Income opportunities in 2022

Investing for income has long been the path to some of the best long-term returns for investors. The combination of receiving the lion’s share of your return in regular, often gradually increasing quarterly payments gives many benefits. This reliability allows investors to feel more comfortable when markets are volatile, helping them avoid the psychological trap of selling when things have fallen, and in turn unlocking the power of compound interest – allegedly described by Albert Einstein as the 8th wonder of the world!

However, these qualities, and therefore this reputation, took a serious knock when Covid-19 shut down the vast majority of the world economy. The sheer level of uncertainty caused even companies that could afford to pay income from cash reserves to instantly stop dividend payments in their tracks. To add to this, governments and central banks put in place curbs on dividend payments, most notably for financials which are one of the biggest payers of equity income.

Coming out the other side?

As the world has started to learn to live with Covid-19 to varying degrees, so we have seen such rules relaxed, and most boards have had the confidence to return to the dividend roster. However, the results are varied with many starting at lower pay-out ratios (amount of earnings paid as dividends) and it’s a time when the active manager is particularly important in gauging which companies will deliver the best and most reliable income through the combination of good business management and perhaps being in less affected sectors of the economy.

Unsurprisingly given the varied conditions of the last two years, there have been some significant moves in prices of income generating investments, and in many cases to the detriment of investors. On the other side this has thrown up some opportunities.

Here, Robert Burdett, co-manager of BMO MM Navigator Distribution fund, gives his thoughts on where those opportunities lie:

“Within the BMO MM Navigator Distribution portfolio we responded to the opportunity in March 2020 by adding a position in an investment grade corporate bond fund for the first time in many years. Previously yields available were below 3% but suddenly over 6% was available and attractive.

“By October 2021 the value of this new holding was already up, over 20%, and with signs of inflation picking up we took profits. We have rarely, if ever, seen such returns so quickly from a corporate bond fund.

“Emerging markets have been amongst the most volatile and this led us to modify the fund’s exposure a little with more short duration exposure (which means less susceptible to rising inflation and/or interest rates) and more credit (company loans rather than government). We made similar duration-related changes within the fund’s high yield bond holdings.

“Turning back to company dividends, the various surveys we receive are now showing very encouraging signs. Most recently the Janus Henderson Global Dividend survey* reported the following highlights:

• Dividends climbed 22% to an all-time high (for the third quarter) to $403.5bn
• The headline figures were boosted by a large number of special dividends
• Across the globe, 90% of dividends were held or increased
• The JH Dividend Index is now just 2% below the pre-pandemic peak seen in Q1 2020

“From an asset allocation perspective, the BMO MM Navigator Distribution portfolio continues to favour the UK market, which is the largest allocation of the fund. There is value in UK equities both in absolute terms and relative to other markets. The UK has been a little unloved by investors post-Brexit, and we are seeing sterling slide.

“The UK stock market also has some large companies in less favoured sectors, and very few listed technology companies which have been the flavour of the month, or even the year. These aspects in combination have led to takeovers happening more often recently – not necessarily healthy in the long term if good UK companies disappear from the stock market, but helpful in turning attention back to this fertile market for stock pickers. For income investors as well, the UK has a history of strong dividend production and we are optimistic we are returning to such times.

“We also like the alternative assets space and have seen very strong recoveries in the less economically sensitive property we prefer for the fund such as Supermarket REIT, which acts as landlord to the major supermarket companies, focussing on the most useful sites that are serving online, click-and-collect as well as normal shopping.

“LXI REIT which funds the development of relatively simple buildings for smaller supermarkets such as LIDL and ALDI, some of the smaller hotel chains and other assets has also done well. Its combination of long leases (typically over 20 years) plus index-linked rent to protect against rising inflation have appealed and its dividends have been increasing to now above pre-Covid levels.

“Elsewhere we have a neutral view on the US with valuations high, but the economy strong, and dividend yields are low compared to other regions. Japan and Europe bring up the rear in terms of desirability for the fund at the moment, but this is kept under constant review and Japan’s recent significant economic stimulus package and their impressive control of Covid-19 keep us looking.

“Overall, 2020 was the most challenging of times for income investors and for this fund. Since the early November 2020 announcement of the efficacy of the vaccines we are now using around the world, performance has rebounded strongly and now dividends themselves are following suit. We are not back to normal in the world just yet, but many companies and funds have already adapted to this more unpredictable environment and for active fund managers it could prove to be a fertile time to the benefit of this fund.”

*Source: https://www.janushenderson.com/en-gb/adviser/jh-global-dividend-index/