Dan Roberts, manager of the £2.1bn Fidelity Global Dividend fund, believes that the market rotation towards recovery stocks has created an opportunity to invest in quality defensives with high dividends.
Over the past year, financial markets have swung from favouring ‘stay at home’ winners to the stocks best placed to capitalise on reflation and reopening.
The market rotation has left behind many quality companies which don’t obviously play to either of these themes. This creates an opportunity for investors to add to them at an “unusual” discount, according to Roberts.
“This investor apathy means that the valuations of some high-quality companies with good dividend prospects are now very low, particularly when compared to the heightened levels of other parts of the market,” he said.
“This unusual backdrop offers investors an excellent opportunity to increase the quality and resilience of their equity portfolios at appealing valuations, and in doing so access attractive income streams alongside prospects for long-term capital appreciation.”
The manager looked back at the past 12 months and recalled how the market has been split into two different regimes.
“The first period, covering the onset of the pandemic and subsequent lockdowns, saw returns concentrated in a narrow group of digital platforms deemed to be the winners of the ‘stay at home’ economy,” he explained.
“Such was the magnitude of their outperformance that even defensive sectors relatively unaffected by lockdown, such as utilities and consumer staples, underperformed the index.”
This changed in November of 2020, when vaccine updates were positive and Biden’s election as US president fuelled demand for investor exposure to the ‘reflation and reopening’ theme – stocks expected to benefit most from a recovery in economic activity.
Since the first positive vaccine announcement from Pfizer on 9 November 2020, defensive shares with less exposure to the anticipated recovery have underperformed in this environment.
MSCI World Defensive Sectors vs MCSI World index since positive vaccine announcement
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Source: FE Analytics
This can be seen in the performance of the MSCI World Defensive index - which has underperformed the broader MSCI World index by 6 per cent.
Roberts said: “Although these were two very different market environments, one trait remained common in both - the increasing risk appetite of many investors.
“In the ‘stay at home’ regime, investors were effectively taking on incremental valuation risk as the stock prices of technology platforms outpaced their earnings growth.
“Latterly, the assumption of fundamental risk has been handsomely rewarded as money has flowed into the stocks of companies whose profits are the most sensitive to economic conditions and therefore the most obvious beneficiaries of reopening and reflation.”
Since the focus of Roberts’ £2.1bn dividend strategy is on mitigating both valuation risk and fundamental risk, the stocks in the Fidelity Global Dividend portfolio have not benefited from either environment.
Roberts said: “On the other hand, apathy towards the ‘quality defensive’ companies that form a core component of the portfolio has left many of them trading at unusually low relative valuations, creating an exceptionally attractive entry point.”
As such, he highlighted how the portfolio has traded at the largest discount to the market since the fund launched in in 2012.
Source: Fidelity International, Refinitiv Datastream
“This valuation discount has materialised despite a persistence in our quality bias and an unwavering focus on sustainable income generation,” Roberts said.
“The income growth the portfolio generated in 2020, when compared to the declines across the broader market, demonstrates the resilience of our portfolio and the defensive cashflow streams we access in the fund.”
He said that the combination of “high-quality assets” and “a large valuation discount” has given him confidence in both the medium- and long-term performance outlook for the fund.
“Our high conviction in today’s portfolio means we have been comfortable increasing position sizes in existing positions which have seen relative share price weakness,” he said.
American multinational consumer goods giant Procter & Gamble was one such company that the manager has been adding to.
Source: Google Finance
“Procter & Gamble [P&G] has significantly de-rated relative to the market since November 2020, despite strong fundamental progress, as investor attention has shifted to more economically sensitive companies,” Roberts said.
“P&G has one of the longest dividend track records in the portfolio, very little debt in comparison to other staples businesses, and a management team doing the right things to improve earnings sustainability.
“For these reasons, we see a very attractive risk adjusted return in P&G shares today.”
Looking ahead, Roberts believes that the markets expectations for earnings recovery in 2021 and beyond could be creating potential for disappointment and downside risk in companies with volatile earnings or high valuations.
He said: “The history of the stock market tells us that periods of excessive risk-taking do, sooner or later, come to an end.
“Quality defensives are priced so appealingly today that we believe that they will provide attractive investment outcomes more or less independently of which direction the economy takes from here.”
“All that is required is some patience,” he finished.
Over the last five years, Fidelity Global Dividend has delivered a total return of 70.71 per cent versus 63.91 per cent from the average IA Global Equity Income peer and 98.73 per cent from the MSCI AC World index.
Performance of the fund over 5yrs
Source: FE Analytics
The FE fundinfo three Crown-rated fund has a 2.81 per cent yield and an ongoing charges figure (OCF) of 0.93 per cent.