James Harries, manager of Newton Global Higher Income, favours Asian and Latin American stocks over American and British – and returns from the two-year-old fund support his approach.
Like America, Britain has a structural current account deficit. Like America, Britain has hugely over-indebted consumers. Like America, Britain has a slowing and now falling property market. But unlike the dollar the pound remains strong. Explain.
According to James Harries at Newton, there isn’t much of an explanation to be found. Instead, the pound is seriously exposed and now that interest rates are heading down, sterling is heading in the same direction as the dollar.
Harries is manager of Newton Global Higher Income, now two years old and one of the top performers in its sector. For a global fund, it has nothing in Britain and America. The Newton house view is that the “Anglosphere” is facing a tough period, but that elsewhere a global economic realignment means that Asian and Latin American stocks can prosper even if America slows down.
“We have been worried about credit markets and over-indebted consumers in the Anglosphere for a long time. It means we took the decision to avoid banks and mortgage lenders, and we have no US, UK or Australian banks anywhere in our portfolios.”
He says there is a “global realignment” going on. “We are moving from a dollar, US, consumer-credit fuelled world into a world that is non-US, non-dollar, producer-led and resource-intensive. It leads you to deemphasise the hegemony of the US and look for opportunities elsewhere.”
A typical British income fund contains high yielding banks and utilities, and tends to go hunting for stocks in Britain, the home of decent dividend payers. Harries turns this approach on its head.
Apart from the absence of British or American banks, he has few utilities. This is an income fund that boasts among its holdings Russian steel makers and Thai coal diggers. Yet it’s on a highly creditable yield of about 3.5% and over the past year has offered capital gains of 19.2%, putting it in the top decile among its competitors.
“Income investors in the UK have traditionally opted first for UK bonds, then property, then UK equities. Global equities would be the last place they’d look.
“But I would argue that we need to flip that on its head. To get growth in income, it’s going to be best to be in global equities, then UK equities, then property and finally bonds.”
He acknowledges that the global dividend payout ratio is low, but that it will rise over time. Currently the FTSE World index yields about 2.2%. Newton Global Higher Income only selects stocks that are offering a 50% yield premium to the index, that is; stocks must yield at least 3.3%. What is more, if a stock’s yield falls below a 25% premium, it has to be sold.
The yield requirements aren’t the start of the stock selection process, but the back end of it. First, the stock has to meet Newton’s thematic considerations, such as underweighting the Anglosphere. Secondly, it must appeal on a fundamentals basis. Thirdly, it must meet valuation criteria and only after that does Harries examine the yield.
The process means that “we are very underweight the US and the US dollar, and to a lesser extent Japan. Where we are finding value is in the currencies we like, across Asia, and in the Brazilian market.”
He points out how Brazil has an inflation rate that is below America’s but interest rates above 11%, some of the highest real interest rates in the world. It’s pretty clear to Newton that rates will move down in a country that is benefiting from an improvement in its terms of trade and enjoys great reserves of both hard and soft commodities.
Brazilian stocks held include Petrobras, TeleNorte Leste and Natura Cosmeticos. That TeleNorte holding is also part of a major position in telecoms across the portfolio. Telstra of Australia is his single biggest holding, then there’s LG Telecom, Korea’s third largest operator, and Cable & Wireless.
Harries is insistent that he doesn’t hold telecoms for traditional yield reasons. “We generally believe that the prospects for mobile growth in emerging markets is very strong, plus data growth over mobile and fixed line networks is beginning to materialise.”
Telstra, though, is a unusual choice. First, it’s firmly in the Anglosphere, with operations wholly based in Australia. Secondly, its chief executive, Sol Trujillo is one of the most controversial bosses in Australia. On a recent trip to Australia, I found the business headlines dominated by stories of angry minority shareholders, bust-ups with regulators and lavish boardroom pay deals at Telstra.
But Harries says that Newton was able to quiz Trujillo and is convinced that Telstra is a “tremendously attractive turnaround opportunity, with an attractive valuation and dividend yield.”
Since launching the fund two years ago, it has grown to £285m in size, testament to its great performance and Newton’s towering reputation in running income funds. Harries has 12 years under his belt at Newton, where he previously ran the Falcon fund and now manages several pension mandates apart from the Global Higher Income fund.
The fund’s success in pulling in the punters show that IFAs in Britain are no longer so attached to UK Equity Income as the only way to find a portfolio with a high and growing yield.
At a time when nerves have been shattered by the American-led credit crunch, it’s a superb way to diversify income streams and cushion the effect of any potential market decline in Britain and America.
“Investors are right to be nervous about the UK, if anything even more so than the US. Whatever your views on the credit crunch, it’s likely to lead to lower interest rates and lower sterling. But that doesn’t mean you have to be bearish about the rest of the world. Large parts of the world still offer relatively good value.”