Aaron Barnfather explains some of the factors that have led Newton to add a European fund to its market-leading range of equity income funds
The average equity income investor can be forgiven for having missed the fact that, since the global stock market crash of 2000, it has been Europe's highest yielding stocks that have signally outperformed European equity markets (see Chart 1).
Even so, the UK fund management industry has been conspicuously slow to recognise the wealth of income opportunities that are now on offer in continental Europe. For one thing, Europe now yields 3%* - the same level of yield as that offered by the UK, the traditional home of equity income investment. More important though, is the fact that, even after recording dividend growth of more than 40% in the last few years - one of the fastest rates of growth anywhere in the world - dividends across Europe are still expected to grow by around 9%* in 2007. This compares very favourably with markets such as the UK where dividend growth is expected to be more like 7%*.
The breadth and depth of yield opportunities in Europe is now such that when the renowned yield discipline that's central to each of Newton's equity income funds is applied to European equity markets, it results in a unique fund proposition that targets a gross yield of between 4% and 4.4% at launch (see below).
Europe turns Anglo Saxon
A number of cultural factors have helped to bring European equity markets to the point where we now expect to see the development of a true equity income sector. For their part, European companies have become far more explicit in their dividend policies in recent times. Where once such companies might have paid widely varying dividends over time, the focus has clearly now shifted to delivering sustainable and growing dividend streams (see Chart 2).
Similarly, payouts are now moving from an annual to a semi-annual or even quarterly basis. There are a number of reasons for this, not least of which is the growing share ownership of company management. With greater vested interests of their own, Europe's company directors now think long and hard before cutting dividend levels, especially as many are now expected to significantly invest in the companies they manage.
But while the international ownership of European equities continues to grow, helping to drive the increased adoption of more 'Anglo Saxon' market traits such as dividend payments, the historic owners of Europe's equities have also had a significant hand in the process. Levels of family and government equity ownership within Europe still remain high in comparison to markets such as the UK, and since equity markets crashed in 2000, these owners have become far more aware of the attractions of higher dividend payments and the increased focus on financial discipline that this requires.
But despite the progress enjoyed by European equities in recent years, valuations remain attractive with P/E levels across Europe still below their long-term average.
Even so, without a means to navigate these markets, it would be difficult to make the most of Europe's evolving dividend culture.
Charting a course
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 the yield of its domestic equity market, while any stock whose yield falls below this level of yield is immediately sold. This ensures that each and every portfolio holding delivers a higher yield than its local market. 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. In essence, Newton's yield discipline allows investors to enjoy the ride as Europe's 'value' stocks re-rate - without ever having to worry about when to get off.
* Source: Dresdner Kleinwort December 2006
