In a low interest rate environment investors have focused more on deriving an income from a variety of equities so much so that from January 2012 the IMA established a new global equity income sector to sit alongside the original UK equity income peer group.
In terms of longer-term performance there is little to choose from between the two sectors. The average of the 15 global funds with a three year track record returned an impressive 66.53 per cent, compared with the 68.87 per cent average of the 91 funds in the UK equity income sector.
However, when compared to the MSCI All-Country (AC) World and FTSE 100 equity markets, the two sectors underperformed, with the MSCI returning 78.21 per cent for the three years to March 2 2011 and the FTSE 100 returning 87.47 per cent.
In part this is due to the volatile macroeconomic conditions since 2009 in the aftermath of the Lehmans collapse, and recent ongoing uncertainty regarding the sovereign debt crisis in Europe and resulting austerity measures, in addition to concerns over slowing global growth.
However in what was one of the most volatile years for investments, equity income sectors performed well in 2011, with global funds returning an average 4.46 per cent, slightly ahead of the IMA UK Equity Income sector’s 3.94 per cent.
In addition, in the past year these income strategies outperformed the main indices, with the MSCI AC World returning a small 0.85 per cent for the year to March 2 2011, while the FTSE 100 returned 2.04 per cent.
That said, the average figures do disguise a variety of individual returns, with the one year performance in the IMA Global Equity Income sector ranging from the 2.5 per cent loss of the £11.75m River & Mercantile Global Higher Income fund to the 10.61 per cent positive return of the £1.88bn Veritas Global Equity income, according to Morningstar.
The IMA UK Equity Income sector also has its fair share of divergence in performance. The worst-performing fund for the year to March 2, the £23.82m Marlborough UK Income and Growth trust, recorded a loss of 5.66 per cent compared with the 12.67 per cent return of the £462.2m Troy Trojan Income.
Reversal in attitudes
The reasons for this disparity in recent performance can in some part be attributed to a reversal in investment attitudes at the turn of 2012 from a strong aversion to risk in first part of the second half of 2011 to appetite for risk returning in the subsequent months.
Kenny Warnock, co-manager of the £48.41m Alliance Trust UK Equity Income fund, which returned 2.72 per cent over the year, explains that in the third quarter of 2011 when eurozone concerns were peaking, economically sensitive firms were badly hit, in spite of having relatively strong balance sheets.
“What was quite interesting was that the extent of the decline of those types of shares versus classic defensive shares – those not so dependent on overall economic growth – was actually greater than we’d seen in the worst stages of the credit crunch. So essentially investors were willing to pay a significantly higher premium for safety than they had before,” he says.
“That presented an interesting opportunity, because companies were in a much better position than they were in 2008, when the banks simply stopped lending and that had sort of ricocheted throughout the entire economy.
“That didn’t happen in 2011 because companies were in a much better position themselves and more importantly they had cash. They were very liquid, they weren’t under any short term liquidity stress and they weren’t beholden to the banks.”
The FTSE bottomed out near the start of the fourth quarter of 2011 resulting in a fairly strong recovery to the year end. However the willingness of investors to pay a high premium for perceived safety seemed to have peaked at the end of December resulting in a fairly violent reversal between the performance of defensive and economically sensitive stocks.
Mr Warnock notes: “In our portfolio our top five performers are up roughly 20 per cent and our bottom five are down an average of 5 per cent. So in an overall market that is up 4-5 per cent, there has been incredibly extreme diversions of performance between the upper end - the cyclicals, the financial sectors and the mining companies - which have all gone up between 15-50 per cent, and at the bottom you’ve got all the companies that did well in the past 18 months, such as the pharmaceuticals, food companies and tobacco.
“That’s a very extreme move. That’s why the turn of the year was an interesting line to draw, as within the equity income sector there are fairly divergent opinions on where to position a portfolio some are heavily into defensive shares and some are not, and clearly that’s been by far the most important determinant of performance in the year to date.”
Regional plays
In addition to a range of defensive and economically sensitive sectors, global equity income funds also access income from a range of different countries, rather than relying on a handful of FTSE 100 companies for UK dividend payouts.
Ben Lofthouse, manager of the Henderson International Income trust, which takes a global income perspective, notes in 2011 those vehicles that had a higher allocation to the US benefited from a stronger stockmarket compared to emerging markets and Europe.
“People started to get more excited about a US recovery than they did anywhere else. In the last quarter of the year the US performed really well as a stockmarket and dividend income performed well within that on a yearly basis. US utilities, tobacco and food companies all did pretty well because they were kind of a safe harbour within a storm,” he explains.
Mr Lofthouse admits that US companies have quite a low dividend payout ratio, at less than 40 per cent of earnings. Yet many investors prefer a safe yield with the potential to grow so they have tended to focus on buying stocks on a 3-5 per cent yield that have been steadily performing rather than those with a high yield that could be cut. Some areas, he says, were not so lucky, but partly thanks to the US the global market as a whole did not cave in.
“Europe was a tough market last year. Some of the hard hit areas were things like utilities. There is a lot of yield in telecoms but that’s been quite a weak sector, with a lot of regulatory changes in the past few years that are still working through. But on the flipside in the US and Canada telecoms were actually good performers.
“So it has been possible by being global to be in a sector that in one market hasn’t performed very well, but in another market has performed quite well. On an industry basis you can diversify your risk and avoid some areas that you might not be able to avoid as much if you’re looking for income on a one country basis.”
While Mr Lofthouse agrees some of the better performing income stocks from 2011 have seen a turnaround since the start of the year, continuing signs of growing dividends are also a factor, even from European companies such as chemicals firm BASF and stock exchange group Deutsche Börse.
He adds: “The US is a lower yielding market overall. The yield in Europe and UK is roughly 3.5-4 per cent, while in the US you’re looking at 2.5 per cent now and maybe a bit less with this rally.
“But there you’re seeing companies like UPS and Home Depot increasing their dividends by high single and even double digit percentages. The market has been fairly volatile recently but what we’re seeing at the moment is that companies are feeling confident enough to increase their dividends.”
Outlook
In the long term, the outlook for equity income seems optimistic. Adam Avigdori, co-manager of the £735.58m BlackRock UK Income fund, suggests the UK market remains attractive, with many companies’ share prices trading on low multiples of their earnings. In Mr Avigdori’s words, these advantages are coupled with “£180bn being held on corporate balance sheets, which will likely lead to an increase in mergers and acquisitions activity, corporate investment and increased dividends, as confidence gradually returns to the global economy”.
However, Mr Warnock adds that for equities to continue their rise upwards – major macroeconomic hiccups aside – the slightly better economic data that is emerging needs to be translated into better expectations for profits. He adds: “It is possible that we go into a holding pattern, with the markets just trading at a range until we see that dynamic come through. If it does come through then the prospects for equities moving higher towards the end of the second quarter and beyond are better than evens probability. If don’t see that then we do run the danger of sinking back down a little bit.”
Nyree Stewart is deputy features editor at Investment Adviser
