While income investors have few attractive opportunities among so-called disruptive companies, closely watching this space can be a useful exercise and help with portfolio construction, according to Fidelity International’s Daniel Roberts.
One of the dominant themes in the market at the moment is the rise of technological disruption, with businesses such as Uber, Amazon and Tesla being seen as heralding in a new era for industries like transportation, retail and vehicles.
However, many of the investment cases for these disrupters is based on technological innovation and rapidly growing market share. Given the challenges of generating this growth, paying out a dividend is often far down the list of priorities for such companies.
Roberts – who manages a number of global equity income funds at Fidelity – agrees that many of these businesses are not appropriate for dividend investors. The table below shows how disruptors tend to be expensive and offer lower yields.
Disruptors’ valuations and dividend yields
Source: Fidelity International, 31 October 2017
The process that Roberts uses on portfolios such as his £898m Fidelity Global Dividend fund focuses on good companies at reasonable valuations, in order to deliver an attractive risk-adjusted, dividend-based total return.
While Roberts does not see many compelling opportunities in the more disruptive part of the market, developing an understanding of the dynamics at play here can be helpful in assessing the rest of his portfolio.
“I spend a lot of time questioning whether the changing landscape the disruptors bring will affect the resilience of the businesses I own,” he said.
“New technologies can bring down barriers to entry, erode industry profit pools and may even render some business models obsolete. Examples of industries affected include telecommunications, retail, and media/advertising agencies.
“This is where I can add value; making sure I do not give in to the siren call of a high dividend yield if the underlying franchise is under threat from these disruptive influences. Avoiding these ‘yield traps’ will help me deliver the sustainable income that will ultimately drive returns.”
Roberts’ comments on technological disruption came as he gave his forecast for dividends in 2018, for which he has a mixed outlook. The manager noted that the dividend yield for global equities is currently near 3 per cent and companies in his portfolio are growing their dividends on average at 4-5 per cent per year.
These two elements suggest a total return of 7-8 per cent, which would be in line with the long-term equity return. However, a wild card for the coming year is how valuations will affect the total return and he concedes that this would be a challenging but not disastrous environment for the fund.
“At a time when starting valuations are so high and interest rates are rising, I feel the risk is to the downside. My holdings will not be immune to a broad based multiple contraction, whether driven by higher inflation or real risk-free rates, but our valuation discipline can offer some protection,” he said.
“On a basic price to earnings multiple, the portfolio trades at circa 16x versus the market at above 19x. This valuation discount, alongside the superior cash conversion of our holdings and a focus on the balance sheet, should serve us well in a less accommodating market environment.”
Volatility has been calm for a long time
Source: Datastream, 10 November 2017
Looking at the factors that could promote a downside event to occur, Roberts said that the direction and speed of interest rate moves is an obvious issue that could take investors by surprise. But it is not the only thing they should be looking at.
The manager pointed out that some significant events over the past few years have been met with a degree of calm by the market, and volatility – as indicated by the VIX – remains at close to record lows. This creates the danger that investors have become too complacent about potential political or economic shocks.
“To the extent that investors equate volatility with risk, a prolonged uptick in volatility could become self-reinforcing,” he added. “After such a long period of calm, this would take many by surprise. For stock pickers like me, it could provide the opportunity to profit from any indiscriminate and outsized moves in prices.”
Roberts has managed the Fidelity Global Dividend fund since its launch in January 2012. During this time it has generated a 119.05 per cent total return, making it the second best performer in the IA Global Equity Income sector and beating its MSCI AC World benchmark in the process.
In addition, the fund has one of the peer group’s lowest maximum drawdowns (standing at 7.55 per cent since launch, compared with 11.38 per cent from its average peer and 10.95 per cent from its benchmark) and one of the best Sharpe ratios.
The FE Invest team, which has the fund on its Approved List, said it is a “no brainer” for cautious investors seeking a global source of dividends.
Performance of fund vs sector and index since launch
Source: FE Analytics
“Roberts’ approach to equity income investment is not revolutionary and does not differ too much from other equity income managers,” the FE Invest team said.
“Nevertheless, he has been more successful in implementing it as he may be more patient than his peers. Roberts also does not hesitate to take strong sector bets, which paid off over time.”
Fidelity Global Dividend has a 0.97 per cent ongoing charges figure (OCF) and is yielding 2.79 per cent.