Global equity as a staple ingredient in your portfolio

Equity income funds have long allowed investors to have their cake and eat it, in that they provide an attractive growing income and potential for long-term capital growth. For UK investors, equity income funds have long been a staple ingredient of their investment portfolios, but diversifying equity income exposure overseas makes perfect sense.

The vast proportion of dividends generated from the UK stock market are attributable to a small number of stocks and sectors and a large proportion of the most popular UK equity income funds will have a high commonality. By contrast, taking a global view provides a much extended universe, through stock, sector and not being so reliant on the domestic economy.

Over the long term, dividend income has accounted for a substantial proportion of the total return from the UK stock market. However, if we look at the MSCI World Index over the past 20 years, up until the past decade you would have struggled to argue convincingly to investors about the merits of global equity income investing.

At that time, recent past performance would have suggested that total returns from global stock markets were driven by share price growth with the capital and total returns being closely aligned.

However, in the past decade, the impact of positive income streams being reinvested over time has a marked impact on total share price returns. If we look at the MSCI World index over the past 10 years on capital basis compared to returns with dividends reinvested, the difference is remarkable. Reinvesting dividends accounts for more than 131 per cent compared to a capital return of 87 per cent.

Key points

• Global equity income is proving an interesting alternative to UK equity income. 
• The establishment of dividends is a function of the increasing maturity of developing world capital markets. 
• Funds that are well diversified geographically help reduce currency risk.

Structural change

The world is changing and where the UK once led the field, the developing markets of Asia, Latin America and the mature markets of continental Europe are now surging ahead. Nowadays, there is a whole world of high yielding investment opportunities to choose from. Chart 1 illustrates the geographical split of the number of FTSE World index stocks yielding more than 3 per cent.

Chart 1: Geographical split of the number of FTSE World index stocks yielding greater than 3% (Source: Newton)

North America 32%

Europe ex-UK 27%

UK 11%

Asia Pacific ex-Japan 20%

Japan 9%

Other 1%

A confluence of factors has caused a worldwide sea-change towards dividends. Global demographics are playing a part. For example, we are all living longer and increasing ageing populations means an increasing demand for real income generating assets. In addition, governments worldwide are beginning to show a more favourable tax treatment of dividends, both from a corporate and individual point of view.

There have also been global changes on the corporation front. Companies are being forced to adopt more efficient capital structures – to avoid hostile takeovers – and are more willing to pay a dividend. The establishment of dividends and a commitment to grow them is a function of the increasing maturity and sophistication of many developing world capital markets. 

The impact of these developments means that in the past 15 years the number of companies listed within the FTSE World Index yielding more than 3 per cent has risen from about 5 per cent to nearly 30 per cent.

A core strategy

This is now an established area for UK investors. The Investment Association (IA) global equity income sector came into force at the beginning of 2012, but this disguises the fact that numerous funds in this area are well established with the longest running funds in the sector having records in excess of 10 years.

As the IA recognised, this had become an established area of investment and not a short-term fad, as some investors wrongly believed it would be following the first few launches. To meet sector requirements, 80 per cent of the fund must be invested in global equities, diversified by geographic regions. The income criteria for funds must produce an annual income yield 110 per cent higher than the MSCI World Index yield.

An increasing number of funds are tapping into the income story globally and/or regionally. We have witnessed several high-profile launches in the past five years for funds looking to exploit the hunt for yield. The sector has expanded from an initial 18 members in 2012 to there now being 51 funds, with most leading providers providing a fund as part of their range. 

Of the funds in the sector, the Dublin-based Veritas fund was first to launch early in 2005, but the pioneer as far as providing access to UK retail investors is Newton, which launched its Global Higher Income fund back in November 2005. This was the first UK domiciled global equity income fund and has been a resounding success. It is now easily the largest fund in the sector, with more than £5.5bn invested. 

Where they invest

The broadly diversified global equity income funds largely tend to be focused towards developed markets where there is an established culture of companies paying dividends. Whitechurch Securities Wealth Managers uses global income funds as core holdings for income and growth investors.  

Providing managers are able to find attractive dividend stocks then I am happy that they have a substantial weighting in US and Europe as these are the major overseas regions. However, I would expect that the managers should also be seeking opportunities further afield and I look for funds that are well diversified geographically. 

One thing I look for when investing in global equity income funds is that they have a low exposure to UK shares. Most investors use these funds to diversify their UK exposure so it is important that they are largely weighted towards overseas markets. We do not want to replicate our UK equity income exposure.

While currency risk needs to be considered if investing in the sector, funds that are well diversified geographically help reduce much of that risk through investing in a basket of currencies. 

Away from the core proposals there are some more specialist funds in the sector. The demand for income has seen Fidelity and UBS launch “enhanced income” products, using the writing of covered calls to boost income generation. Other specialists in the sector include offerings from Premier Asset Management, Legg Mason and Miton that focus upon infrastructure.

Looking ahead

Despite the number of launches over the past five years I see this sector as having significant scope for development. The sector currently has £16.8bn invested with the majority of the monies invested in the largest five funds (Newton Investment Management, Artemis, Pioneer Investments, Columbia Threadneedle Investments and Veritas Investment Management).

This is a fraction of the amount invested in UK equity income funds. However, given the concentration of dividends in the UK stock market and current headwinds for dividend growth across many sectors dominating the UK market, it is likely we will see more invested overseas.

I expect to see continual changes in the structure of funds investing in the sector and how they will differ from broader global stock market benchmarks. For example, although profits have seen increasing dividends payments in the US, following the strong share price performance of US shares, the yield on the S&P 500 has fallen below 2 per cent.

This is leading to most fund managers in the sector looking further afield and reducing US exposure in favour of other markets. As stock markets develop and corporate governance improves in emerging markets, I would expect them to become increasingly important in terms of the global equity income sector. Asia already is a big component of dividend payers. 

Finally, there is a misconception that in the hunt for income, high-yield stocks have indiscriminately outperformed, leaving yield stocks in bubble territory. This is not the case and over the past five years the MSCI World High Dividend Index has underperformed the wider MSCI World index.

Global dividend stocks provide good opportunities and this sector is set to remain a hunting ground for core holdings across stock market exposure.

Gavin Haynes is managing director of Whitechurch Securities