periods.
Taking a look at the fund's top ten holdings, you might be a bit surprised. What we see are several names that we see everywhere else. This is why the ESG in the fund's title might get some attention, but it might not be what investors are expecting at the end of the day.
To be fair, NextEra Energy (NEE) is the fund's largest position, and that is clearly a play on clean energy. They are the leading renewables utility in the U.S. They are the world's largest producer of wind and solar energy.
One interesting name is Invesco QQQ Trust Series (QQQ). That's certainly an odd "ESG" holding. I'd have to believe that's just a placeholder for some cash at this time and that eventually, ETFs won't be present in the fund. BCAT had this same thing happening too when they initially launched in having ETFs as their largest holdings.
ECAT is a newly launched BlackRock fund. The market has been having a tough time lately, which could present a good time for ECAT. While the fund's NAV has declined so far, they also carry a sizeable cash allocation. If they can deploy that prudently and successfully, we could see ECAT perform better in the future. The fund has an ESG tilt, but it seems that category is quite broad. They seemingly can invest in just about anything they want as long as it isn't a weapons manufacturer, tobacco or energy company with too much in coal and oil. The other interesting thing about ECAT at this time is the fund's price collapse. Relative to the NAV decline, it has been quite profound, making the fund's valuation quite tempting.
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Disclosure: I/we have a beneficial long position in the shares of NEE either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article was originally published to members of the CEF/ETF Income Laboratory on March 2nd, 2022.