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Why global equity income funds can continue their rich vein of form

04 March 2024

In a febrile global interest rate environment, there is comfort in a long-term reliable dividend.

By Darius McDermott,

Chelsea Financial Services

After almost a decade when global equity income funds trailed their racier rivals in the global sector, they have hit a winning streak over the past three years. The average return from funds in the sector is only bettered by that of the North America and India sectors. What they have lacked in technology companies, they have made up for elsewhere. But what are their prospects from here?

Although sector performance is strong over three years, returning 30%, 2023 had some headwinds for these funds. Once again, the technology giants dominated performance of global indices, which left global equity income funds struggling to keep up.

It has been a perennial problem for the sector, which generally can’t invest in these companies because they don’t pay dividends.

The relative weakness of ‘quality’ stocks was also a problem. Those sturdy, reliable, dividend payers, with strong balance sheets and sound cashflows tend to be where many global dividend managers gravitate.

Stuart Rhodes, manager of the M&G Global Dividend fund, said it is extremely rare that quality delivers this level of underperformance, saying it was the worst year of underperformance for this part of the market since the fund’s launch in 2008. 

In spite of an economic environment that appeared to favour defensive positioning, areas such as REITs, healthcare, utilities and consumer staples had a tough year. The reasons for this weakness were idiosyncratic.

Rhodes said that interest rate rises hurt higher debt sectors such as utilities and REITs.  He added: “Staples and healthcare got hit by the GLP-1 factor. People became concerned on consumption of food and drink.”

GLP-1 is the foundation of a series of new weight-loss drugs and has hurt consumer staples groups such as Coca-Cola, but also some healthcare companies that made treatments for obesity-related problems – stents, heart valves and so on.

Rhodes said: “We saw some great names falling 20%. This is very rare and just came from the hype about what the drugs would be able to do. We believe it is a long time before these effects show up in revenues.”

The Guinness Global Equity Income fund encountered a similar phenomenon. Manager Ian Mortimer said its overweight position in consumer staples and underweight in technology was the biggest drag on performance over the year. Its overweight in industrials and underweight in energy compensated.

Global equity income in 2024

However, Rhodes believes this underperformance of ‘quality’ companies has created the strongest opportunity for the year ahead. He added: “Better valuation opportunities are coming through. The numbers for these companies haven’t changed much, but the share prices have.” He gave the example of Asian bank DBS.

Mortimer is fishing in a similar pond. He pointed out the recovery in share prices across many sectors has been driven by multiple expansion. In some sectors this has come with negative earnings revisions, which has left valuations looking strong.

The exceptions, he said, have been in consumer staples, utilities and healthcare. “These are interesting areas. The market moved against them in 2023 and there is an opportunity for them to turn around.”

The biggest weights are in consumer staples and industrials at around 26% and 27% of the portfolio respectively. It continues to own nothing in the consumer discretionary, energy, utilities and real estate sectors. In geographic terms, its European exposure is notable, at 30%, higher than usual and some way ahead of its benchmark. 


The outlook for dividends

Rhodes said markets are now starting to price in a more normal interest rate environment. He believes this is likely to be a stronger backdrop for dividend-paying companies more generally

He said: “If we get to a point where we have consistent rate cuts coming through, we think that will be a pretty favourable environment for dividends generally.” He believes interest rates will ultimately settle at between 3% and 3.5%.

He also doesn’t see a significant risk to the outlook for dividends, adding: “Normally when we get into periods when people are worried about the economy, there are questions over whether there will be dividend cuts.

“To answer this, investors need to look at balance sheet strength – some 95% of dividend cuts come from a balance sheet that has got out of control. Finding stable dividends and hitting income targets requires a focus on balance sheets. We always have less leverage than the market.”  

Last year was the fund’s strongest-ever year for dividend growth.

Mortimer agreed that there are still plenty of opportunities to grow dividends in the year ahead. The fund looks to balance capital growth with income generation and continues to focus on quality.

Nevertheless, Nick Clay, manager of the TM Redwheel Global Equity Income fund, said that when the world is more volatile, focusing on downside risk is likely to be more important and dividends help people manage the volatility in markets.

“In this environment, the mathematics of not losing as much money is far more powerful than the mathematics of making as much money as possible when things go up,” he noted. This is his focus on the fund.

In a febrile global interest rate environment, there is comfort in a long-term reliable dividend. Many of the factors that have penalised global dividends strategies – the outperformance of technology, the weakness of quality – are likely to ebb in the year ahead. Global equity income funds could have significant appeal in this environment.

Darius McDermott is managing director of FundCalibre and Chelsea Financial Services. The views expressed above should not be taken as investment advice.

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