After three tough years in which momentum and growth strategies have fared best, income is due a comeback, says Newton’s Nick Clay.
Relatively speaking, the past three years have not been especially kind to income investors.
Broadly, global equity markets have shown resilience to the widespread geopolitical threats around the world; volatility has been low, performance has climbed steadily upwards and flows have followed that enthusiasm. Investment Association statistics showed almost £7bn of retail assets moved into global equity funds over the 12 months to 30 June 2018, defying the spectre of loosening central bank monetary policy, onerous debt levels and rising geopolitical risks.
Yet in such a ‘Goldilocks’ scenario as witnessed in the last three years – neither too hot nor too cold, sustained moderate growth coupled with low inflation - profitability and momentum-based strategies tend to fare well.
Over the three years to 31 August, for instance, returns from profitability (gross profit over assets) and momentum strategies have stood out, while dividend income has lagged. The chart below illustrates how profitability styles delivered a 48.4% return while momentum gained 44.3% over the same period. Against a benchmark of the FTSE World Developed Stocks Index return of 38.9%, only dividend income strategies performed worse, posting a return of 38.1%.
But is the tide ready to turn? In the second quarter of 2018, as volatility returned to markets after a period of relative calm, inflows slowed sharply to just £190 million, and levels have been broadly flat since.
The return of volatility since January 2018 has been exacerbated by concerns over global trade wars, and, in our view, investors’ mindsets are beginning to shift away from the aforementioned ‘Goldilocks’ environment to focus more on ‘end-of-cycle’ considerations.
We see attention switching back towards global equity income at a time when more defensive stocks have been better supported by recent flows, with investors refocusing on the prospect of a more secure and stable dividend stream in more volatile markets.
We believe this recent support - for more defensive companies with sustainable cash flows - is happening because investors are starting to remind themselves of what has worked over the long term, rather than simply focusing on a fairly short-term period of underperformance of dividend income.
As the chart below shows, over almost five decades, dividend yield, and the compounding effects of dividend growth, have provided the largest proportion of equity returns across all seven of the biggest investment markets listed in the chart.