Aaron Barnfather explains some of the longer-term factors that underpin the launch of the cutting edge Newton European Higher Income fund
The news is slowly starting to percolate the UK investment establishment - something of a sea change is under way in Europe's equity markets. It is now difficult to ignore the fact that dividend levels there jumped close to 21% in 2006 alone and that, after several years of similarly impressive growth, European markets yield 3%, the same level of yield offered by the UK equity market - the traditional home of equity income investment. This means that although Newton may be the first recognised equity income specialist to target a high yielding equity fund at Europe, we are unlikely to be the last.
Importantly, there are now a number of factors to which we can point in Europe that look set to underpin the emergence of a true equity income sector. Not least of these is the demographic 'time bomb' that can now be heard loudly ticking beneath the Continent (see Chart 1).
It's rarely reported, but Europe as a whole has one of the fastest ageing populations in the world. Indeed, by 2015 some one in three Europeans is projected to be over 65 years of age.
This will create tremendous demand for savings and investment solutions that can generate income. Considering the traditional bias of European investors towards bond investment and the long-term decline that Europe has seen in both bond yields and interest rates, we can expect to see a considerable migration of capital toward high yielding equities over the coming decades.
Europe's quiet war
Another key factor that is likely to help fuel European dividend levels for decades to come is the war that has broken out between European states over corporation tax (see Chart 2).
The Republic of Ireland began the process about a decade ago, and while its economy has benefited greatly as a result of the increased business investment the move has helped to attract, its major European peers have only now started to join the battle.
While Europe's governments may see this in terms of a battle to remain competitive, its consequences are of prime importance to European equities.
This is because a falling tax-take necessarily results in a bigger pool of profits that companies are able to either retain or to distribute to their shareholders in the form of dividends. Although corporation tax in Ireland now stands at a diminutive 12.5%, this year has already seen Holland cut its rate from 29.6% to 25.5%, while Spain has announced plans that will see corporation tax there decline from 35% to 32.5% as part of a planned migration to 30% by 2008.
Perhaps most tellingly, Europe's industrial powerhouse, Germany, has also committed to reducing its tax-take from around 38% to circa 29.5% at the start of 2008, while Denmark has become the latest combatant with its recent proposal to cut rates from 28% to 22%. It may still be early days, but at this stage it's difficult not to suspect that Europe's largest economies will go still further before this particular battle comes to an end.
But despite the increasingly positive backdrop for dividend levels, capturing the most from today's European markets still requires a truly focused approach.
A strategic advance
This is where the yield discipline that underpins each of Newton's equity income funds comes to the fore. In the case of Newton European Higher Income Fund, this discipline requires that any new holding must offer a prospective yield that is 15% greater than that of its domestic equity market, while any stock whose yield falls to market levels is immediately sold. By ensuring that each and every portfolio holding delivers a significant yield, the fund represents a unique proposition that targets a gross yield of between 4% and 4.4% at launch (see below). Meanwhile, Newton's unique sell discipline means that capital is constantly recycled from those stocks that have already made strong progress to those best placed to do so. This approach ensures that even while Europe's residents may be getting 'long in the tooth', the Newton European Higher Income Fund retains its cutting edge.
