Expert: Nick Clay, Portfolio Manager, Global Equity Income Strategy, RWC Partners Facilitator: Stephen Dowds, Hayhill Wealth
The session addressed the view that there is currently a prevalence (even among income investors) to invest heavily into large US technology giants regardless of the minimal levels of yield they produce. The reason for this, Nick believes, is that their performance and weight in benchmarks means it is difficult for an income fund to outperform otherwise.
Nick also highlighted a number of concerns he has that arise out of this phenomenon:
- Overly focusing on the short term. There are different ways to generate total return – and that some are better suited to a more challenging market background than we have had over the past 18 months. The power of compounding (even slightly) above market dividend yields remains a strong long-term driver of return
- It’s wise to question the crowded nature of the big tech trade – many so-called income investors have been forced to hold them, not for income but to participate in their performance
- Investors seeking yield have, in many cases, taken on more risk than they would normally do in order to generate income. Often this comes in the form of increased default and / or liquidity risk. Don’t forget that you can generate decent total returns from a diversified portfolio of higher yielding equities without this kind of additional risk.
The ensuing discussion drew a large number of questions many of which focussed less on the topic itself (which seemed to be generally accepted) and more on the ways in which Nick and his team sought to manage the RWC fund without falling into those traps.
Participants wanted to know how RWC defined their income universe, how rigid they were about it and what their yield target / benchmark was. Nick gave a good description of their screening process and yield target of 1.25x the yield on the FTSE World Index.
There were also questions on how the team dealt with ESG issues and the preponderance of income being generated in certain sectors such as Banks and Energy. Nick outlined how, in the energy sector, he would generally prefer a “transformation” play rather than a straight renewables stock given the need to generate cash in order to reinvest into newer technologies.
Nick was also asked about the value bias that he indicated he had, where the sources of total return derived from in their process and if a portfolio of stocks with growing dividends was better than a higher yield approach. Nick agreed that the sources of return were primarily twofold, namely compounding and a change in valuation. He believed that the compounding effect of a higher starting yield outweighed the benefit of a growing dividend, while the value bias they have means that as the market changes its perception on the stock, the change in relative yield was likely to be a strong source of capital growth
Other questions related to currency hedging (they don’t), yield enhancement (they don’t) turnover (typically 20%pa) and what their sell discipline is (yield below market for more than 30 days tiggers a sell within the next 60 days).
In response to a question about how their approach had changed over the years, Nick responded that originally, they had sought a 4% yield from their stocks. This, however, forced them to over-emphasise the “quality” characteristics of the stock, as they needed to know that the dividend was sustainable and as a result, narrowed their universe. What the now focus on is quality at a reasonable price, recognising that you may only get this when the market does not share your view if the quality. However, a change in that perception is what provides the revaluation component of the stock’s potential return.
Finally, in terms of the risks inherent in their approach, Nick stated that the main one is a cut in dividend. That is why they focus on quality and on the company’s “ability to suffer” i.e maintain the dividend, for whatever reason, in the face of pressure.
This was an interactive session which, though focussing less on debating the title question, gave a good insight into the key considerations required when managing an income portfolio.