Defensive positioning, capital generation and the right balance of conviction and diversification are just some of the factors that income investors should take into consideration at the moment, according to Daniel Roberts.
The manager, who runs the four crown-rated Fidelity Global Dividend and the five crown-rated Fidelity Global Dividend SICAV funds, hasn’t had to cut income pay-outs since either of the investment vehicles’ launches in January 2012, but says that this hasn’t been easy over recent months.
The hunt for yield has become more fevered over the last year or so due to negative investor sentiment caused by plummeting oil prices and China’s growth slowdown, plus the idea of receiving regular pay-outs is particularly attractive during down markets as yield generation is regarded as a safety net.
Performance of indices since 2015
Source: FE Analytics
While there are indeed a number of high-yielding stocks available, many investors have been worried about the sustainability of their dividends due to companies’ unhealthy balance sheets, particularly those in the oil and gas or mining industries.
In an article published last year, Rathbone’s David Coombs warned FE Trustnet about a potential yield trade sell-off at a time when bonds offer low yields at high valuations and income-seeking equity investors are likely to fall into value traps.
“Bond proxy-type stocks have started to become a bit more volatile – we’re starting to question at last whether these valuations are a bit stretched,” he said.
“Also, you’re seeing higher volatility in bond markets and it just feels that the end is in sight in terms of the never-ending rise in these sorts of stocks and asset classes.”
Another article published yesterday found that almost 60 per cent of global equity income funds cut their dividends in 2015, and Roberts says that despite the current desire for yield it has been a challenging time for managers to generate income.
“Dividend investing as a style hasn’t done particularly well on a global basis over the last three or four years,” he said.
Performance of indices over 3yrs
Source: FE Analytics
“The dominant reason for this is that the US has been such a significant outperformer and the US market is a relatively low yield market, so an underrepresentation of dividend strategy in the US has been a big headwind for a global dividend strategy and you can see it in peer group performance. But we’ve managed to overcome that headwind with what we think has been some pretty good stock selection in the portfolio to date.”
Since the Fidelity Global Dividend OEIC’s launch, the manager has owned a total of 108 stocks and the number of holdings has remained at just above 50 over this time period, which means the average portfolio turnover ratio is around 25 per cent.
He says that this relatively low turnover demonstrates good stock selection, and points out that the key behind choosing these holdings is to take value, growth prospects and downside protection into account.
In fact, out of all of the stocks ever held in the fund, only 12 have detracted in excess of 20 basis points from the fund’s performance. Roberts adds that the portfolio’s strong current performance is driven by a wide variety of stocks as opposed to one or two significant outperformers.
Over the last year when many funds have struggled, Fidelity Global Dividend has achieved a top-decile total return of 5.8 per cent compared to its peer group composite’s loss of 3.54 per cent and its benchmark’s loss of 3.26 per cent.
Performance of fund vs sector and benchmark over 1yr
Source: FE Analytics
“In terms of sector positioning currently, there’s a relatively defensive feel to the overall portfolio – the consumer sector is pretty well represented. I think the fundamental characteristics available in those sectors lend themselves to this strategy,” he said.
“I would also say that if you look across the market, one of my major concerns is the level of overall corporate profitability in the market which, in my view, looks very high in a historical context.”
“For many of these consumer stocks, profitability looks less stretched than other areas of the market. They may look expensive in terms of headline P/E multiples but we think the ‘E’ within the P/E will prove to be much more resilient than wide swathes of the market from here.”
At the same time, Roberts is careful not to overpay so as not to dilute the total return received from these investments. Another area of the market that the manager is seeing income opportunities in is healthcare, which is a sector he has felt positive towards since the fund’s launch.
“Healthcare has had a more difficult time recently but we’re still keen on the stocks we own in that sector. I should say that we’re not in the sexier healthcare stuff – we’re not in biotech for instance,” he pointed out.
“Many of the stocks we own are relatively diversified healthcare companies paying good dividend yields, have strong balance sheets, and their earnings profiles look pretty defensive from here.”
Another reasonably unpopular sector that the manager is seeing opportunities in is financials, which currently makes up 14 per cent of the fund’s NAV.
However, the manager says that this exposure is relatively small compared to many other income managers’ portfolios, and says that he avoids life insurance and banking stocks because he believes them to be complex, opaque and highly-geared businesses that he struggles to value within the broader sector.
“By sector we’re relatively defensive, but taking a look at the cumulative distribution of yield – from highest yield contribution to lowest - we can measure the [fund’s] aggregate contribution. It’s not quite a straight line but it’s a relatively even distribution across the stocks within the portfolio,” he continued.
“Up until recently more than 50 per cent of the UK market’s yield came from just 10 stocks within the overall market, which a significant concentration of yields in a handful of stocks. That is not a problem we face within this fund and the overall yield is relatively well distributed across the overall portfolio.”
Roberts allocates to various yield buckets and says that he doesn’t restrict himself to stocks with yields of a minimum certain percentage. Instead, he blends high-yielding stocks that pay dividends in excess of 5 per cent, low-yielding stocks with good fundamentals and growth prospects and high-quality medium-yielding stocks.
While the manager “isn’t shy” of allocating to high-yielders, he warns that investors should ensure the high headline yield is an indicator of value within the underlying investment and not a precursor to structural challenges or signs of stress.
“Most of the fund is in that 3.5 per cent yield sweet spot where there is a good premium to the broader market but the dividend yield is good quality, and I would expect [their yields] to grow in the foreseeable future,” he said.
“In the UK market dividend cuts have been happening left right and centre. In this strategy we’ve seen the dividend growth accelerate over the last year unlike many country-specific funds, so when there’s concern in some countries around overall levels of distributions, the distribution growth in this strategy is actually accelerating. This year we would expect mid-single-digit growth, and looking into next year as well.”
Richard Scott, senior fund manager at Hawksmoor, has a 4.1 per cent holding in Fidelity Global Dividend within the Hawksmoor Vanbrugh fund, and a 6.9 per cent holding in the Fidelity Global Enhanced Dividend in the Hawksmoor Distribution fund. He says that the firm has also listed the OEIC on their ‘buy list’ for private clients.
“The reason we like the fund is we feel Dan has a similar mind-set to us as investors, which is seeking to provide a decent total return over time and give investors a total return that is a real, minus-inflation return and focuses very much on avoiding big drawdowns,” he explained.
“It’s about looking for that margin of safety and the fact that he talks about all of these things is positive. We’re also big believers that, in the challenging economic environment we’re in, you have to really adopt a non-benchmark approach. It’s looking for those companies that can continue to prosper even in a challenging environment.”
Fidelity Global Dividend has a clean ongoing charges figure of 0.98 per cent and yields 2.66 per cent. It also has an active share of 90 per cent.
