Global equity income investing can provide a relatively high income yield for retirees and other investors, as well as steady capital gains. It gives fund managers the flexibility to pick the best income stocks globally, rather than being limited to a single market.

The key is a truly global approach, an uncompromising search for well-run companies which pay a steady stream of dividends, and eschewing complex derivative-based strategies in favour of simplicity. When these principles are applied effectively, global equity income strategies can play an integral role throughout Australian savers’ lifespans, from the growth phase all the way into retirement.
Australia boasts a strong dividend culture and a history of delivering good growth. However, much of these dividend yields have come from the financials and materials sectors, with little diversification further afield. Australian yields may be reasonable today, but given the narrowness of their sources, it is questionable whether they will continue to deliver in all market environments.

Going global

Why go global? A global approach provides the opportunity to access the world’s most promising high dividend stocks. This means a better diversified portfolio, offering a degree of downside protection if a particular country or sector underperforms. Investors benefit from a larger pool of prospective companies and industries than they would get by looking purely within Australia.
Global equity income funds have come to the fore in the wake of the financial crisis, which highlighted the need to diversify. Since then, other market events, such as the sharp fall in oil prices, have demonstrated the importance of not being overly reliant on one sector.

A badge of investment quality

Having so many stocks to choose from gives access to more well-run companies which pay consistently high dividends.

Dividends are an under-appreciated sign of investment quality. There are several reasons why companies which pay consistent dividends are appealing. Businesses which prioritise paying a steady stream of income to their shareholders are typically effectively managed, with a strong degree of cashflow certainty. They are usually established, profitable companies.

Empirical research by Robert Arnott and Clifford Asness showed that high dividend pay outs indicate a company is confident about the future. They concluded that company management confident of sustainable future earnings growth tend to pay out a large share of earnings in the form of dividends, unlike those that are more pessimistic who pay out a lower share – perhaps so that they can be confident of maintaining the dividend payouts.

Such well-managed companies tend to have a high dividend yield, earnings growth and robust balance sheets. Furthermore, as the table below shows, reinvested dividends compounding over time make a powerful contribution to capital growth. As a result, these companies offer the ideal combination of high income and potential capital growth.

The role of global income

Global income strategies can play a key role in giving investors a retirement income. Australian savers are moving away from taking their superannuation pension savings as lump sums and instead are adopting strategies which allow them to gradually draw income in retirement.

The latest data from the Australian Bureau of Statistics (2015) suggest that barely half (53%) of Australian retirees expect their main source of personal income in retirement to be superannuation, an annuity or allocated income.

Yet like many people all over the world, Australians are concerned about funding their retirement and their future financial security in general. Data from a white paper by IPSOS/MLC Australia, A look at lifestyle, financial security and retirement in Australia (2016), found that a third of Australians believe their children will not be able to afford the same quality of life that they have enjoyed.

Almost three in five Australians were concerned they would be unable to fund their current lifestyle over the next decade, with people aged 50-70 marginally more concerned than other age groups.

As investment products grow more sophisticated to meet the needs of retirees who no longer want to simply take a lump sum at retirement, global equity income strategies can play an integral role in meeting their needs. This style of investment gives investors a good yield, with the potential for growth over time.
Moreover, the role of income investing isn’t limited to the post-retirement universe. In fact, global equity income investing can help to accumulate capital. When dividends from an income fund are reinvested and compounded over time, they can form a large chunk of long-term growth.

It’s time to re-think the role of income in Australian investors’ portfolios. Income is much more than just a bond proxy. Across the globe, it is possible to identify companies which prioritise delivering solid dividends, while pursuing long-term growth. These companies represent an attractive proposition for Australian investors, wherever they are on their savings journey. The effect of compounding reinvested dividends adds to the attractiveness of this style of investing for younger savers.

By Stephen Thornber, Global Equity Portfolio Manager

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Craig Mowll

Equity income strategies may have performed well in the last few years, but as quantitative easing is wound back and growth accelerates, can yield stocks really continue to deliver?

Absolutely, says Stephen Thornber, Fund Manager, Global Equity Income at Threadneedle Investments, who explained why investing for income can add performance over time, regardless of wider macroeconomic or stock market conditions.

“We believe there are fundamental reasons why high dividend companies outperform over the long term. Dividends demonstrate a commitment to creating shareholder value, promote long-term decision making, and reduce the risk that management makes poor investments.”

“Successful income investing is about identifying businesses that are paying high and growing dividends while sustaining a robust financial position. In a rising interest rate environment the importance of focusing on dynamic growing companies cannot be understated,” Mr Thornber explained.

“There is a misconception that performance of dividend stocks is closely linked to interest rates. In fact the majority of dividend stocks are priced by the market on a ‘total expected return’ basis against other stocks with similar prospects.”

“The exception to this is stocks we call ‘bond proxies’, typically companies that offer little or no growth, but a reliable income stream”. Regulated utilities or REIT’s would be good examples. These stocks are interest rate sensitive, and challenged by rising rates.”

Given the strong performance of the past few years, there is concern that equities may now be overvalued, and that investors should exercise caution.

Mr Thornber said that in his view equities remain attractive given valuations are at or below long term averages, and earnings are set to accelerate as a global recovery takes hold.

“High-dividend paying companies are trading at a discount to the broader market in every major market” he explained. “We are taking particular care when selecting companies in the US, where valuations are higher, but having said that, we feel the strong prospects for the US economy support higher valuations,” he said.

Mr Thornber continued by saying that dividend investing remains a sound investment approach for a number of reasons.

“For a start, current dividend payout levels are set to rise because corporates are in good health. In stark contrast to governments, corporates have done a good job of repairing their balance sheets in recent years. Cash generation is good, and because there is still reluctance to commit to large-scale capital expenditure, companies are using their cash in shareholder-friendly ways, such as dividend increases, special dividends and share buybacks,” he said.

In conclusion, Mr Thornber said that a global approach to equity income investing provided investors with a wider opportunity set.

“By adopting a global approach, investors gain access to economies which may be growing more quickly than their domestic economy.

“When managing portfolios, we aim to tilt the portfolio towards the fastest-growing industries and economies, spreading risk and increase total returns for our investors,” he said.

Threadneedle’s partner in Australia, Certitude Global Investments, reaffirmed that an equity income strategy is a particularly apt solution for local investors looking for international diversification.

CEO of Certitude, Craig Mowll said: “Australia represents only a small fraction of all investment opportunities, and local investors have recognised the need to diversify offshore. However, volatility in global markets is a concern for many Australian investors who want to preserve capital ahead of their retirement years. An equity income solution is therefore well-suited for investors who are looking to capture growth opportunities beyond our shores but still benefit from income that these dividend paying stocks provide.”

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Income story: is growth and returns possible?

Regardless of whether improving economic data prompts the Reserve Bank of Australia (RBA) to keep official rates on hold tomorrow, interest rates will remain at historic lows. So should income-seeking investors consider moving out of dividend stocks and seek capital growth as global economies pick up?

“Worldwide economic indicators are definitely improving, and with the property market also showing signs of life, most analysts would be surprised to see the RBA cut rates next week,” says Stephen Thornber, Portfolio Manager, Global Equity Income, at Threadneedle Investments. “In fact, if global economies continue to improve, at some next year point rates may even be lifted.”

Nonetheless, Mr Thornber says that a dividend income-based strategy can offer investors both a high yield and the potential for capital growth.

“Investing in dividend stocks doesn’t have to mean that the potential for capital growth is compromised,” he says. “In fact, the last two decades have shown that investing in companies which pay high dividends actually results in superior total returns.”

Talking about the effects on income-based strategies of better global economic data, Mr Thornber said that by focusing on dividend paying companies that are growing, investors can participate fully in rising markets.

“Traditionally income strategies have been a defensive investment, but a new generation of funds have been successful in both protecting capital during market weakness, while keeping up with rising markets – as we have seen this year.”

Equity income investing has grown in popularity as retirees seek alternatives to bonds and term deposits, which are less attractive as inflation rises.

“Equity income provides a good hedge against inflation, which is particularly valuable in an environment of quantitative easing as we have seen in recent years,” he explained.

In a low-growth world companies are using dividends not only as a means of rewarding investors, but also to demonstrate financial strength and draw new investors.

“A robust balance sheet means that a business can sustain rising dividend payments, weather potential economic storms, and invest in profitable growth,” Mr Thornber said.

Mr Thorber continued by saying that the volatility risk of owning equities can, to some extent, be offset by being prepared to invest for the longer-term, allowing the benefits of a rising stream of income to drive value creation.

“The right equities can deliver both yield and growth with manageable levels of risk,” he said.

At Threadneedle, meeting companies and conducting fundamental research lies at the heart of the stock picking process. This bottom-up stock analysis is then combined with thematic insights and overlaid with macroeconomic factors gleaned from colleagues working across all investment classes.

Mr Thornber concluded by saying that he expects continued growth in the global equity income sector in the years ahead, as the dividend culture gains momentum in world markets, and an ageing population continues to focus on yield.

“With the right stocks, investors should absolutely be able to expect strong and consistent income as well as capital growth as markets improve,” he said.

The Threadneedle Global Equity Income Fund (Unhedged), an Australian registered investment management scheme which invests in the actively managed Threadneedle Global Equity Income Fund, is available in Australia via Certitude Global Investments.

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Global equities pave their way

Investors’ appetite for income shows no sign of abating in 2013, but with interest rates and bond yields at historically low levels, their eyes are increasingly turning to global equities for dividend income and the prospect of capital performance.

But not all global equities are created equal, and real success lies in picking the right ones, explains Stephen Thornber, Portfolio Manager, Global Equity Income, at Threadneedle Investments.
 
“Investors have been asking me whether the renewed focus on income means that income stocks are expensive now,” he said. “My response is that, high dividend paying stocks have historically traded at a discount to the broader market, and this discount is actually higher now than it was two years ago.”
 
Mr Thornber said that Threadneedle’s belief in fundamental, bottom-up stock selection, informed by top-down economic and thematic inputs as a key driver of returns has translated into strong performance from its Global Equity Income strategies.
 
“Following the GFC many companies strengthened their balance sheets by paying down debt and reducing costs, however recently corporates have been increasingly rewarding shareholders through higher dividend payments.”
 
In November last year Certitude Global Investors launched the Threadneedle Global Equity Income Fund (Unhedged), an Australian registered investment management scheme which invests in the actively managed Threadneedle Global Equity Income Fund. The Threadneedle Global Equity Income Fund has consistently outperformed its benchmark, the MSCI AC World Index, over 1, 3 and 5 years, providing annualised returns of 19.8%, 15.4% and 5.2% respectively, to 31 January 2013*.
 
“We look for companies with ‘quality’ income, which for us means three things.  Firstly, we insist on a minimum yield of 4%, as every stock has to contribute to achieving a high portfolio yield.  Secondly, we seek dynamic companies that are growing earnings and dividends, and lastly we look for companies with a robust balance sheet, which gives us confidence in future dividends and the ability of the company to invest in growth,” Mr Thornber explained.
 
Meeting these criteria does not mean a stock is automatically held, rigorous fundamental research is conducted to investigate which opportunities are the most attractive.  The focus of the investment team turns to fundamentals, such as industry dynamics, competitive advantage, margins, free cash flow generation and quality of management in order to produce a valuation price target.
 
Mr Thornber finished by saying that risk control was also central to good portfolio construction and by investing globally he is able to construct a portfolio that is well diversified by sector as well as geography.  “In Australia the big four banks and BHP account for nearly half of all dividends paid.  By investing globally we spread the risk far more widely while still generating a high portfolio yield.”

 
* Annualised gross returns to 31 January 2013, in USD

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