Why should you consider Global Equity Income funds?

Cherry Reynard looks at why a global approach to equity income is the way forward.

The weaknesses of the UK Equity Income sector have been ruthlessly exposed by the volatility in markets. First, high-yielding financials took a tumble, then companies across the board cut dividends and now income managers have the BP crisis to negotiate. The sector has attracted criticism for becoming progressively more concentrated. The Global Equity Income sector has expanded on the back of this weakness, plus an improvement in dividend payouts globally. The past year has seen new launches from, among others, Artemis, Invesco Perpetual and Sarasin. Does it now provide a real alternative?

The arguments for taking a global approach to equity income have become increasingly compelling. James Harries, manager of the Newton Global Higher Income fund, admits that up until as recently as five or six years ago, a fund manager could not have built a credible global income portfolio. But since then, there has been a significant improvement in the dividend yield of companies across, in particular, Continental Europe and Asia-Pacific as they have moved to accommodate the needs of a global shareholder base.

Job Curtis, manager of the Henderson Global Equity Income fund, says: “This expansion has raised some interesting income opportunities. Some markets have always been good dividend payers, such as Hong Kong, but now Taiwanese companies also have good yields, plus many Australian companies. The US is still a lower-yielding market overall, but there is more interest in dividends as the tax treatment is extremely favourable.”

Excluding the UK market

The greater choice available is in contrast to the increased concentration of the UK Equity Income sector with around 10 stocks providing up to 50% of the overall yield on the All-Share. Global equity income fund managers can move into certain sectors that do not pay dividends in the UK market. Harries gives the example of mining companies: few pay a dividend in the UK, but there is plenty of choice globally. There are even some technology stocks, such as Intel or Taiwan Semiconductor, now paying a yield.

That said, Curtis says there are still certain sector biases. He says: “It tends to be utilities, telecoms, pharmaceuticals, food and beverage, tobacco and oil, but within this there are more opportunities – in oil, for example, we are not restricted to BP and Shell, but could look at ENI, Statoil or PetroChina.”

Gary Potter, joint head of multi-manager at Thames River Capital, says the concept of seeking income globally is sound: “The dividend payout ratio for companies outside the UK is improving and also because of the concentration of the UK stockmarket it can be an important diversifier. Also, Sterling is vulnerable and it can be good to generate more income from overseas sources. This is not simply the latest fashionable sector – there are strong reasons behind it.”

But does it work in practice? Many of the funds are relatively new to the market, including those from Artemis, Invesco Perpetual, Lazard, Baillie Gifford and M&G. Of those with a three-year track record, performance has been mixed. The Newton Global Higher Income fund is the top performing, sitting 28th out of 250 funds in the global growth sector over three years, with a return of 1.7%. The Threadneedle Global Equity Income fund is next, sitting 52nd in the sector. It has dipped 2% over the same period. At the other end of the scale are the Henderson Global Dividend Income and JP Morgan Global Equity Income funds, which have lost 27.6% and 18.3% respectively. To put this in context, the average fund in the UK Equity income sector fell 16.5% over the same period.

The sector has not been immune from the problems of the UK income sector. Financials were a high-yielding asset class globally and banks outside the UK were badly hit. The three year returns reflect that weakness. Many of the funds have done substantially better over one year, notably the M&G Global Dividend fund (launched in July 2008), which lies 6th in the sector having returned 37.8%.

Regional vs general approach

The sector tends to divide into those managers with large global resources to call upon where analysts in regional centres will submit their best ideas, such as Lazard, Newton or Henderson or those with smaller teams who focus on knowing a small number of global stocks very well and trading between them, such as Veritas. Potter says there has been no discernable difference in performance between the two approaches and over three years both types sit at both ends of the performance tables.

Individual funds will also have a different approach to income. The Newton fund, for example, will only invest in a company yielding 125% of the MSCI World Index and will sell out if the dividend drops below that level. Others are less strict and will incorporate stocks that may be relatively low-yielding, but have good dividend growth prospects.

Most will be looking for similar qualities within the companies they choose. Paul Boyne, manager of the Invesco Perpetual Global Equity income fund, for example, looks at metrics such as price to free cash flow, return on capital higher than cost of capital, cash generation and balance sheet strength. Harries’ starting point is the Newton global thematic process, but he is also seeking out companies with strong balance sheets and cash flow generation.

Too much choice

A standard criticism of global funds is they have to manage a huge universe of stocks. Curtis says the dividend discipline provides its own screen when both buying and selling stocks. Cross-border comparisons can also be difficult. Boyne is conscious of the problem and aims for a consistent judgement across all countries:

“In the US, investors are overloaded with information, but in certain emerging markets it can be very different. We aim to hold everything to the same standards and if we can not get comfortable with the financials, we simply do not buy, whatever the valuation.” Other groups, such as JP Morgan Asset Management, will ensure its analysts submit ideas on a template to facilitate cross-border comparison.

A number of commentators have suggested that with economic growth anaemic, global stockmarkets will eventually come to favour the large cap, high-yielding, blue-chips that characterise global income portfolios, but this has not yet materialised. Harries says: “We have a pretty cautious outlook. We think credit availability peaked in 2007 and this will not be a normal recovery. We have got used to low interest rates and big stimulus and when either normalise, it will cause problems. It should favour high quality, well-financed large cap companies, and these are currently on very good valuations. It looks like an anomaly.”