23rd September 2016
23rd September 2016
We have written on many occasions about the importance of income; you can see a list of our favourite income funds here. One asset class which offers an attractive income opportunity is US equities.
Clare Hart, manager of JPM US Equity Income, which is on our Recommended Funds list, says active managers are able to target those sectors paying higher dividends. Hart has a preference for companies with a low payout ratio (the fraction of net income a company pays to its shareholders in dividends), which therefore have enough earnings that they can reinvest in the business.
In the article below, written for our partners Morningstar, James Davidson, manager of another JP Morgan fund, JPM Global Equity Income, discusses the importance of dividends in overall returns from US equities and where he sees opportunities in a low growth market.
Old fashioned dividend stocks are having a moment. Equity markets have tripled since 2009, but investors have scant sources of income with government bond yields at record lows. Therefore, if investors are not thinking about income dividends and growth as a component of total return then they aren’t considering the full story.
Going back to the 1920s, nearly half of the return from holding US equities has come from the contribution of dividends, making them almost equally as important as capital appreciation. Although collecting dividends may seem an uninteresting way to accumulate wealth, it can be pretty effective, particularly when the global economic environment remains uncertain.
Past performance is not a reliable indicator of future returns
Source: JP Morgan
Ironically high dividend stocks underperformed when interest rates were at 0%, as sectors such as utilities were left behind under the allure of quantitative easing, which helped to support prices for growth stocks. Now that US 10-year Treasuries yields have rallied 80 basis points to 1.5% since the Federal Reserve’s first interest rate rise in December, the market is reassessing traditional income stocks.
As the bond refugees pitch up in equity land, they don’t just want the highest-yielding stocks. They want stocks that remind them of bonds: long duration, well managed, stable cash flows, low volatility, low-risk of contagion.
To this end dividend policy is, over and above the income it provides, a terrific signal: it indicates management’s confidence in their business, their commitment to their owners, and last but not least their competence in extracting cash from their businesses. This qualitative aspect is what the market is rewarding too. Thus so-called dividend aristocrats which haven’t cut their dividends in 25 years, have done so much better than stocks which simply have a high dividend yield.
These ‘bond refugees’ are also increasingly looking in the media sector. Some companies in this space have recurring revenues and long term intellectual capital and dividend growth alongside share buyback targets.
The toughest sector is financials which has underperformed for ten years now. European financials have their own risks around regulatory intervention and negative interest rates. The US banks on the other hand are now fully repaired and as such are permitted to pay out up to 100% of earnings.
Sectors with utility-like characteristics and substantial pay-outs even in the absence of further US rate rises will bear watching.
So where are we now? Trend growth globally is around 3% but global GDP growth is around 2% to 2.5%, but recent survey data suggests this may have bottomed out, while at the same time downside tail risks have been receding.
Find out more about the JP Morgan US Equity Income fund:
The views are of the fund manager and not those of TD Direct Investing.
Remember that each fund is unique and hence exposed to different levels of risk. Some are relatively low risk, whilst others can be very risky and those will only be appropriate for more sophisticated investors.
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