As investors continue to seek alternative sources of income to traditional bonds and UK equities, some are turning towards global equity income funds.
Net retail inflows into the Investment Association (IA) Global Equity Income sector have been steady but not spectacular in the past 12 months, with the category unable to surpass £200m in a month.
The appeal of these funds is the idea of diversification of income sources and moving away from the UK, where the top-15 dividend payers in the third quarter of 2015 accounted for 62 per cent of total UK dividends. But exactly how global are these income vehicles?
Research conducted by Neptune – using data from FE Analytics – suggests a number of funds within the IA Global Equity Income sector could be considered overweight the UK compared with the MSCI World index, which has 7.7 per cent allocated to the country.
The data shows that at October 5, only one global equity income fund was underweight the UK relative to the benchmark, while 24 out of 36 funds had a double overweight.
In addition, 11 out of 36 vehicles had more than 20 per cent invested in the UK, while the average global equity income fund has 17 per cent.
The research argues this over-concentration leads to significant overlaps with UK income funds, with vehicles in both sectors often holding the same firms.
Neptune Global Income fund manager George Boyd-Bowman says: “I am mindful that many UK investors use global equity income to diversify their domestic exposure, so I am keen to ensure my fund isn’t too UK-focused. That said, I’m relatively cautious in my outlook for UK equities. While the recovery since the financial crisis has been impressive, we believe there are a number of underlying fragilities that many investors are ignoring.”
Stephen Thornber, manager of the Threadneedle Global Equity Income fund, notes that while his vehicle has 16-17 per cent in the UK, this is driven primarily by the fact the country is a good source of income with more strong-yielding companies than many other markets.
He says: “The US and Japan don’t have as strong a dividend culture. You have to go where the opportunities are and there are more in the UK and Europe.”
He adds that many UK firms are not pure plays on the domestic economy. “A lot of the companies are global, so we’re not owning them because they’re UK but because they’re global. Only a small amount of the UK exposure [in the fund] is pure domestic UK. There can be a disconnect between where a stock is headquartered and what drives its returns.”
Henderson International Income Trust manager Ben Lofthouse notes the UK forecast dividend yield from Citigroup at the end of September was 4.1 per cent for the UK, 2.1 per cent for the US and 2.6 per cent for Japan.
He points to the strong dividend and corporate culture in the UK compared with other markets. “That is why a global fund would have more in the UK. For example, an energy company in the UK might pay more than one in the US because of the corporate culture.”
But Mr Lofthouse adds that the problem is whether UK exposure is diversifying holdings the client already has, or building on existing exposure to certain stocks. “I don’t think the idea of UK investors holding UK stocks is wrong,” he says.
“But the risk is that if you’re buying lots of funds that [include] the same stock, then what we saw in the crisis is a lot of people owning Lloyds and RBS, and then BP when Macondo happened, and so the diversification aspect of investing had declined a bit.”
Jacob de Tusch-Lec, manager of the Artemis Global Equity Income fund, agrees that any investment has to be considered in conjunction with what the investor already holds.
He says: “It is not just how much UK you have, but if you have the [exposure] that your client already owns. It is different if you have names that are listed in the UK but are not the mega caps that people already have a lot of.”
Meanwhile, Newton Global Income fund manager James Harries points out the UK remains a fertile source of ideas for income portfolios, combined with the fact it is “not particularly representative of the UK economy”.
He explains: “In our case, you end up having 85 per cent of the fund overseas and you still benefit from being able to access some of the best firms in the best global markets. It is likely that an income fund, even a global one, will have an allocation to the UK and that’s perfectly sensible. If it has 40-50 per cent in the UK and calls itself global, then you’d have grounds for questioning it.”
Nyree Stewart is features editor at Investment Adviser
OPPORTUNITIES: ARE THEY BIG IN JAPAN?
Neptune suggests Japan is an overlooked market for income as 55 per cent of companies listed on the Topix index increased their dividend in 2014, while total dividend payments from the largest firms surpassed ¥9trn (£48.2bn) and share buybacks rose 76 per cent in 2014. Its research notes 86 per cent of funds in the IA Global Equity Income sector are underweight the country, while 20 per cent have no exposure.
George Boyd-Bowman, manager of the Neptune Global Income fund
“Japan gives my portfolio a good layer of diversification. The UK, Europe and US have relatively high correlations to one another, but Japan typically has a lower correlation to these markets. Emerging market firms could also be used to further diversify the portfolio, but I’m cautious in my outlook for the asset class. I have around 6 per cent in emerging markets, mostly in India, but would up my exposure significantly if the situation improved.”
However, other global income managers suggest there are not as many opportunities as you might think.
Ben Lofthouse, manager of the Henderson International Income Trust
“Dividend growth in Japan is strong but it is coming from a low base. The payout ratio is low – somewhere in the 20 [per cent range] – whereas the UK is closer to a 50 per cent ratio. It is a tricky one, we are certainly seeing a lot more stocks yielding attractively. The problem is that some of those with high yields are in areas of the market that have been structurally challenged. The range of higher-yielding stocks in Japan is not across as broad a base as in other markets, so the number of opportunities you can look at are probably lower there than [elsewhere].”
Jacob de Tusch-Lec, manager of the Artemis Global Income and Global Equity Income funds
“I’m drawn to Japan from a micro point of view, but I’m slightly underweight [the country]. It only pays about 5 per cent of global dividends, so you have to go very overweight for it to make a meaningful difference. The problem is the micro reform we’re seeing is good, but it [tends to] apply more to stocks that have very low dividends to begin with. Companies with high dividends have already done that. Japan is somewhat cheap and is doing something to transform itself, although it’s going slowly.”
James Harries, manager of the Newton Global Equity Income fund
“There are arguments to suggest that corporate governance in Japan is changing so that shareholder returns are being given a greater emphasis, but I’m sceptical about it. There are individual examples where that is the case, and some companies are putting up their dividends quite substantially, such as Japan Tobacco. We are struggling to find businesses [in the country] in which to invest. We are underweight Japan, but we have hedged into the yen as we recognise how cheap [the currency] is.”
Stephen Thornber, manager of the Threadneedle Global Equity income fund
“We like the Japanese recovery and we think [prime minister Shinzo] Abe’s policy is moving the right way, but it is not going to be able to cure all ills at the same time. [There are] fewer opportunities but quite often those are international in nature, such as Canon. We like Japan and the dividend culture is beginning to change, but from such a low level it will be quite a while before meaningful yields come through.”
