Pfizer’s announcement of an effective Covid-19 vaccine has had a dramatic impact on stock markets. It spurred a rotation out of technology and other stocks deemed to benefit from a ‘lockdown’ world and into areas expected to capitalise on a more rapid return to normal life and better economic growth.
Whether this trend has legs depends on whether the efficacy of the vaccine lives up to its promise and, logistically, how quickly it can be rolled out. There is also the possibility that other successful vaccines could emerge and help beat the virus. Disappointments could easily see the trend reversed, but on the other hand, the past week could be just a taster of what is possible from the cohorts of under-owned and unloved stocks that investors have been quick to abandon in an increasingly digitally-driven lockdown world.
Amid some exceptional daily moves in individual stocks prices – 30% or more for some of the most acutely sensitive companies in areas such as air travel and leisure – the overall trend of the past few days was a dramatic upturn for cheaper, ‘value’ companies and high dividend payers. According to Stuart Rhodes, manager of the M&G Global Dividend Fund, his portfolio had its best day ever since the launch in 2008 when the Pfizer vaccine was announced, powered by the element of his fund invested in the most extreme value areas. With some continuing to offer yields in excess of 10% he still views them as exceptionally cheap.
Mr Rhodes’s fund invests globally in businesses that have the potential to grow dividends significantly over time. Often this means accepting a lower starting yield in exchange for likely future growth in dividend payments, but he explains this approach generally offers better long-term returns. When companies increase payouts over time, through both good and bad times, the share price usually follows them upwards. This can lead to better long term returns in terms of both income and capital. Conversely, companies that are only able to maintain their dividends or, even worse, forced to cut them, are actively avoided, though inevitably this is difficult to achieve across a broad portfolio. Any business can fall victim to changing industry dynamics or misfortune.
Mr Rhodes categorises his portfolio into three ‘buckets’: ‘quality’, ‘assets’ and ‘rapid growth’. Quality companies (typically making up 40-60% of the fund) are those with disciplined and reliable growth strategies that can usually thrive despite what is going on in the wider economy. This includes more defensive areas such as pharmaceuticals and food producers. ‘Assets’ are economically-sensitive businesses whose earnings are less consistent but should still trend higher over time – energy or commodities companies for instance. These tend to represent a quarter to a third of the portfolio. Finally, in the ‘rapid growth” category are companies whose pace of expansion (and dividend growth) has the potential to surge thanks to a strong growth in a new market or product line. This is usually the smallest of the three components (at 10-20% of the fund) but one that provides important diversification and differentiates the fund from many of its peers.
Since the vaccine news, Rhodes has been active in his search for new ideas. Similar to the situation in March in the immediate aftermath of the Covid-19 stock market slump, he and his team have stepped up efforts to find new growth opportunities which may have been sold off unfairly due to the rapid change in sentiment. While the ‘value’ areas of the market have provided exceptional returns in recent days, and potentially offer much more, he is keen to keep the portfolio balanced and not be too aligned to economically sensitive areas that inevitably provide less certainty of profitability and dividends.
The summer was an active period for the fund too, with particular focus on adding new names to the defensive ‘quality’ bucket. The manager bought Procter & Gamble and Coca-Cola in consumer staples, as well as Novo Nordisk and Takeda Pharmaceutical in healthcare. These stocks were available on attractive valuations – Coca-Cola was yielding 4% – and helped to strengthen the fund’s income stream in a tough environment for dividends.
Vinci (motorway concessions and airports) and Walt Disney were also sold as markets rebounded in April and May in the belief the pandemic would weigh on the operating performance of these companies over the medium term. Healthcare giant Johnson & Johnson was also disposed of, one of the original holdings from the fund’s launch in 2008, with Rhodes becoming increasingly concerned about the long list of lawsuits filed against its businesses, which in his view will have financial consequences. The stock’s resilience during the period of market volatility provided an opportunity for exit. The summer rally also saw the disposal of luxury goods firm LVMH and the paring back of global payments company Visa.
Despite the recent upturn in the fortunes of dividend-paying stocks, and hence equity income funds, Mr Rhodes sounds a note of caution. In his view, we are currently experiencing the worst dividend environment since the Second World War – even worse than the 2007-08 financial crisis. He urges that being selective will be paramount, and balance sheet strength remains an important focus of his analysis to help ensure that dividends are sustainable in the current climate.
He notes that despite the difficult environment, the majority of the fund’s holdings continue to deliver dividend growth, but for the first time in the fund’s 12-year history, the list of holdings growing their dividends at 0-5% year is longer than the list growing at 5-15% – a reflection of the harsh realities Covid-19 has inflicted. Some holdings have cut their dividends for various reasons including long-term top-five holding Methanex, a direct consequence of the extreme circumstances created by the pandemic and the effect on demand for methanol. Overall, though, Mr Rhodes believes the fund’s objective of growing the income stream can be met in the current financial year (ending 31 March 2021).
Since the launch of the fund in 2008 Mr Rhodes’ philosophy of backing companies that grow their dividends while avoiding high yielders whose payouts don’t grow has been largely successful. The fund has been able to healthily increase its payouts to investors. Impressively, it looks on course to do so this year, albeit modestly, despite the adverse conditions posed by the pandemic.
Given the fund’s well-rounded approach Mr Rhodes has been able to perform in a variety of market conditions – although it has also endured periods of underperformance and past performance is not an indication of future returns. We continue to believe the fund is an attractive proposition for those seeking a rising income from global companies in this challenging environment. It continues to form part of our Direct Investment Service Preferred List our curated list of investments for new investment in their respective sectors.
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