Global Equity Income is an increasingly popular choice for investors, Says Stephen Spurdon. But the portfolio balances are shifting
There’s no doubting the popularity of the Global Equity Income sector – or the reasons for its attraction to UK investors. The combination of a fully-managed stock-picking approach with a focus on income (always a reassuring thing in itself) has proved a winner among a public that knows it ought to be taking a healthy interest in the wider world outside the UK but isn’t always sure where to start.
Remarkably, it’s barely a decade since the first few global equity income funds hit the market, and just seven years since Threadneedle raised the game with the launch of its own performance-topping fund back in 2007. Since then, the field has expanded to a heady 30 funds.
But the last few years have not been kind to internationally-oriented funds – and especially not to those which have gone heavily into emerging markets. The last year in particular has seen a retreat from China and Latin America, as sharply declining economic growth has put the skids under some of the hefty assumptions that seemed only logical a few years ago.
The corollary has been that interest has been returning to those funds that major on the developed world economies – and, dare we say it, to the UK Equity Income Sector, which has more than 90 funds. And which is outpointing the global sector by a small margin at present. (Will that advantage last? We’ll ask again in a minute.)
But that would be to ignore the basis of the sound arguments in defence of the global approach, which contend that having all your eggs in one basket – in this case UK shares with strong, consistent yields – can have risks, no matter how good are the returns on such funds over time.
A Bumpy Ride for Britain
The credit crunch was probably one of the key reasons why global equity income has gained so much ground against UK funds during the last five years. The travails of the banking sector punched a dent into the UK income – notably the situation at Lloyds, a favoured dividend generator, where dividends were abruptly halted in 2008.
Alas, that wasn’t to be the end of it. The spring of 2010 brought the BP oil spill in the Gulf of Mexico and the cancellation of dividends for a couple of years. Bear in mind here that, according to data from Capital Registrars, a quarter of all UK dividend payments in 2009 came from BP and Shell.
Small wonder, then, that investors began to seek a more diverse universe of equities. Why stick to just the UK which was dominated by a relatively small group of companies, and where a premium was added to the price of such stocks?
Better Value Outside the UK
But there are other sound reasons why investors may be better advised to stay aboard the international bus. Ben Lofthouse, co-manager of Henderson Global Income, says there’s simply better value to be had abroad.
“Look, for instance, at Icande, a French property company [and a recent addition] with a 5% yield and a 5% discount to book value. In comparison, UK property companies are trading at a premium to book.”
Why is that? Partly, he says, it’s down to the UK’s unique ‘dividend culture’ that has been established for such a long time. But recent decades have seen dividend payments advancing in Europe and the US as well as in Asia.
Nick Mustoe, chief investment officer and chair of the Global Income Group, Invesco Perpetual, and lead manager of the Invesco Perpetual Global Income fund, also makes the case:
“A global approach is complementary, because it gives exposure to parts of the global economy which would be otherwise unavailable to those only holding UK-listed stocks. The opportunity set in some sectors is greater outside of the UK too. To gain exposure to technology companies, for example, the majority of which reside in the US, and to a lesser degree north Asia, a global approach to investing offers broader scope for fundamental research. It can also potentially provide diversification benefits to a portfolio already invested in UK equity income.”
The Yield Gap is Shrinking
But, even if that is the case, surely the yields on offer on foreign markets pale in comparison with the UK? Mustoe agrees: “If we take a look at the historic yield numbers, the average yield of funds in the IMA Global Equity Income sector has tended to be lower than those of the IMA UK Equity Income sector.”
“In 2013 the average yield for funds within the IMA Global Equity Income sector was 3.5%, compared to 3.8% for the IMA UK Equity Income sector.” But it’s important to remember that that UK figure was sharply down on the previous year’s 4.6% average yield – “whereas the global equity income sector had yielded a steady average of 3.5% for the past couple of years.” [Source: Invesco Perpetual calculations based on Lipper IM data, as at 18 March 2014.]
But the evidence is there that dividend growth from global markets has been picking up pretty strongly too. The latest Henderson Global Dividend Index, published in March, showed that global dividends had reached a record of $1.03 trillion in 2013 – and that the annual average dividend growth has been 9.4% over the last five years.
Henderson also noted that, although emerging market dividend growth slowed considerably last year, emerging market dividends have grown by a heady 107% over the past five years – and that they now comprise $1 in every $7 of global payouts.
The US, by comparison, has seen dividend growth of 49% over the past five years, meaning that it now accounts for comprises one third of the global total payout – while Asia/Pacific payments grew by 79% over the same period.
Europe, of course, was a different matter. The dark pall of the euro crisis hung over our continental cousins during the same five year period – during which time total dividends paid grew by a mere 8%. Which is not to say that European payouts are insignificant – Europe (excluding the UK) contributed a fifth of the global total last year.
Growth Trend Will Continue
The global dividend total record is likely to be broken again in 2014, according to Henderson’s Lofthouse. “The dividend growth figures we are seeing suggest that most economies will see dividends at a higher level than last year. For instance, recently, we have seen Novartis up 7% and Las Vegas Sands up 43%.”
But are there realistic expectations of a real spread of the ‘Anglo-Saxon dividend culture’ across the world? “Yes,” says Lofthouse, “it’s spreading, and payout ratios have been rising in Europe since the 1990s. In Brazil, for instance it is mandatory to pay out a certain proportion. Australia and Canada are big income payers. What we are seeing around the world is an ageing demographic. In US for instance, far more companies are now paying dividends.”
The View from Liontrust
James Inglis Jones, co-manager of Liontrust Global Income, is more sceptical about the emerging market prospects. “What we do find,” he told IFA Magazine, “is that there are often significant family shareholdings in businesses. Such companies are usually very interested in cashflow, and highly cautious in investment decisions. The salaries they get as managers pale in comparison with the dividends they receive from the businesses. For instance, we have such situations in two of our Hong Kong based holdings – which tends to provide a smoother dividend path.”
Another of the accusations that are occasionally levelled against Global equity income funds is that they maintain such sizeable portfolios that you might as well buy the index. But that doesn’t apply to Liontrust Global Income fund, where Inglis-Jones and co-manager Samantha Gleave run a ‘best ideas’ type portfolio of just 26 holdings.
The smallish portfolio size reflects the demands placed on the fund by Liontrust’s Cashflow Solution screening system, which Inglis-Jones says tends to eliminate around 80% of companies from consideration. It was this consideration that played a part in last year’s decision to change the fund mandate to include companies outside the UK, and to transfer it from the UK Equity Income to the Global Equity Income sector.
“The requirements imposed on the fund meant that only a handful of UK companies could be considered. And we needed to provide diversity.” But, he adds, portfolio changes since last summer have actually not been major.
Two Main Approaches
Invesco Perpetual also warns of the need for rigour in selecting income opportunities. “Not all dividend-paying stocks are created equal,” says Mustoe. “We believe that there are broadly two approaches to the equity income investment style. The first looks to maximise income in the short term by focusing on the highest yielding parts of the market. The second – and the one that is at the heart of the investment philosophy of the Invesco Perpetual Global Equity Income Fund – is to focus on sustainable income. We refer to this approach as ‘quality income’.
Free Cashflow Generation
Artemis Global Income Fund, a relatively recent entrant to the sector, is also one of the relative small number to have actually made money last year. Managed since its 2010 launch by Jacob de Tusch-Lec, the Artemis fund relies on a highly-developed house screening style focusing on free cashflow generation.
So far so good. But de Tusch-Lec anticipates that 2014 might prove to be a tougher, more volatile year than 2013, and he has shifted the portfolio accordingly to a more defensive stance while also reducing its exposure to emerging markets. This has already paid dividends – the Artemis fund held up better than others during the torrid start to this year, beating its benchmark even though it was slightly into negative territory by the end of February.
The Longer View
The main problem with comparing the international sector with the UK Equity Income sector is that, despite appearances, you are not comparing like with like. As Inglis-Jones puts it: “You probably have a long dataset in the UK. And certainly, the number of funds in the Global Equity Income sector has grown over the past 10 years. Now, 10 years is a relatively short time to make such a judgement. A much longer time is required to see whether one management approach is better than another.”
An Artificial Boost?
One criticism that can’t be so easily dismissed is the fact that the majority of the funds in this sector allocate costs and charges to the capital account – thus enhancing the yield artificially. Fundsmith’s Terry Smith recently asserted that this was likely to mean investors sacrificing capital for income. But we always need to remember that portfolios of shares with consistent dividend yields do tend to provide better capital gains over the long term – which, of course, is likely to impact beneficially on the total return from re-investing income. This one will run and run.