With investors continuing on their hunt for yield, global equity income funds remain firmly in the spotlight. The popularity of the sector is a phenomenon that started following the financial crisis in 2008, when investors rushed into safe-haven assets. Dividend stocks provided a welcome shelter from the storm.
Extensive quantitative easing programmes from central banks across the globe since have put pressure on bond yields, providing a further reason for investors to turn to such funds.
From the trough of the financial crisis in March 2009 to July 2016, the Morningstar Global Equity Income category has seen total net inflows of €43.2bn. This pushed total assets under management to €82.6bn, an increase of 1,200 per cent from the €6.3bn invested in global equity income funds in March 2009. This significant growth dwarfs the 248 per cent organic growth achieved by equity strategies in general.
But despite their popularity, global dividend funds have had difficulty beating the MSCI World index over the past three years. Only five out of 38 funds in the IA Global Equity Income sector managed to achieve a superior performance versus this benchmark.
It has been a difficult environment as higher-yielding stocks lagged the broader market, while value stocks trailed growth stocks. In addition, US stocks, which have historically been a strong underweight versus the MSCI World index, outpaced European stocks, which have typically been popular among equity income managers for their higher yield and lower perceived valuations.
Looking closer at performance, two important sectors for equity income strategies have faced significant headwinds in the past three years. Financials, often a core position in dividend funds, underperformed as a result of declining interest rates, tighter margins, higher capital requirements and regulatory pressure. Adding to the uncertainty was the exposure of banks to (potential) non-performing loans in the energy and mining sectors, while the pile of non-performing loans on the books of Italian banks caused further market stress.
The natural resources sector is also going through a rough patch, with commodity prices falling to historical lows across the board. Despite this year’s rebound of some major commodities, including oil and iron ore, many natural resources companies have had to cut their dividend. Even the dividend of oil majors is under scrutiny from investors.
The challenging environment causes differences in portfolio positioning among equity income managers. Where some are attracted by the low valuations and higher yields, others remain shy on adding these fallen angels to portfolios. It is one of the factors causing the large dispersion of 23 per cent in year-to-date returns (to end of August) among equity income funds, evidencing the need of a thorough selection process.
Looking at IA Global Equity Income funds we find a wide variety. Although all construct a portfolio that has a higher yield than the broad market, their approach can differ meaningfully.
Veritas Global Equity Income holds a gold Morningstar analyst rating, which is based on our high conviction in its management. Charles Richardson and Andrew Headley, who previously worked together at Newton, have been at the helm since its launch in 2006 and have run the institutional version since 2003. The fund’s standout characteristic is the extent to which the managers aim to deliver real returns. They invest in companies with durable competitive advantages and strong, sustainable cash flows that can lead to dividend payments. Yield is one of the considerations but the managers are not prepared to invest in high yielding companies unlikely to contribute to capital growth. Finally, they use a thematic framework to help identify industries globally to benefit from long-term structural drivers.
Deutsche Invest I Top Dividend has built a strong track record under the leadership of Thomas Schüssler since 2005. This conservative dividend strategy focuses on quality companies able to pay out sustainable and preferably growing dividends, that are financially sound, generate stable cash flows and have a strong competitive advantage. The giant/large-cap dominated portfolio of approximately 70 stocks is held for the long term, evidenced by 20 per cent average annual turnover in the past five years. Cash-like positions are used to change the characteristics of the portfolio. With an allocation of 4.5 per cent to cash and 7.4 per cent in US government bonds, the fund’s positioning is conservative, further demonstrated by its 53.6 per cent allocation to defensive sectors, versus a category average of 33.8 per cent. It earns a Silver rating.
M&G Global Dividend earns a silver rating based on its solid approach, which has a bit more flexibility than traditional dividend funds. Stuart Rhodes, at the helm since its July 2008 inception, has served investors well, albeit with a higher level of volatility. Unlike some dividend strategies in which the investment process centres on relative yield, Rhodes targets companies growing the absolute level of the dividend. This steers the fund to the faster-growing, more cyclical part of the universe. Rhodes balances these higher-beta dividend payers with conventional income sectors. This high-conviction approach has had a difficult period since mid-2014 but we believe Rhodes has continued to implement his process consistently despite it being out of market favour.
Jeffrey Schumacher is senior manager research analyst at Morningstar