Will growth make a come back in 2023 or will income prevail? Maybe investors cover all their bases, suggests Darius McDermott, managing director, FundCalibre
Was 2022 the year the music finally stopped for growth investors?
It really is a tough question to answer at the moment. We know last year was a challenging one for investors as the QE taps were turned off by central banks and investors realised growth at any price was an unsustainable model.
But 2023 has been something of anomaly year to date. On the one hand inflation remains high, but there were signs towards the end of last year that it was peaking – for example, factory gate prices and shipping rates eased, as did the likes of food and gas prices.
In tandem with these views, some of the events of 2023 – such as those in the banking sector – have encouraged investors back into growth names in the hope that interest rates are about to fall. But this is far from certain – greater power competition, increased defensive spending, rising wages and the energy transition are all long-term factors in markets at the moment – indicating higher rates and slower growth are here to stay.
It almost seems like an insoluble equation at this point in markets. Which is why investors would be right to cover all their bases in this scenario.
Covering all your bases
It was the desire for diverse sources of returns which gave rise to global equity income funds over a decade ago. Today, the sector has some £20bn plus of assets under management – with almost every major asset manager having one of these funds in their stable*.
Income is firmly back on the agenda in an inflationary world, but these funds have the additional geographic diversification of their dividend streams (remember that almost 60 per cent of all UK dividends comes from the largest 15 stocks in the market)**. It also allows investors to tap into specialisms in certain regions and offer diversification of currency exposure.
That diversification of returns was highlighted last year when no less than 12 countries produced record dividend pay-outs in dollar terms***.
Going global also gives greater scope for growth as evidenced by the significant outperformance of global equity income funds versus their UK peers in the past decade****. To be clear, I’m not telling anyone to steer clear of UK income, but diversification globally offers its own unique benefits.
Are the inflationary winds pointing to global income in 2023?
A research note from the TM Redwheel Global Equity Income team earlier this year says we are either likely to see inflation taming – but at the cost of a proper recession and causing rates to remain higher for longer to ensure inflation’s demise – or that the prospect of such pain is too much to bear and the Fed pivots to avoid a deep recession.
Redwheel believes the pivot scenario seems likely as a means of protecting the most indebted segment today – the governments – but says either is likely to result in greater volatility for asset markets.
It says: “Both possible outcomes see the return of an economic cycle and earnings cycle. And it is this earnings cycle that the market in 2023 may have to come to terms with.”
These cycles are normal, with Redwheel pointing to a return to client’s growing wealth at a slower pace. “The growth in dividends over time can combat the impact of inflation. We should see valuations matter again and high-quality companies with excessive valuations possibly becoming the riskiest investments. The valuation you pay for a stock may impact your ability to suffer volatility. Companies that have pricing power should suffer better than those who’s business models are based around driving prices ever lower, or who are price takers,” the group adds.
Dividend cover remains high
Janus Henderson head of global equity income Ben Lofthouse says the outlook for global dividends in 2023 remains strong, with dividend cover remaining high on an historical basis.
He says: “Areas like the energy market, the resources market, are still seeing high prices which leads through to strong cash flow. And in the financial services sector, whilst there are concerns around credit potentially from higher interest rates, many companies also benefit from higher interest rates.
“We often see in periods where you get rising rates that dividends are a large part of the total returns for equities over the following years. And certainly we would see that could be something that could happen from here.”
Aviva Investors portfolio manager Richard Saldanha says while more cyclical dividend payers like banks, basic materials, consumer discretionary and certain industrials face challenges – more defensive companies like consumer staples, healthcare and utilities don’t tend to cut dividends.
He says: “We prefer to focus on where we can find resilience in businesses and some degree of certainty in terms of earnings and dividends. We’ve been adding to more defensive sectors that have trailed the rally this year, such as healthcare. Health insurance providers are a good example of demonstrating resilience in prior downturns. Yet their current valuations, relative to the wider market, look attractive in our view.”
Since 1970, compounded dividends have accounted for over 70% of global equity returns^ and they continue to form a bedrock of total returns across both developed and emerging markets. It is much more than a UK story – with the growth in dividend returns overseas often overlooked. With a growing dispersion in economic outlooks, the stars may be aligned for this sector as a one-stop-shop for those wanting a mix of income and growth in uncertain times.
Funds to consider:
Guinness Global Equity Income
This portfolio typically consists of around 35 equal-weighted stocks, which means that investments are very different from the benchmark index. The managers focus on how well and consistently a company can use money to generate returns. They also have substantial freedom to entirely avoid countries and sectors they don’t like.
JPM Global Equity Income
This is a core equity income fund. It has a value tilt and will invest globally – including in emerging markets – in large to mega-cap stocks. The managers have three sources for ideas – high growth, high yield, and compounders (the core of the portfolio) when building a portfolio of 40-90 holdings.
M&G Global Dividend
Stuart Rhodes avoids the highest yielders and buys companies which are growing their dividend every year. This fund is quite different from its peers because Stuart is not afraid to have some commodity exposure. A portion of the fund is also invested in rapid growth businesses, which may have small starting dividends, but are growing quickly.
Trojan Global Income
Manager James Harries is exceptionally experienced, and the fund has historically done an excellent job of preserving capital in difficult markets. The fund has a consistent bias to quality and businesses with low capital intensity and low cyclicality are much more likely to make it into the 30-35 stock portfolio.
*Source: Investment Association, February 2023
**Source: Link Dividend Monitor, Q4, 2022
***Source: Janus Henderson Global Dividend Index – March 2023
****Source: FE fundinfo, total returns in sterling, 25 April 2013 to 25 April 2023.
^Source: T. Rowe Price – Tapping the Power of Global Equity Dividends
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
