Equity income investors may be having a simpler time of it than bond counterparts struggling to cope with negative rates of interest, but the search for yield is becoming harder in stockmarkets, too.
While a falling pound has helped increase the attraction of dividends denominated in other currencies – including those paid by some major UK-listed stocks – the contrasting dangers of yield compression and dividend cuts have tempered the appeal.
With valuations for income-paying stocks having been bid up in the UK, the US and further afield, and dividend growth looking a tough ask in some quarters, Société Générale head of quantitative equity research Andrew Lapthorne has ventured an unlikely alternative.
“In a world where higher dividend yield stocks have been getting re-rated on the back of aggressively low interest rates, Japan has been the exception,” Mr Lapthorne said.
“We never thought we’d say it, but not only is Japan attractively valued, it is increasingly becoming an equity income pick.”
Japan’s equity market is expected to yield only 2.5 per cent next year, well under the 4 per cent predicted for the UK, the 3.8 per cent estimate for European stocks and the 2.7 per cent forecast for the runaway US market.
But Mr Lapthorne identifies one particular quality which strengthens Japan’s case, at a time when corporates are being encouraged to boost payout ratios.
UK investors will be familiar with the problem of dividend cuts amid a string of high-profile UK businesses slashing payouts over the past 18 months, but Japanese corporates’ ability to use their profits to return money to shareholders looks more reliable.
Japanese companies had the equivalent of £2.4 trillion in cash on their balance sheets as of last year, roughly double the £1.2 trillion that Moody’s has estimated was held by US corporates in 2015.
“Not only does Japan offer a dividend yield not seen outside of a crisis, but that dividend yield is also underpinned by better dividend cover than either the US, Europe or Asia ex-Japan,” Mr Lapthorne said.
Japan may not be the only unfavoured region worthy of reconsideration by income investors. Alex Dryden, global market strategist at JPMorgan Asset Management, notes that European corporates’ typical payour is now 120 basis points above even the highest yielding eurozone government bond – Spanish 50-year debt.
Speaking at a FundCalibre event, Alice Gaskell, manager of the BlackRock Continental European Income fund, said her portfolio was able to achieve a 4 per cent yield “without banks, autos or miners”.
Nor is the European market reliant on increasingly expensive bond-like stocks to deliver income, according to the BlackRock manager. Ms Gaskell claimed there was “a lot more choice in Europe [than other dividend-paying markets]”.
In valuation terms, both Europe and Japan look attractive from the perspective of price to book value (BV) ratios. Europe trades on 1.6 times BV, with Japan trading on just 1.1 times, according to Société Générale.
But it is income generation which remains the overriding concern for many portfolio managers.
“Traditional income assets look incredibly expensive. While I don’t think equities are higher risk, if you think of risk as permanent capital loss, they are certainly more volatile. That’s of particular concern for income investors, most of whom are in retirement,” said Dan Kemp of Morningstar.
