The current febrile market offers income managers an uncomfortable choice. They can either invest in ‘expensive defensives’, where reliable earnings come with a hefty price tag, or cheaper cyclicals, which – in many cases – may be experiencing some element of distress. The recent sell-off has exacerbated this problem, with the weakest companies getting cheaper and no real dent seen in the price of highly prized defensives.
Michael Clark, manager of the Fidelity Moneybuilder Dividend Fund, recognises the problem: “During the correction, those companies on a low price-to-earnings ratio have fallen more than most, particularly commodity-type stocks such as mining and oil. The more ‘visible profit’ type companies have proved defensive.”
His response has been to start looking tentatively among the cheaper companies. He points out that mining was once considered an income sector before the China boom brought it to the attention of growth investors.
However, it requires selectivity: “We want good quality companies with a spread of commodities. From an income point of view, there are some that are starting to look interesting. That said, we haven’t sold out of our high-quality names to buy them.”
"Companies on a low price-to-earnings ratio have fallen more than most."
Clark is not interested in companies that have a poor financial structure or could be exposed by high debt no matter how cheap they are. He gives the contrasting examples of Glencore and BHP Billiton: Glencore has had to raise capital and cut its dividend because it had too much debt, while BHP Billiton has remained committed to paying its dividend and has only relatively low levels of debt.
He adds: “A company’s debt is the first thing we need to be comfortable with. Can they function in a lower-growth environment? Can they meet their financial obligations? If they need to restructure, they’re not for us.”
For Clark, however, this is still very much at the periphery of his portfolio. The core of the Fidelity Moneybuilder Dividend Fund is made up of healthcare, consumer staples and utilities. The position in healthcare was built up some years ago when it was out of favour. He still likes the sector because companies generate a lot of cash, have a strong dividend culture and are geared into long-term demographic trends.