How can an attractive dividend yield be achieved without giving up future growth and capital appreciation? Thornburg Investment Management looks for global stocks with a solid history of dividend payments and the capacity to increase their dividends over time. Thus, to provide an additional source of income, it also invests in bonds and hybrid securities.
Thornburg Investment Income Builder invests in a broad spectrum of securities that generate recurring income, at least 50% of its core assets are dividend paying shares, while the rest of the portfolio is composed of the fixed-income securities that serve as support.
Thornburg points out the historical importance of dividend yield as a component of shares’ total return. According to a study conducted from 1871 to 2001 over 10 year periods, shares with high payout ratios generated higher future earnings growth rates. In contrast, those companies that distributed a smaller percentage of their profits in the form of dividends, generated negative real earnings in the future.
“When selecting stocks, we focus on those stocks that have the capacity and willingness to pay dividends. By capacity, we mean those businesses that are able to generate cash flows, whereas willingness is more related to the dividend policy that the members of the Board of Directors and the management team have decided to implement. In that respect, we are interested in those companies that are willing to share their profits with shareholders,» they remarked.
Where are the best opportunities?
Diversification is important to the strategy’s performance. Looking at the expected dividend yield for 2018 by country of origin, the UK and Australia are at the top with 4.5%, well above the global average. These are followed by the Nordic countries’ stocks with an average of 3.7%, European stocks (excluding the United Kingdom) with an average of 3.6%, Latin American stocks with 3.5% and Canada with 3%.
«Dividend yield varies considerably around the world. Japan and the United States are among the countries with the lowest dividend yields, with 2.3% and 2.2%, respectively. In Japan’s case, companies are known to accumulate high levels of liquidity, without giving productive use to this cash. In the United States, however, the issue is related to double taxation of dividends: when a company generates a dollar in profit, it taxes 36% at the federal level. In addition, once profit is distributed as a dividend, the shareholder is taxed once more, causing more than half of that dollar generated to end up in the hands of the government. In that respect, we expect some kind of tax reform in the United States to improve the distribution between government and investors, although we don’t believe that double taxation will be eliminated.»
If you evaluate geographic regions in detail, there are higher dividend yields outside the United States, particularly in the United Kingdom, where there is a strong dividend payment culture and no double taxation on dividends. Generally speaking, a high dividend yield is offered in Europe, as there are more quality companies controlled by a family group, which demand the payment of dividends as part of their remuneration.
According to Thornburg, by sectors, there are attractive opportunities in the telecommunications sector, which is why the strategy allocates almost 20% of the portfolio to this sector. The exception is in telecommunications companies in Latin America, which have a lower dividend yield than in the rest of the regions. This is because Latin American companies are currently building their network systems, which requires high cash flows and limits their ability to distribute dividends.
Another sector with high exposure in the portfolio is the financial sector. Except in the United States, the dividend yield of the financial sector is far superior to that of other sectors due to its dividend payment policies. However, they expect that the capital requirements policies demanded of the US banks will change and allow an increase in the distribution of their profits as dividends.
Finally, Thornburg sources point out that it is quite common for the PE and forward PE multiples of the portfolio to be two or three decimal points cheaper than the market as a whole.
As regards fixed income, the fund takes advantage of the flexibility provided by the mandate to reinforce dividend yield with the coupons received by the corporate and hybrid debt instruments in which the portfolio invests. The strategy, with a benchmark index of 25% of the Bloomberg Barclays Aggregate Bond index and 75% of the MSCI World index, currently has a fixed income allocation of less than 10% (As of 5/31/17) because, according to Thornburg’s managers, prices in the fixed income market are manipulated by the effect of central bank actions. They expect this situation to continue until there is a clear change in trend; and they will strive to increase their debt position only when this adjustment will benefit shareholders.