There is much discussion about the importance of dividends to overall investment returns for equity investors. At Funds Forum in June, BlackRock’s Alex Hoctor-Duncan commenced proceedings with the prophecy that the next 10 years will be the decade of the dividend. With negative real interest rates, the expectation of low growth and supposedly low inflation, these indeed are likely to be wise words.
Whatever the case, dividends are at least very important, and maybe more so, to equity investors. The evidence is compelling. In the UK since 1970, according to research from M&G, the average annual real return from UK equities has been nearly 5%, the vast majority of which (nearly 90%) has come from dividend yield, a little from dividend growth and virtually nothing from change in valuation.
The pattern is similar in other markets. For example, the return from Germany has been 4.5%, with 60% coming from dividend yield and 40% dividend growth, and in the U.S., 5.4% with 60% coming from dividend yield and 30% from an increase in valuations. Japan has seen change in valuation being a greater portion of total return, some 75% of a 2.8% per annum real return, although dividend growth has been negative. The key is that dividends should be reinvested so that compound interest can get to work.
Many UK investors appreciate the importance of dividends and reinvesting them. There is some £52.5 billion currently invested in the IMA UK Equity Income fund sector, but in contrast we reckon only £4 billion is invested in the relatively small universe of global equity income funds. However, the arguments for spreading the net wider and broadening the opportunity set are compelling. Many managers of UK funds take advantage of the ability to hold up to 20% in overseas stocks. The investment universe globally is far greater, whichever way you cut it. Other markets offer attractive dividend yields, for example Europe ex U.K. at just shy of 4%, Asia Pacific ex Japan 3% and even North America approaching 2%. Clearly there are many company specific opportunities within these markets which will appeal.
What about currency risk for U.K. investors? We would argue that this is inherent in U.K. equity income funds too as companies listed in the U.K. derive much and in many cases most of their revenue from overseas and in currencies other than sterling. Another valid argument in favour of a global approach is one of diversification. Over 50% of the income generated by the U.K. market comes from just 10 stocks and nearly 70% from just 20. The BP (BP.) effect is a living example of eggs and baskets.
As with UK equity income investing, there are different ways in which fund managers address the opportunity globally. Funds which have caught our eye include the Invesco Perpetual Global Equity Income fund, which offers a total return approach comprising equal consideration of capital and income, with a strong emphasis on the need to sustain and grow the income over time. (Premium subscribers can read our analysts' research report here.) The M&G Global Dividend fund aims to deliver a yield above the market average and, equally significantly, to grow distributions over the long term in order to maximise the total return by focusing on companies that can grow their dividends. Veritas Global Income has a dividend yield which is significantly higher than that of either the Invesco or M&G funds and aims to deliver a high and growing level of income from a global portfolio with a strong emphasis on the need to preserve capital in real terms over the long term. (Premium subscribers can read our analysts' research report here.)
Whilst the opportunity seems all too apparent we feel that investors have yet to really get behind it. Perhaps many are rightly being loyal to their U.K. equity income managers but it is certainly worth considering a broadening of the horizons.
This article first appeared in Investment Adviser.
