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14th Mar 2022
In this month’s Insight, Mark Barnett explores the significance of income investing within the asset management industry, and the evolution of investor tastes, ahead of the launch of the TM Tellworth UK Income and Growth Fund.
During the 25 years I have managed income funds, I’ve tried to adhere to an investment mantra that is summarised by the acronym K.I.S.S: Keep It Simple Stupid! I know that I’ve been guilty of ignoring this rule at times! But actually, it’s a pretty good rule of thumb for investing along with other aspects of life. Translating this mantra into an investment philosophy: the primary purpose of every investment is to produce a recurring stream of income. This is a fundamental tenet that sits behind every financial investment decision whether we are thinking about Bonds, Property or Equities.
Source: Morgan Stanley, as at February 2022
It’s perhaps too easy to underestimate the importance of income when investing in equities as many people are hypnotically attracted to the ever-changing share prices that wink away on their smartphones. But the truth is that dividends really do matter. The impact of dividends on the returns received from owning UK equities over the long term is neatly summarised by the graphs above. On the left-hand side the red line shows the massive impact from including dividends in the return from the UK equity market over the past 25 years. The right-hand chart provides a breakdown of overall market returns by earnings, dividends and PE multiple expansion. The two left-hand bars show that over longer time periods dividends have accounted for around 50% of total returns in the UK stock market but in the more recent past and especially during periods of market volatility experienced since 2020, dividends have accounted for 150% of total returns. This surely represents powerful evidence of the importance of receiving a tangible cash return from owing an equity.
What is indisputable is that the hunt for income has persisted in investors’ minds over the past decade as central banks around the world have maintained extremely loose monetary policies by holding bank rates close to zero and massive Quantitative Easing programmes. This policy has resulted in a bull market for fixed income securities and high growth equities. Perversely these market dynamics have resulted in underperformance of equities paying a strong, sustainable dividend, and funds that follow these strategies. Many investors and wealth managers have accepted a lower yield as inflation pressures were becalmed and capital growth especially in the US tech sector was the gift that kept on giving. But the demand for income has not disappeared and for many investors the desire to deliver sufficient income from a portfolio of diversified investments is still high priority, and for many the desired outcome. For a private investor free to allocate between bonds and equities which is the most interesting asset to own in order to achieve this objective?
Source: Berenberg, as at February 2022
As this chart above clearly shows, investors have enjoyed a fantastic bull market in UK sovereign bonds over the past 40 years, and although the 10-year gilt yield has risen to 152bp from a low of 8bp in August 2020, this remains very low by historical standards. By contrast UK equities offer a pretty stable yield over the same time period and currently offer an attractive historic dividend yield at 3.3% which is covered by earnings over 2x. There is a similar story to tell when extending the comparison of UK equity dividends to UK corporate bond yields. The difference is less pronounced but still represents a yield benefit to investors by owning equities over corporate bonds.
Source: Berenberg, as at February 2022
The choice for income seeking investors is clear in answering the question about how to allocate funds. Equities remain attractively valued against fixed income assets and offer the extra benefit of growth in dividend streams which is clearly unavailable in the world of fixed coupons! The allure of equities is further enhanced if we consider the current economic backdrop which is more inflationary than for many years. Historically equities have been one of the best ways of protecting capital during periods of high inflation through the benefits of pricing power. The chart on the left below shows the return from UK corporate credit and UK equities during periods in the past 40 years when inflation has exceeded 4%. The average return shown in the final bars clearly underlines the point in favour of equities over bonds.
The final important factor to consider when thinking about the yield available from owning equities is that the security of UK equity dividends is better now than at any time in the past decade. The chart below right shows how the dividend cover from the market has improved since 2020.
Source: Berenberg and Lazarus Economics and Strategy, as at February 2022. Data beyond February 2022 is forecast, and is not a reliable indicator of future performance.
The pandemic has represented a dividend reset for the market where many companies, who were not forced to cut or eliminate dividends for cash flow preservation/regulatory reasons, chose to rebase dividends as a prudent response to the pandemic. In any case the outcome looking forward should be seen as improvement in the overall level of security of equity dividends and is clearly of significance as Tellworth takes a leap in the UK Equity Income sector with the TM Tellworth UK Income and Growth Fund, due to launch later this month. As an actively managed unconstrained fund, the portfolio is free to select the most interesting opportunities across the market regardless of company size and industry. The key is to identify companies that can maintain and grow dividends led by management teams that view equity in their businesses as a precious and rare resource. The investment objective is to deliver a growing stream of dividend income by investing in a diversified portfolio of equities. This seems to us a great time to be reappraising the importance of dividends as an essential part of a diversified investment portfolio.
The views and opinions contained herein are those of the Tellworth Investment team. They do not necessarily represent views expressed or reflected in other BennBridge investment communications or strategies and are subject to change.
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BennBridge and Tellworth decline all responsibility in the event of a decision whether or not made on the basis of the information contained in this document or in the event of any use whatsoever of said information which may be made by a third party.
Tellworth is a UK and European equity investment management boutique which launched in partnership with BennBridge Ltd.
BennBridge is authorised and regulated by the UK Financial Conduct Authority (FRN: 769109) with registered address: C/O Windsor House 5 Station Court, Station Road, Great Shelford, Cambridge, England, CB22 5NE.