The threat of dividend cuts is not something that should only worry UK equity income investors, warns Artemis’ Jacob de Tusch-Lec, who has been increasing his top-performing global fund’s exposure to dividend growers to defend against this risk. 
The potential for some of the market’s biggest income payers to cut their dividend payouts has been discussed on many occasions over the recent past, with the likes of Standard Life Investments UK Equity Income Unconstrained manager Thomas Moore warning that income-paying stalwarts are under increasing levels of pressure.
“At the moment, it’s almost a perfect storm for income,” he told us back in August 2015.
“If you’re a traditional income investor you have to worry about big oil; you have to worry about mega-caps’ earnings downgrades and the cash flow shortfall of companies like Glaxo; and on top of all of that, you have a rate rise leading to a de-rating.”
More recently, the latest edition of the Capita Dividend Monitor noted that 2015 was dominated by high-profile dividend cuts but argued that the “greatest impact is yet to come”.
The report revised down its dividend forecast for the next 12 months to £86.5bn, down from the £89.8bn it was expecting at its previous update in October. It added that the group is “far less certain” about the outlook for UK dividends for the year ahead than it has been for a number of years.
UK large-caps’ dividend cover
Source: Canaccord Genuity Quest
De Tusch-Lec, who has managed the £2.9bn Artemis Global Income fund since its launch in September 2010, says that it is not only UK names that could be forced to lower payouts to investors this year as pressure is being felt in many parts of the globe.
“It’s clear now that there are pressures on dividends. We’re seeing it in certain markets more than others. Clearly, equity markets like the UK – where there’s a huge concentration of resources, energy and other sectors under pressure – are the areas that will see the biggest pressure on dividends,” the manager said.
But he adds that he expects to see pressure on dividends increases even in parts of the world like the US, where sectors such as energy and mining – which have been hit hard by plunging commodity prices – are a smaller part of the index.
US companies have benefitted over the past six years from cheap and available labour, the low cost of borrowing thanks to record low interest rates and subdued cap-ex spending, owing to increased outsourcing to emerging markets. However, these factors might not be supportive over the coming years.
De Tusch-Lec explained: “Going forward some of those trends are going to reverse – we’re already seeing authorities hitting the Googles of the world, Apple has trouble repatriating cash to the US as the government wants a bigger share of the pie, we’re seeing Jeremy Corbyn in the UK and Bernie Sanders in the US presidential campaign talk about the 1 per cent and living wages. Lastly we’ve seen credit spreads widen quite dramatically over the last six to nine months, with the Fed very gently but nevertheless increasing the cost of capital at the very short end of the curve.”
“With all this, it seems fair to think that profit margins globally have peaked for this cycle – and that’s never good for equities. When profit margins peak, P/Es tend to come down. When companies decide what to do with their remaining cash, it will be tough over the next couple of years to have funds for dividends, share buybacks and investment. That’s something we’re very aware of.”
Given the manager’s outlook on dividends, Artemis Global Income has seen its bias towards stocks with more reliable earnings and stronger balance sheets – often known as ‘bond proxies’ – increase over recent months.
The fund’s overweight to this type of stock (shown by the shaded blue area in the below graph; the brown line is the US 10-year bond yield, inverted) fell to around 10-15 per cent in the aftermath of the taper tantrum, having previously stood a 30 to 35 per cent overweight.
Fund’s allocation to bond proxies
Source: Artemis
De Tusch-Lec has been adding to these “defensive, boring” companies over recent months, arguing that the global economy has ended up in a deflationary state rather than the inflationary one promised by quantitative easing. He expects to continue to add to these stocks.
Furthermore, the manager has been paying more attention to companies that have a prospect of strong dividend growth rather than the ‘cash cows’ that show high yields at the moment. In October, the fund had around 30 per cent of assets in dividend growers and 25 per cent in cash cows, but over recent months more has been added to the former type of holding.
“Over the past six months, we have moved more of the fund towards the dividend growers. We want to have more dividend growth in the portfolio because if companies have to pay more for their capital [due to rising interest rates], then the very levered ones will not be able to grow their dividends,” he said.
“With the greater pressure on dividends, we’ve put more of a focus on growth. I think if you bought our portfolio today and held it for a year, the underlying dividend growth would be around 8 or 9 per cent.”
Since launch in September 2010, Artemis Global Income has made a 91.45 per cent total return, ranking it first in the IA Global Equity Income sector where the average gain has been 56.72 per cent. It has also outperformed its MSCI AC World index benchmark by a similar margin.
Performance of fund vs sector and index since launch
Source: FE Analytics
The fund is highly rated by investment analysts with it holding a place on the FE Invest Approved list of FE Research’s favourite funds and being awarded an A rating by Square Mile Investment Consulting & Research.
Square Mile said: “This strategy differentiates itself versus many of its peers both by steering away from the more traditional income stalwarts and by combining stock selection with a consideration of the macro backdrop.”
“The manager ultimately looks to provide a blend of companies with different characteristics whose fortunes do not rise and fall together, as may be the case with a portfolio made up of purely high yielding bluechip names.”
Artemis Global Income has a clean ongoing charges figure of 0.84 per cent and yields 3.87 per cent.
