The current environment makes it a good time to invest in high-yielding equities, and a great way to get exposure to these is via an investment trust as it is hard to generate better returns through direct investment
There should always be a place for investment trusts that focus on dividend strategies in investors' portfolios. These strategies can provide a lower-risk means of generating steady returns in the long term. Moreover, now is a particularly good time to invest in high-yielding equities. Those companies with regular income flows and stable growth profiles are likely to outperform in what we expect to be an environment of slowing earnings growth going forward. The most attractive dividend strategy from a risk/return point of view is an active managed fund approach that looks for a diversified exposure to companies that pay out a high dividend, and have attractive business models and superior earnings growth.
The financial health of corporates in the UK is strong, balance sheets are in good shape, and free cashflow levels are high. Management teams have cash to spend either on investing in their business, making acquisitions or returning cash to shareholders. Companies with a policy of combining these options - using cash for acquisition and reinvestment as much as for returning money to shareholders - will secure future growth and, therefore, future dividend payments.
A high dividend payout can instil a sense of capital discipline in companies and is a sign of quality. Investors can have greater confidence in a company management team that is prepared to return surplus cash to shareholders rather than spend it on risky acquisitions or investments. Because when managements do decide to spend cash on investments, they are likely to be doing this to underpin rather than dilute earnings. This should lead to greater earnings and share price growth over time, and permit future dividend increases.
The best strategy is to look, above all, for companies that strike a healthy balance between the amount they pay out to shareholders, and how much they spend on investment and acquisitions. We try to identify companies that, besides providing a high and stable income, have strong growth potential as a result of attractive business models and sensible investment plans.
Dividends are crucial to long-term returns, so from a long-term perspective, investors should always consider exposure to income securities. High-yielding stocks, if carefully analysed and chosen, offer stable and sustainable returns.
Over time, about 50% of equity investment returns derive from dividends. The risk profile, and hence volatility of dividend funds, is lower than comparable benchmarks while the average turnover of high-yielding stocks is only half that of non dividend-paying stocks.
The lower volatility of dividend-paying stocks is not only related to their ability to provide a regular income stream.
As a result of this lower risk profile and lower volatility, yield investments improve the overall risk/return profile of the equity proportion of any portfolio and are an ideal complement to higher risk assets such as Asian or emerging market equities.
When taking a diversified approach investment trusts provide an excellent way to gain full exposure to high yielding stocks. A typical equity yield fund may contain on average 60 stocks, all of which have been selected by a specialist fund manager and, in most cases, a team of analysts with in-depth knowledge of industries and sectors. Even the most sophisticated private investor will find it hard to generate better returns at lower risk through direct investment in individual securities.
A professionally managed fund is also more likely to find opportunities beyond traditionally high yielding sectors such as utilities and financials. These trusts can offer more sophisticated dividend strategy approaches providing diversity through specific geographies and sectors.
Our approach combines growth and yield regardless of focus, and we look for exposure to attractive business models and superior earnings growth, at the same time as a regular income stream.
Looking both long and short-term, a dividend strategy is attractive. In the short-term, companies with regular income streams and stable growth profiles are likely to outperform in the current environment of slowing earnings momentum.
This year has been dominated by two opposing elements: the conflict between, on the one hand, a slowdown in profits growth; and on the other hand, support from mergers and acquisitions (M&A), which have led to an increase in volatility across the board.
We may be entering a period in which investors punish companies for disappointing numbers one day, only for bid rumours to push prices up the next. In this environment it is wise to be positioned in areas where growth is strong and in stable defensive companies that can sustain revenue and profits growth, to maintain dividend payouts and growth at all stages of the economic cycle.
Dividend strategies look particularly attractive right now. Corporates have a lot of cash, debt levels are reasonable and balance sheets are in good shape, so cash may well be used for reinvestment as well as dividend payouts and share buy backs.
While the strong returns we saw from high-yielding stocks in, for instance, 2004 are not likely to be repeated year after year, income-generating stocks are attractive from a long-term perspective. Dividend strategies have not lost their appeal - a stock picking approach to investing with a dividend strategy should continue to produce good returns in all market conditions.
l Companies with regular income flows and stable growth profiles are likely to outperform in an environment of slowing earnings growth and the most attractive dividend strategy will be an active managed approach, which looks for companies with high dividends, attractive business models and superior earnings growth.
l Yield investments help improve the overall risk/return profile of the equity proportion of a portfolio and are an ideal complement to higher risk assets such as Asian or emerging market equities.
l The strong returns from high yielding stocks in 2004 are not likely to be repeated year after year, so income generating stocks are attractive from a long-term perspective.