Pedestrian growth will bedevil western economies for years as both governments and consumers struggle to reduce their excessive debts. Interest rates will be kept low as a result at both ends of the yield curve. In such an environment, dividends will become more important to overall market returns. But an important market shift is taking place, with an increasing proportion of equity income being generated overseas. This has happened relatively quickly and is ongoing, and investors need to position their portfolios accordingly.
The income shift
Earlier this year, I highlighted the growing opportunities from decent yielding overseas companies. Recent figures have revealed the extent to which, during the past 15 years, the geographical split of FTSE World equities yielding more than 3 per cent has shifted. The UK used to have around 20 per cent of these companies, while Asia excluding Japan had 16 per cent. Today those figures are very different. The UK has dropped to around 7 per cent with Asia rising to just short of 30 per cent. Broadly speaking, a drop in North America has been made up by the rise in Japan and to a lesser extent 'Other regions', with Europe remaining the same.
This is understandable. Although British corporate balance sheets are healthy, the banks and other FTSE 100 companies such as BP have disappointed when it comes to dividends. This has reminded investors of the importance of diversification when hunting for equity income. The smaller company sector is one such area, but investors have even greater choice when it comes to mainstream overseas companies in faster growing economies. This is particularly the case in Asia where around one-third of all global equities yielding more than 4 per cent originate.
A number of factors are at play. The eurozone crisis has reminded investors to revisit risk perceptions when it comes to the developed and emerging markets. The lower debt levels of both governments and consumers, strong corporate balance sheets, improving corporate governance and political stability have all added to the attractions of many emerging markets.
But there has also been the sea-change in corporate thinking as to the importance of dividends. Many of these relative newcomers to the global stage realise the importance of accessing the capital markets, particularly when it comes to expansion. Paying a sustainable dividend is one of the rites of passage – something they can well afford. Meanwhile, other lesser but still important factors include the high rate of family ownership, particularly in Asia (outside Japan and Korea) which encourages the payment of decent dividends to help keep family members happy, and the growing appetite for income from Asian pension funds.
Whatever the reason, more and more overseas companies are growing their dividends. Investors are spoilt for choice. There is a currency risk of course. But with The Bank of England printing money and state finances weak, the odds remain fair of sterling continuing its gradual decline, especially against those currencies where less debt and no quantitative easing remain the norm. Indeed, if logic prevails, overseas dividends should benefit from a currency kicker.
Portfolio changes
I have sold Scottish Mortgage trust (SMT) in both portfolios, and Ruffer Investment Company (RICA) in the Growth portfolio. Both have done their job but better opportunities exist elsewhere.
In their place I have introduced Middlefield Canadian Income trust (MCT) to both portfolios. Canada has one of the healthiest debt profiles and banking systems in the west. Its people are very entrepreneurial and hard working, and it has an abundance of natural resources including fresh water. It is a country with a great future. MCT has a 4.7 per cent yield and a very good track record relative to its S&P/TSX Equity income benchmark. Speaking with its management, a good proportion of the portfolio's earnings are generated overseas, especially from emerging markets. A further positive is that the currency exposure has not been hedged.
Within the Income portfolio, I have also introduced Murray International trust (MYI). I have long liked this trust and speaking with Bruce Stout earlier in the year confirmed my impressions. A bias towards well-run strong companies, a near-4 per cent yield, an excellent track record and a near-30 per cent weighting in Asia remain attractive. The downside has been the premium to NAV but I've decided to swallow and buy, with the intention of adding over time - perhaps on bad days.
In the Growth portfolio, I've introduced Utilico Emerging Markets trust (UEM). It invests in infrastructure and utilities - areas where many developing countries are increasingly focused. Water treatment, for example, is a key investment. UEM concentrates on income-producing assets rather than start-ups, and so is a conservative play on infrastructure. As such, UEM has a 3.5 per cent yield and is presently on an 8 per cent discount – a little harsh given its good track record.
I've also introduced North Atlantic Smaller Companies trust (NAS). This is a somewhat unusual trust in that its portfolio is split approximately 50:50 between unquoted and quoted smaller companies on both sides of the Atlantic. This helps to explain a 25 per cent discount, although valuation of unquoted investments adds a small element of uncertainty. However, its interim report in September talked of a substantial uplift in the values of a number of these unquoted companies should sales complete. A good track record, together with substantial buying of shares by the manager who now owns around 30 per cent of NAS, more than outweighs a zero yield.
Finally, further to my column 'A classic out of favour opportunity' (4 May 2012), I have added to existing positions in Worldwide Healthcare trust (WWH) in both portfolios following a recent catch-up with the manager.
See John Baron's page for details of his updated investment trust portfolio.
