InvestmentsJan 2 2018

The 'dividend heroes' of the past three decades

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
The 'dividend heroes' of the past three decades

Voters forget governments’ unfairness and ineptitude, for that is what they expect. But they don’t forgive governments that make them poorer, which is what this government has done since the financial crisis 10 years ago.

Moreover, the recent Budget made it clear this impoverishment will continue through at least the next decade, perhaps even longer.

Hard choices

British equity investors have had a better time of it, and their alternatives remain unattractive. Cash yields at best 1-2 per cent, while inflation is already 3 per cent a year and may well rise again in future. 

Gilts are overpriced by any conceivable yardstick, at the very moment that central banks the world over are beginning to rethink their policy of quantitative easing (QE), akin to medieval kings and tyrants’ practice of debasing the currency.

Extremely low interest rates helped banks and their corporate customers survive the worst banking collapse since the 1930s. QE’s purpose was to encourage companies to invest, either to increase capacity or improve productivity, and thus stimulate employment and pay. This experiment with our money was additionally intended to frighten savers out of cash or relatively safe investments such as government bonds, and into real but risky assets such as property, private businesses or the shares of quoted companies.

Confidence and consumption

The policy has saved the banking system for the present, but has proved, to those willing to see, that the ‘trickle down’ theory of wealth creation is crazy. Boosting asset prices simply makes the rich richer, and does nothing for the poor. 

Austerity has kept demand low, increased income disparities and ensured that political tensions remain high. Modern economies are built on confidence and private consumption, and companies only invest when they see a rising demand for their products; otherwise they leave the money in the bank or return it to their shareholders.

Historically, rising inflation or higher bank rates push gilt prices down. However, reducing the amount of cash available to the markets at the same time as QE is scaled back could well have a catastrophic effect on sentiment, and affect all asset prices.

The pied pipers of the investment world, having failed with active and passive investment strategies, are now experimenting further with the discredited efficient market hypothesis – the idea that it is impossible to beat the market. 

Investment factors such as size, value, momentum, quality, and low volatility are at the core of smart beta or factor-based investment strategies, which promise to enhance performance over time. ETFs have lured in much investment capital with this promise.

Safety first investing

Common sense should protect sensible and patient investors. Investment funds managed under corporate law, more commonly referred to as investment trusts, have significant advantages over all other forms of collective investment, as Table 1 shows. 

Managers know how much they have to invest and know that they have it forever; they can plan sensible investment strategies without worrying about outflows or inflows of investable capital as market conditions and investor attitudes fluctuate.

Given the same mandate, same manager and same period of investment, trusts outperform all competitors; this outperformance margin is tiny, but it is all that is needed where compounded returns and the world of stockmarkets are concerned. 

Smart beta and the efficient market hypothesis do not concern their managers. They are instead focused on ensuring the companies they hold have the management, products and services needed to see off all competition.

British investment trusts can hold back profits ingood years, as capital and revenue reserves, and pay them out as dividends in bad years. Every trust in Table 1 has increased its annual dividend for at least the past 30 years. 

Assuming £10,000 had been invested on 31 December 1996, shareholders would by now have received the bulk of their capital back as dividends – as shown in the penultimate column of the table. Dividend yields for many of the trusts remain low in absolute terms, but this statistic shows the power of consistent growth over the years.

Better yet, these improved dividends have increased the attractiveness of the shares. The majority have increased by more than three or four times, with some rising even further. So investors have not only had much of their original capital repaid by dividends, but have also seen that capital multiplied in value several times over.

Of course, these results do not translate into instant riches, but only fools expect that from stockmarket investment. What it does do is cement long-term savings into real wealth for retirement, and it does so through the only practical strategy of investment – investing for regular, and preferably growing, income. Other methods have been tried – and most have failed, for even successful traders within bank-dealing rooms often lose out.

Income or capital – the choice

The table reiterates another lesson. Investors can have income, or capital growth. They cannot usually have both. This is shown by the results of the two Baillie Gifford trusts. Scottish American is an equity income fund and, as Table 1 shows, has done significantly better than most others in dividend income. However, the shares have not appreciated in value nearly so well. Scottish Mortgage, on the other hand, has not only been an early advocate of technology, but has held onto its shares when conventional wisdom would have sold them. Its lower dividend yield is in part a reflection of the capital growth it has enjoyed. The lesson: if you want it now, you cannot have as much in the future.

Most companies are under threat from artificial intelligence, and commentators such as McKinsey believe that nearly half of existing jobs will have gone in the next 20 years or so. The investment environment has already changed, but it is now changing more and faster, and in ways that are hard to imagine. Managers must have the freedom and flexibility to make difficult or contrarian decisions that will stand them well over the long term.

Back to the future

The British economy, too, is changing at a rapid rate. Brexit has already exacerbated the country’s burdensome productivity problem, and this will only get worse as the process gathers pace to 2019. 

Despite Brexiteers’ dreams to the contrary, the British economy has never been renowned for its flexibility and excellence. Britain was the sick man of Europe in the 1960s and 1970s, and joined the EU to boost its skills and markets.

Unexpectedly this also solved another problem. Foreign direct investment flowed into an English-speaking country that gave access to the EU market, and suddenly governments no longer had to worry about sterling weakness every time they tried to boost the economy. 

Those deficits and that sterling weakness remain, but the overseas investment may not remain for much longer. Factor investing may not capture these changes and challenges in the way that unconventional thinkers will.