Given the disappointing lack of yield across all bond asset classes since the world was turned upside down in 2007/8/9, investors seeking income have increasingly moved away from bonds to run headlong into equities.
But in these past seven/eight/nine years, investors have still not taken any great equity steps beyond their domestic market when a broader view will provide multiple opportunities across every possible sector, industry and company. It really is this simple.
This kind of narrow, domestic-only view highlights concentration risk at not only a portfolio level but also at a fund level as each manager will also be analysing, researching and then investing in a necessarily limited number of stocks; that is to say, they all end up investing in the same thing.
Investing globally frees investors from their dependency on specific stocks or industries for their income, meaning such concentration risk becomes less relevant.
The concentration risk coming out of this reticence to look further afield is clearly visible in a FTSE dividends table that is dominated by a handful of UK companies. According to the latest Capita UK Dividend Monitor (October 2015), the percentage of dividends paid by the top five companies in Q3 2015 was 31%, a figure that nearly doubles, to 61%, when widened to include the top 15 companies. The contribution from just the top five companies has been as high as 47%, in Q3 2009.
Even those investing according to, say, the MSCI World Index, means their benchmark considerations are reduced when compared with a domestic market’s narrower range of opportunities.
Middle management
The MSCI AC World Index offers a larger number of mid-cap stocks to choose from. Typically less mature than their large-cap counterparts and with stronger growth prospects, mid-caps offer greater scope for capital growth. In contrast to larger companies, they are significantly less researched and less widely owned, so are more likely to trade at a discount to their actual value – recognising this is, after all, the value added by the fund manager.
Most critical of all, perhaps, sustainable dividend growth can enhance capital growth and therefore total return. Looking at our own domestic market (see table), our analysis shows the close correlation between dividend growth and share-price performance, which highlights the importance of an income strategy as part of a total-return approach. Too narrow a focus and a fixation on yield alone can mean significant incremental return is left on the table.
Determining a company’s dividend growth characteristics requires a detailed, bottom-up focus on a company’s fundamentals to gauge the extent and, again, sustainability of earnings trends that will ultimately provide the long term income growth we are after.
It is also important to generate additional capital growth rather than income alone, to help maximise an investor’s long-term total returns.
Portfolio construction
Once the rigorous stock-selection process is complete, the portfolio is constructed.
Understanding the importance of a diversified income stream, the focus is on three distinct types of stock: high dividend-paying (companies that pay a premium and sustainable income), dividend upgrade (businesses that pay dividends on an opportunistic basis) and dividend growth stocks.
Each category plays a key role in driving the performance and fulfilling the fund’s mandate.
Of those, dividend growth stocks will typically make up around 50% of the portfolio. These are companies that are building, or have built, a track record for growing their dividends. Such stocks may initially represent a lower yield, however by choosing businesses that will gradually increase payments, we aim to secure a healthy future income stream for long-term investors.
With income ever-more important to total investment returns in the current environment, ensuring the stability and security of income streams is of paramount concern to investors.
Global opportunities allows for more systematic exploitation of the more sophisticated income strategies available, ultimately giving an investor access to faster-growing economies and companies across the market-cap spectrum.
These are critical to providing the sustainable income and income growth so inextricably linked with generating enhanced long-term total returns.
UK dividend growth
Driving returns (2012)
|
Average dividend growth (% pa) |
Average share price performance (% pa) |
|
Less than 5% |
6 |
|
Between 5-10% |
7.5 |
|
Between 10-20% |
14 |
|
More than 20% |
26 |
Source: Standard Life Investments; Oriel Securities (April ’13)
