As the current economic cycle continues to confound investors and fears of a recession grow, the quantitative easing-fuelled levels of growth of the past decade seem unlikely to be repeated in the coming years.
The renewal of the US-China trade spat has made investors increasingly wary of a potential downturn for both economies and the possible negative impact for global markets.
With the post-crisis era of loose monetary policy also drawing to a close, it is likely that investors will find it more difficult to find drivers of growth for their portfolios.
Source: BofA Merrill Lynch Global Fund Manager Survey
However, the solution might be found in income stocks and strategies.
Companies with a good dividend yield play an important in the £2.7bn Pyrford Global Total Return strategy. Pyrford international chief investment officer and fund manager Tony Cousins said its ‘value indicator’ – which combines the current dividend yield plus five-year forecast annualised real earnings per share growth – helps it identify stocks that should help it deliver stable total returns.
“We like stocks that have a decent dividend yield, because that obviously means you need to be less heroic on your earnings forecast,” said Cousins, who oversees the £2.7bn Pyrford Global Total Return fund. “But you can’t just buy stocks solely on dividend yield. You need to be convinced that there is some growth in income.
“If you look at long-term returns half comes from initial income, the other half comes from growth and income of total return.”
In addition, dividend-paying stocks have a strong track record of outperforming those that reinvest cash flows, according to Allianz Global Investors’ Simon Gergel.
Gergel (pictured), who oversees the four FE Crown-rated Merchants Trust and is chief investment officer for UK equities at Allianz, said there was ample evidence of dividend-paying stocks outperforming their peers. 
“If a company pays lots of money to shareholders each year, is that going to be better than a company that retains the money in the business and reinvests it?” he asked. “Well, actually there’s evidence that will move to this company’s pay out their income as a high yield on average outperform in terms of total returns.”
Gergel added: “If you take, for example, the UK, if you’d bought the highest yielding company you would have outperformed the lowest yielding stock by about 3 per cent per annum over 40 years, which is really quite a remarkable result in terms of compounding.
“It may not sound a lot, but over such a long period it’s significant and this effect isn’t just over the long term, it’s actually happened since the year 2000.
“And it hasn’t just happened in the UK – it happened in the US and has happened in pretty much all the major markets with the exception of one or two very smaller markets, where particular stocks that might distort it.”
The power of compounding – the so-called ‘eighth wonder of the world’ – can be seen in the chart below, with the price return and total return (with income reinvested) of the FTSE All Share compared.
Performance of index over 10yrs
Source: FE Analytics
“If you look at most asset classes over the last 20 or so years, then even with equities more than half of their returns have come from dividends,” said Investec Asset Management’s Jason Borbora-Sheen.
And it’s not only equities this applies to, he added.
“In the case of fixed income assets it’s more than 80 per cent – and sometimes more than 100 per cent – coming from their coupons,” said the fund manager.
“So really, we’re trying to get investors to focus on this concept of the importance of compounding yield rather than just viewing assets which have got an income as a way of generating cash flows.”
This message appears to be filtering through to investors, with other equity income managers beginning to see greater interest in their strategies from investors as the outlook for growth fades.
“For me, income funds are about two things,” said Chris Murphy, manager of the £979.8m Aviva Investors UK Equity Income fund. “There’s the obvious thing of providing a yield premium to the end client to the market. And it’s important, in the long run, that yield and dividend grow, even in a low inflation world.”
He added: “But I think there’s another aspect to income funds as to why people buy them and that’s the make-up of the total return that they get, particularly if they don’t take out the dividend.
“Actually, by choosing consistent businesses with good cash flows that generate yield, you get lower volatility of returns and more consistent returns.”
Borbora-Sheen, co-manager of the £942.3m Investec Diversified Income fund, said investors have increasingly sought out his fund for the total return rather than just an income vehicle.
“If we look at the distribution of unit sales, we’re now seeing more flows coming into the fund as an accumulation investment, meaning that investors don’t actually take the income from it,” he said. “We’re trying to get across the use of income as an engine as opposed to an outcome.”
Performance of fund over 3yrs
Source: FE Analytics
While income stocks can play an important part in portfolios, value investor Gergel warned that investors should not focus too much on yield alone, arguing that the total return is paramount.
“We never buy a share because it’s got a high yield,” he explained.
“We buy a share because we think we can make money: a total return. The income might be a part of that but it’s never the only answer; we’re always looking at the total return we’re going to get.”