August’s market rout has as least one silver lining. It has made yields on income funds look more attractive than they have for years.
The prospective dividend yield on British and European shares is typically in the region of 3.5-4%. As a multiple of their earnings, stocks are priced at less than half their 20-year averages. It’s difficult not to see this as a buying opportunity.
Traditionally, income investors have stayed close to home, and for good reason. London-listed shares still pay better dividends than you find almost anywhere else, but as Artemis is keen to point out, that is changing fast. Its Global Income fund, managed by Jacob de Tusch-Lec, pays out roughly the same level of income as Adrian Frost’s better-known Artemis Income fund. Since launch in July last year it has shot into the top quartile of the Global sector.
De Tusch-Luc says the opportunities for investors are companies with dividend yields of 4-7% and payouts growing at 5-30% a year. In a snapshot of the 3,300 biggest global companies, he shows a graph on which lots of companies inhabiting that space are British, but many more are not.
“You can find Asian companies now with a clear declared dividend policy. They know that western investors like that and will give the stock a re-rating,” he says. The total value of dividends a global investor can harvest is four times the level of 10 years ago, he adds, underlining how a British-centric approach to income may soon be old hat. Of the large listed companies that yield more than 3% and increase that yield by more than 4% a year, only 10% are in Britain. (Collinson continues below)
Yield compression in every other asset class means that global equities offering a decent yield have outperformed strongly. Even after the market downturn, de Tusch-Lec’s fund is up 7% over the year, against a small decline for the average global fund.
He has not gone anywhere near global bonds for income. “Do I want to finance bankrupt governments or growth companies?” he asks. But the forces at work driving sovereign bonds to ultra-low or ultra-high levels are the same forces driving his stock selection. “We are in a macro environment. You have to take a view out there. You can pick great stocks, but if you are in the wrong country you can get killed.”
Mining stocks might be just such an area. De Tusch-Lec says he could create a portfolio of mining stocks with a yield of 10%, but he shares Frost’s concern about the sector.
Instead, he is encouraged by the huge cash balances held by so many global companies. Many are aware that Apple has more cash in hand than the American government, but Apple is just at the top of a list of cash-rich mega-caps.
“If you look around the world today, the only bit that is economically healthy is the corporate sector. Wages are subdued, unemployment is high, and developed-world corporates have more cash on their balance sheets than ever before. Cash as a percentage of market cap is also close to an all-time high.”
When money starts burning a hole in a chief executive’s pocket, it usually results in a surge in investment spending (new IT kit, research facilities and so forth) or a round of acquisitions. But chief execs are also painfully aware of how little share prices have moved for a decade.
Frost chips in with this observation: “How do you make a share price go up? I wonder if we will see companies drive up valuations through distribution policy. The alternative is to just become more of a Leviathan.” He says this with a weary tone, evidently having seen too few mega-cap acquisitions pay off for investors. He’s in the camp that would happily see BP broken up as the best route to accessing capital. On balance, though, he doesn’t see that happening – and on balance, thinking of the wider interests of Britain rather than just shareholders, I’m glad it won’t.
More likely, says Frost, is that if companies can’t increase the E in EPS (earnings per share), they can shrink the S. Artemis expects more and more share buybacks. “IBM has done it for years. One company – Next – has bought back 50% of its equity,” says Frost. In that time Simon Wolfson, Next’s chief executive, has not sold a single share. “Next could be left with just one shareholder, Simon himself.”
Some cash-rich companies could even borrow cheaply and pay out the money almost instantly to shareholders, taking advantage of ultra-low financing rates. As an example, de Tusch-Lec takes Altria, whose bond financing rate is 4.7%, whereas the firm’s equity is yielding 5.6% and the stock offers a dividend growing at 7% a year.
Telecoms, though, is among his favourite sectors, with KPN of the Netherlands one of his low-turnover stocks. Banks are almost invisible in the portfolio, which has helped during the latest downturn. In particular, he thinks Latin American banks are liable to have an accident.
The portfolio is not hedged, which will make some British investors uneasy, but as Artemis points out, global companies derive their earnings from so many different areas that currency swings can largely cancel themselves out.
The argument against a global income fund is that the world is in a deflationary spiral, so bonds will be the place to be. But Artemis doesn’t buy the deflationary thesis, although it doesn’t expect rampant inflation either. More likely, in its view, is volatile inflation, an environment in which equity income should prosper.
The big risk to the global dividend bonanza is that bankrupt governments will shove corporate tax rates up. With households so indebted and fragile, they have nowhere else to go. De Tusch-Lec says that big companies have had it almost too easy, with two decades of benign tax cuts. That is likely to reverse, although it shouldn’t hit returns too hard. After all, we all know how easy it has become for companies to hide profits in low-tax domiciles overseas.