You would expect the manager of an equity income fund to make his primary focus a hunt for yield. So when Stuart Rhodes, manager of M&G Global Dividend (GB00B39R2M86) - an IC Top 100 Fund, admits that he "will never run a screen that looks for the best yield in a sector or geography", it is perhaps surprising.
Or not. "Doing this can lead to some catastrophic situations, normally because the share price is going down," he says. "There are many value traps."
This is underpinned by his focus on dividend growth rather than the level of yield. "Rising dividends create a culture of discipline because long-term dividend growth requires disciplined growth in the business," says Mr Rhodes. "Dividends shouldn't be an afterthought - too many businesses see how much cash they have and then set a dividend - the better ones decide what the dividend will be at the start of the year and there is money left over for more successful projects that will achieve a decent return. It is an integral part of good management."
And dividends and growth are not mutually exclusive. He believes that "it is a misconception that only mature companies pay dividends".
Some 94 US companies have increased their dividend for 25 years or more, including large established names such as Johnson & Johnson, McDonalds and Chubb. This group of companies has achieved an 11.4 per cent annualised total return over the past 12 years, in contrast to the S&P 500 which has made 1.8 per cent. "Dividends and share prices go hand in hand and this disproves that companies can't grow if they pay dividends," he explains.
Mr Rhodes adds that the fund's distribution has grown around 38 per cent since launch as a result of increases in dividends from underlying companies.
So what does Mr Rhodes look for?
"I look to see if the company has a long track record of dividend growth," he says. "From a universe of around 20,000 companies, I look to see which ones got through the last five to 10 years with their dividends intact, and this discipline narrows it to around 1,000. We then analyse them to see if this can continue. We also look at whether the company invests its capital wisely, and if the company can grow in a sustainable manner over time. The last thing we look at is what yield we can get for this type of company."
He seeks three distinct categories of shares for the fund. "I have diversified sources of performance because different buckets perform in different market environments, and each of my buckets has added value since the fund was launched in 2008."
Around 50 to 60 per cent of the fund is typically invested in what he describes as quality stocks: well managed businesses with steady dividend growth, often traditional dividend producing multi-nationals, examples being Nestlé and Mattel.
Mr Rhodes says that Mattel, the world's largest toy manufacturer, has recently added value following healthy fourth-quarter earnings, which underlined the company's strong revenue growth momentum, driven by its diverse portfolio of mature and high-growth brands. It announced a quarterly cash dividend of $0.36 a share, an increase of 16 per cent the previous year's distribution.
Some 20 to 30 per cent of the portfolio is in disciplined asset-backed cyclical names that can grow their dividends across different economic environments. These "can be very valuable when markets are rising", says Mr Rhodes.
Examples of these include Methanex, the largest supplier of methanol, and miner BHP Billiton.
And 10 to 20 per cent of assets are invested in rapid growth shares that can translate the growth into their dividend stream, examples being Analog Devices and Australian-listed analytical testing provider ALS.
Mr Rhodes is what is described as a bottom-up stock-picker - he chooses investments on the basis of the company fundamentals rather than because he wants a certain percentage of assets in a particular sector or geographic region. But last year he started to increase his allocation to Europe ex UK where valuations are cheaper. Europe ex UK accounts for around a quarter of the fund's assets, although the US remains the largest geographic weighting with around 40 per cent of assets.
"It is rare for us to do this, normally we focus on the underlying fundamentals, but we are finding so many cheap shares in Europe," he explains.
A recent sale, meanwhile, is Heinz, following its acquisition by Warren Buffett's Berkshire Hathaway investment vehicle and Brazilian investment company 3G Capital. Mr Rhodes initiated a holding in Heinz at the fund's launch in July 2008, and from an original purchase price of $48.99 the share price has risen more than 45 per cent, with the dividend up 24 per cent. The fund has collected more than $8 a share in dividends during that time, equivalent to 17 per cent of the initial purchase price.
"The Heinz takeover was pleasing because it made the decision for us," says Mr Rhodes. Heinz was getting towards our valuation target for selling. Other names we have sold recently include Coka-Cola and ADP. US names are starting to look more unreasonable compared with Europe and Asia. That said, the US is such a deep market you can still find good valuations there."
Read our last interview with Stuart Rhodes
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