Martin Connaghan and Samantha Fitzpatrick, deputy co-managers working with Bruce Stout on the Murray International Trust discuss how they are building resilience and diversification into the global income portfolio in today’s difficult markets.
The recent market disruption has been revealing for income investors, exposing weaker companies and poor diversification
The arguments for looking globally for income are well-made, but it won’t bring automatic diversification
It is important to focus on quality businesses that provide real diversification in an uncertain world
Warren Buffett famously said that it was only when the tide went out that you could see who was swimming naked. In this respect, the recent market disruption has been revealing, particularly for income investors. It has ruthlessly exposed those companies with high debt or flagging business models or where investors have had insufficient diversification.
The arguments for looking globally to generate income have been well-made: it can bring new sources of growth to a portfolio, away from the large, mature businesses that tend to dominate UK dividends. It allows investors to incorporate new sectors, unrepresented in the UK, such as technology. At the same time, fund managers can gravitate to ‘best in class’ global companies rather than limiting their exposure.
Equally, for any investor relying solely on the UK for their income, it has been a tough period. Overall, 45% of UK companies announced cuts to dividends in the first quarter, with a further £23.9bn at risk later in the year. The UK’s largest dividend payer, Shell, cut its payout by over two-thirds. It is not all doom and gloom: over £31bn in dividends are considered to be ‘safe’ and sectors such as mining and pharmaceuticals have held up well, but investors without sufficient diversification in their portfolios may have been caught out.
However, in this environment, looking globally is not an answer in itself. Household names such as Boeing, Ford or LVMH have cut their payouts. Specific industries have been hit wherever they are in the world – airlines, travel and hotels, the oil majors. The government and reputational pressure not to pay dividends at a time applies as much across Europe, for example, as it does in the UK.
Investing globally brings access to a broader range of options at a time when diversification is vitally important, but some discrimination is needed. For example, in emerging markets the banks are not subject to the same pressure as they are in the UK or Europe. Having not received the same level of support from governments, they can be in control of their own destinies. This is particularly notable in Asia, where economic activity has bounced back quickly. Banks such as Siam Commercial and OCBC Singapore have looked robust through this crisis. At the same time, emerging market banks may be in a different – and potentially more supportive – interest rate cycle.
It is also important to focus on quality, particularly at a time when companies are facing unique challenges. In theory an income discipline should naturally lead investors to quality companies. However, this hasn’t necessarily been true in recent years, with companies engaging in some financial engineering to shore up their dividend payments. Companies may have borrowed to pay dividends and let dividend cover drop (the extent to which dividend payouts are covered by revenues). As such, investors need to look beyond the headline yield to build a true picture of the company’s strength and ability to maintain and grow their dividends over the longer term.
The current environment has muddied the waters. While a lot of companies are cutting dividends, their reasons for doing so may be very different. Some companies will have strong balance sheets and little debt, but simply have no visibility on earnings in this environment. As such, they consider it prudent to shore up cash while they can, rather than pay it out to shareholders. We hold groups such as Kimberley Clark Mexico in the portfolio, which has been a major beneficiary of the demand for basic household goods during the crisis but has sensibly decided not to raise its dividend until the environment is clearer. To our mind, this is a reasonable approach in uncertain times.
There are others, however, where there are far greater risks. They may be in an ‘at risk’ sector, or they may be a structurally vulnerable business with high debt that they need to roll over in the short-term. They may be in danger of a major reputational hit if they are seen to pay dividends in this environment. As dividend investors, it makes a difference why a company is cutting its dividends and, as such, whether it should remain in the portfolio. Decent businesses with strong balance sheets should eventually get some clarity on the economic recovery and dividends should resume.
Also, we would argue, being in the ‘right’ sector is not enough. The pharmaceutical sector is in favour at the moment, but not all companies have participated equally. Roche has been at the forefront of Covid-19 testing thanks to its largest diagnostics capability, while many other pharmaceutical companies around the world have been forced to catch up. Looking across the globe means that we can cherry-pick the strongest groups in each sector.
Having a wide choice at this time, when a number of sectors have been affected very badly, is vital in this environment. However, diversification doesn’t happen automatically simply by looking globally. To find those companies capable of maintaining and growing a dividend over the long-term requires discernment, particularly in today’s uncertain environment.
Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.
Risk factors you should consider prior to investing:
- The value of investments and the income from them can fall and investors may get back less than the amount invested.
- Past performance is not a guide to future results.
- Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
- The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
- The Company may charge expenses to capital which may erode the capital value of the investment.
- Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
- There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
- With funds investing in bonds there is a risk that interest rate fluctuations could affect the capital value of investments. Where long term interest rates rise, the capital value of shares is likely to fall, and vice versa. In addition to the interest rate risk, bond investments are also exposed to credit risk reflecting the ability of the borrower (i.e. bond issuer) to meet its obligations (i.e. pay the interest on a bond and return the capital on the redemption date). The risk of this happening is usually higher with bonds classified as ‘subinvestment grade’. These may produce a higher level of income but at a higher risk than investments in ‘investment grade’ bonds. In turn, this may have an adverse impact on funds that invest in such bonds.
- Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
- The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.