SPONSORED FEATURE: Why and where passive works for equity income

Better data has led to more successful income strategies in recent years, says Lyxor.

Using passive funds for income isn’t a new concept but it is one that’s picking up speed. Low yields, an overdue shake-up among active income managers and big data have brought many more strategies to the market. Yet the allure of the star fund manager remains strong.

The first generation of passive strategies were simplistic – and often concentrated on just a few dozen shares or held large biases towards a few individual sectors. Costs were low, but still much higher than a traditional tracker. More recent launches have tackled these issues head on to create low-cost strategies with a laser-like focus on the highest-quality income stocks, not just the highest yielders.

Targeting a smarter income
There are typically two ways to find passive equity income – buying high-yielding markets or smart beta strategies explicitly focused on income.

Dividends_graphBuying a higher-yielding mainstream index (in the UK or Asia-Pacific, for example) entitles you to its dividend returns. This is a simple, often very low-cost approach and it allows you to spread your portfolio over growth stocks as well as income producers. Such diversification can be detrimental over time, however. An index’s income prospects can and will change. Be distracted for a moment, and your dividends could look very different.

Income-focused ETFs, however, cannot let their focus slip. Early on, their methodologies led to concerns over concentration, sector biases and falling into the ‘yield trap’, but bigger and better data has led to the launch of more refined, and more successful, strategies in recent years.

Role reversal
These strategies offer an alternative to an active equity income fund, but without the risk of managers making a bad investment call, altering the approach that attracted you to them in the first place or just jumping ship.

Our latest performance results suggest income-focused ETFs should become more than an alternative. In fact, when averaged out across the UK, European and Global universes, only around 17% of active managers have outperformed in the income sector over the last decade1 . In our view, the roles of passive investing and active management in a portfolio could easily be reversed.

The picture is still, superficially at least, positive for dividends around the globe, with more companies maintaining or raising their dividends. As always, though, it’s important to distinguish high and sustainable yields from those that are high for less palatable reasons.

Why the sun might be rising on Japan
Japan’s journey from relatively uninspiring destination for dividend seekers to viable equity income play is nearly complete. The country now yields a similar amount to the US and, because its payout ratio is so low, has the safest dividends in the developed world.

SGQJ, our new Japan Quality Income ETF, selects 60 of the finest stocks, stress-tested for leverage, balance sheet strength and the size of their dividend yields. And, with a current yield of 2.40%2, and a track record of higher returns and lower volatility than mainstream indices, what’s not to like?

5 things to know about SGQJ3
   • The least sensitive Japanese equity index to movements in the yen – it gets around 75% of its revenue domestically versus around 50% for the Nikkei 225.
   • Excludes financials entirely – a sector which dominates large-cap indices and is still struggling to recover from the Negative Interest Rate Policy launched in January 2016.
   • No size weighting in its methodology, so it has much more of a small-cap bias than any other index – smaller-caps look set to continue their outperformance versus their larger peers under ‘Abenomics’ 3.0. Greater domestic demand and corporate tax cuts in particular look favourable.
   • More growth-oriented than the market cap indices – Choosing a quality income play doesn’t have to mean limiting your participation in a recovery.
   • Far less top-heavy than the Nikkei 225 – 17% of SGQJ is in the top 10 stocks versus 31% for the Nikkei.
Why choose Lyxor ETF for income?
We’ve been managing dividend-targeting ETFs for years. For European, Global and now Japanese dividend-payers, our ETFs follow the SG Quality Income indices. These strategies were created by top-rated analyst Andrew Lapthorne.

The latest additions to our range, however, follow FTSE indices instead because we felt the strategies were more appropriate to the UK and US markets they cover. The Lyxor FTSE UK Quality Low Vol Dividend (DR) UCITS ETF (DOSH LN) and Lyxor FTSE US Quality Low Vol Dividend (DR) UCITS ETF (BUCK LN) focus on volatility and company quality to minimise risk. And with TERs of 0.19%4, you won’t be paying back your whole yield in fees.

1 – Source: Morningstar & Bloomberg data from 31/12/2006 to 31/12/2016.
2 – Source: Lyxor / Bloomberg. Data as of end September, 2017.
3 – All data: Factset, Bloomberg & SG Quantitative Research, 30 September 2017
4 – Source: Lyxor International Asset Management. Data as of November 2017.
Past performance is not a reliable indicator of future returns.

This communication is for professional clients and qualified investors only.
Past performance is not a reliable indicator of future results.
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We recommend to investors who wish to obtain further information on their tax status that they seek assistance from their tax advisor. The attention of the investor is drawn to the fact that the net asset value stated in this document (as the case may be) cannot be used as a basis for subscriptions and/or redemptions. The market information displayed in this document is based on data at a given moment and may change from time to time. The figures relating to past performances refer or relate to past periods and are not a reliable indicator of future results. This also applies to historical market data. The potential return may be reduced by the effect of commissions, fees, taxes or other charges borne by the investor.
Lyxor International Asset Management (Lyxor ETF), société par actions simplifiée having its registered office at Tours Société Générale, 17 cours Valmy, 92800 Puteaux (France), 418 862 215 RCS Nanterre, is authorized and regulated by the Autorité des Marchés Financiers (AMF) under the UCITS Directive and the AIFM Directive (2011/31/EU). Lyxor ETF is represented in the UK by Lyxor Asset Management UK LLP, which is authorised and regulated by the Financial Conduct Authority in the UK under Registration Number 435658.

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