Global equity managers who invest for growth can only stand and watch as the income theme dominates. Nick Fitzpatrick asks if good economic news means an end to their waiting.
Unless they are enjoying the benefits of equity income funds, some people are becoming frustrated with companies which focus on rewarding investors with dividends.
Dividend funds have attracted huge inflows in the past couple of years, and continue to do so, as companies seek to reward shareholders in some way other than with share price growth.
Not only does returning money to shareholders mean businesses are investing less in growth, there are also questions about the sustainability of certain high payouts, or about how paying good dividends is distracting companies from other priorities.
For an example of concern, look at ITV, a UK television channel, which paid a £156-million (€183 million) special dividend this year for 2012. Moody’s, a ratings agency, suggested it was “excessive”.
Upgrading the company’s credit rating, the agency said in August: “Moody’s cautions that the current ratings assume that the special dividend of £156 million announced by ITV in H1 2013 is an exceptional and non-recurring payment and that the company will continue to favour prudent financial policy over excessive shareholder returns.”
At least there was something behind ITV’s high dividend. Performance has been good, with non-advertising revenue up and the outlook for advertising improved, the broadcaster said.
Even so, ITV is not a traditional income stock and its dividend policy is a reflection of the pressure on companies to produce good returns in difficult times.
“The shift from capital expenditure to dividend distribution and share buy-backs has coincided with pressure from shareholders who want higher payouts,” says Ben Stapley, portfolio manager on the JP Morgan Strategic Dividend Fund.
The dividend strategy is recognised for being suited to periods of low growth, particularly when yields are low in other assets.
Yet now, after threats of low growth, or even no growth, in developed markets for years to come, the US is beginning to recover while growth in China and Brazil has slowed. Most recently, in August, the eurozone emerged from 18 months of recession.
How do equity specialists view this recovery, those who do not see dividends as central to their strategies and who might prefer companies to focus on growth instead? Will the dividend theme unravel, and can companies that have focused on dividends adjust easily?
Romain Boscher, global head of equities at Amundi, says: “Many corporates in Europe and elsewhere have large amounts of cash on their balance sheets as if they were facing a very severe crisis.”
This could be used for growth if confidence returns meaningfully, but Boscher is not calling the end of the dividend run yet. Though companies may use this cash to pay for mergers and acquisitions, he says, they may also use it to increase dividend policies even though there would be less pressure to distribute dividends.
“Now the situation is more normal, we envisage perhaps higher dividend policies or a trend for M&A,” he says.
He says dividends are not a major criteria for Amundi’s global equities and that a focus on dividends would expose a global portfolio more to Europe. But he is positive for the recovery.
“Growth is more balanced and people are now ready to envisage slower growth for China and Brazil while seeing a US recovery at the same time. There is a light at the end of the tunnel. The worst European nations are not out the woods, but we do have a different picture today.”
What happens, then, should growth return in earnest? Could the focus on dividends at certain companies make it hard for them to adapt and become attractive to a broader range of equity managers?
Virginie Maisonneuve, head of the global and international portfolio team at Schroders, is guided more by growth than dividends. She says: “As a growth investor, I always thought the dividend was nice to have but not a reason to buy a stock. For us, it’s about understanding how a company can grow.”
She prefers a company to reinvest its cash in the business if a higher return is possible.
“Large dividend payout ratios seen at some companies are detrimental to them. What if the company wants to grow? How will growth be financed?”
She highlights a risk, too, that high payout ratios give companies less of a cushion should they need funds quickly, as seen with the banks facing regulatory costs since the banking crisis of 2008.
Like Boscher, and despite being led by growth, Maisonneuve is also not predicting a sudden retreat from the income theme.
“The dividend theme will still be more valuable to investors over the next 12 months than it has been in the past 20 years, but less so than in the midst of the crisis,” she says.
“You could say we are on a path to healing and normalisation which began in the US. In that environment, dividends could be cut back and look less attractive.”
The outlook for dividends may already not be as good as it was. In the UK, dividends hit another record in the second quarter at £25.3 billion, according to Capita Registrars, but growth of 1.1% compared to 2012 is the slowest headline and underlying growth rate in three years.
In France, fund management start-up Melanion Capital has launched what it thinks is the world’s first dividend futures fund. Jad Comair, founder, notes that many telecom stocks have cut their dividends over the past two years.
Telefonica, the Spanish operator, cancelled its dividend corresponding to 2012 in order to shore up its finances, though it has re-instated its 2013 dividend.
Melanion research suggests that when a dividend yield reaches 10%, the company almost always follows this with a dividend cut. Telefonica’s yield was at 14% when it cut the dividend, says Comair.
France Telecom’s was at 11% when it cut its dividend by 45%.
ITV’s dividend yield was 1.2% at December 31, 2012, and is expected to be 2.02% this year, according to Morningstar.
Melanion bets on dividend futures and is currently short on high dividends and long on lower dividends.
The Euro Stoxx 50 has priced in a dividend reduction nearly every year for the next 10 years, says Comair, though he thinks the market is wrong, at least about next year. “This year has been good for companies with some positive surprises. This year’s good results are next year’s dividends.”
The view from dividend specialists is still positive, too. “The theme has a lot longer to run,” says Stapley at JP Morgan Asset Management. He acknowledges that dividend expectations have been heading downwards, but says dividends are resilient.
“The effect of the last downturn is to force companies to deleverage and to focus on cashflow and returning cash to shareholders. Dividends are here to stay given the mindset of companies.”
Vinit Srivastava, director of strategy indices at S&P Dow Jones Indices, says: “There is a perception that dividend payers have been overbought. Things have got pricier but in comparison with other asset classes it’s very attractive.”
To be sure, fund flow data do not suggest investors are backing away from dividends. In June, flows into the Morningstar Global Equity Income sector globally were €1.02 billion, while broader equity funds saw outflows.
BlackRock reports that global dividend exchange-traded products (ETPs), which focus on dividend-paying equities, held a total of $87 billion (€65 billion) at the end of the second quarter. This equalled 5.7% of total equity ETP assets, compared with just 2.9% in 2010.
The dividend theme has escaped speculation about a bubble, unlike high-yield bonds. As investors hunt yield and have little to invest in, it’s not illogical to suggest one.
Perhaps the prospect of lower dividends could thin the crowd out. Boscher says Japanese corporations could become more important to dividend investors, too, serving to broaden the market.
©2013 funds europe