Tim Richardson

While US inflation concerns and breakout stocks such as Nvidia are currently hogging the limelight in global equity markets, broader growth opportunities are currently scarce and could have more influence on markets.

Tim Richardson, global equities Investment Specialist at Pengana Capital Group, says the current bifurcation in global equities provides selective opportunities for astute active managers. “The six S&P 500 stocks which delivered the fastest earnings growth in 2023 accounted for over 130 per cent of the earnings growth of the market, while many stocks in the index saw earnings fall back.

“This is a classic stock picker’s environment with winners and losers defined by their alignment to long-term growth themes. The AI theme is one such example. Nvidia is riding a wave of insatiable demand for the computing power required to train the large language models which support AI applications.

“But we expect to see a broadening of interest along the AI value chain, as businesses which aren’t specifically AI companies, but use AI tools to improve their services, deliver sustainable earnings growth.

“There will be major opportunities via these companies and the key is to identify them before the earnings growth becomes priced into market valuations.”

Mr Richardson said the Pengana Axiom International Ethical Funds had benefitted from exposure to Nvidia, with the fund delivering a 43.7% net return to investors over the year to 29 February 2024.

But he said Nvidia is only part of the story, with strong returns from several holdings which demonstrate ‘dynamic growth’. “In an environment where growth is scarce, targeting companies which are changing for the better is an important source of alpha.

“There is opportunity in companies that are either restructuring or developing new products or services, which may also be linked with secular growth trends such as deglobalisation and disruptive innovation.”

For example, Mr Richardson said understanding consumer trends had proved to be fertile ground for identifying dynamic growth stocks. “While consumers have been under pressure in aggregate, there are pockets of consumer spending which are performing well.

“For example, discount stores appealing to those who still have money to spend, such as Costco, affordable luxuries such as e.l.f. Beauty and high-end luxury which is insensitive to rising living costs, such as Hermes and Ferrari.”

He said Axiom had also been early to identify the shift to buying services over products, “The growth in buying services has been good for companies such as Visa, Starbucks and live entertainment group Live Nation. It even includes increased spending on pets, boosting stocks such as IDEXX Laboratories.”

Quantum change had also been evident in the pharmaceutical sector. “The successful development of treatments for obesity has brought rapid earnings growth for a very small set of companies.”

The scarcity of earnings growth is set to be a defining aspect of share markets for the foreseeable future, according to Axiom. “Markets are being influenced by four major big picture trends: debt levels, deglobalisation, demographics, and  disruptive innovation – each of these is providing opportunity for stock pickers who can identify companies poised to benefit.”

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Tim Richardson

The drop in local dividends has the potential to become more acutely felt as more Australian investors have become ‘over-exposed’ to a small number of sectors, according to Tim Richardson, Investment Specialist at fund manager Pengana Capital Group.

He said the ‘hot’ sectors for dividends on the ASX are now cooling, while overseas dividends delivered record highs for the first quarter of 2023. “While dividend yields now exceed pre-Covid levels, averages can be misleading, and conceal the fact Australian dividends have become concentrated in fewer sectors.

“Australian dividends are experiencing pressure on a few fronts, including interest rates and inflation. Energy prices are drifting lower as the global economy slows, and commodities such as iron ore and coal have fallen, while bank lending margins is also coming under pressure.

“But a bigger concern for Australian income investors is the potential to become over-exposed to a few sectors, including the potential for higher exposure to cyclical industries as the global economy slows.”

Mr Richardson said achieving adequate diversification for income stocks on the ASX had become more challenging in recent years. “Australian dividend stocks have become concentrated, with 80 per cent of dividend income being delivered by stocks in just four sectors.

“This concentration has worked to offset declining dividend yields in other parts of the economy. But it leaves the potential for dividend investors to be under-diversified and more exposed to cyclical stocks including those linked to materials, financials, energy and property.”

He said overseas stocks could provide more diversification, including access to a wider universe of profitable growth stocks in the healthcare, technology, and industrial sectors. Importantly, this could still be achieved with franking credits.

“It is possible to diversify into other markets including income-producing stocks overseas while still retaining franking credits, via the Listed Investment Company structure on the ASX.

“LICs such as Pengana International Equities Limited generate franking credits because they pay taxable income in Australia.”

As at 30 April 2023, Pengana International Equities Limited (ASX: PIA) reported profit and franking reserves (which support a fully franked dividend of 5.4 cents-per-share per annum, paid quarterly) through to the 31 December 2024 dividend, which is payable in March 2025.

When franking credits are included, this equates to an effective dividend yield of approximately 7.4%, based on the 24 May 2023 share price.

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