Why dividends are moving up the investor’s priority list

Hello, I’m James Yardley, and today I’m joined by Stuart Rhodes, the Elite Rated manager of the M&G Global Dividend fund. Stuart, thank you very much for joining us today.

[00:10] Not at all. Thank you.

Stuart, maybe if we start with a bit of a recap of last year. I mean, your fund was one of the very few which managed to generate a positive return in a very difficult year. So, how did you manage it?

[00:27] Yeah, 2022 was I guess a very different year from what we’ve been used to for the preceding years prior to that. And it was a year where we were really well-positioned for that kind of environment. 

We’ve got three main sources of dividend investing within the fund, the quality defensive portion, the cyclical asset portion, and then the growth portion. And the growth portion of the fund is always the smallest – it’s somewhere between 10 and 20% of the fund. And so, the other two portions, the quality defensive, and the cyclical assets, really do dominate performance. And 2022 was a year that very much favoured those two parts of the market rather than the growth element. 

And if we think about how the year developed, the quality defensive part of the portfolio – so, I’m referring to consumer staples names here, like PepsiCo, Colgate, Coca-Cola, these kind of names, and healthcare names [like] Bristol Myers Squib etc. etc.- these businesses really did perform well throughout the whole year. 

2022 was defined by kind of an initial growth to value rotation, followed by a pretty strong recessionary narrative, given by how far interest rates were moving up to combat inflation. So, as we moved through that as a narrative through the year, defensive businesses just performed well, really all through the year. And so that part of the portfolio kind of built consistently and was a strong contributor to performance. 

And then the cyclical assets also had a very strong year, but it wasn’t quite the sort of straight journey that the quality defensive businesses were. So, in the first half of the year, you had commodity prices do very, very well. So, quite a few of our more commodity exposed, cyclical businesses had an exceptionally strong first half of the year, gave a little bit back actually as we moved into Q3 and that recessionary narrative really took over but then finished the year very strong, when it looked like some of the inflation data was starting to improve towards the back end of the year. 

So, I would say those are the two major contributors to why the fund had a good year is that we had a significant proportion of the fund in defensive companies. And also, the other significant portion of the fund is in the more cyclical side of the market. And hence, you know, the valuations that we were paying going into 2022 seemed very, very fair and we weren’t caught in some of these high valuation companies that derated pretty significantly. So, I think that’s how I would kind of describe 2022 to you.

And do you think there’s now a renewed focus on dividend investing again? I mean, because everyone sort of forgot about it when all these high-flying tech stocks were shooting the lights out, and you had your more boring, steady dividend payers were kind of thrown out, but it seems like they’re a bit more back in favour now. Do you think that’s a trend we’re going to see continuing going forward as well?

[03:43] Yeah, yes, I do. I mean, it’s no secret that dividend investing was quite hard work sort of prior to 2022, because the capital performance of parts of the market had been so strong. So, if you think about how well growth had done up until 2022, just the sheer capital performance made up for not really getting any dividends from that part of the market. 

And, you know, I think what we’ve learned over the last sort of 15 months or so, [is] that dividend investing hasn’t gone away. It was sort of out of favour for a little bit, but people are starting to understand why it has the track record it does over the long run and why it’s such an important part of total returns within equities. 

And so, given the sheer scale of change that we’ve seen since the start of 2022, money not being free anymore, yields and interest rates really on a different path than what we’ve been used to, having a compelling dividend profile I think is going to be a much more important feature of any equity really going forward. Certainly, relative to the 10 years that we had, post the global financial crisis. 

So, you know, for me, the two big aspects of why dividend investing is probably going to be a bit more popular over the next few years compared to what it has been over the past few years, is that valuation of dividend investing is normally pretty grounded – so, you are very rarely paying astronomical prices, so, you don’t have that vulnerability to high rated businesses derating significantly. And that can be very painful if that happens. 

And then also, you are providing some sort of inflation hedge. So, if you think about inflation nowadays being much more of a hurdle rate to get over, a much more significant topic than what we’ve been used to, having a dividend that can at least compete with the inflation rate and critically, grow quicker than the rate of inflation, I think is going to be an incredibly useful asset to deal with in the next few years, is it looks like the underlying pressure for inflation is now up rather than the downward pressure that we’ve been used to for the last 10 years.

So yeah, in a nutshell, I think, and we’ve seen it, [there’s] a lot more interest in the strategy, and dividends in general, I think, have moved up the priority list as a result of what we’ve seen over the last 15 months or so.

And what is your outlook in the fund for dividends in 2023? I mean, can we expect to see growth in dividends going forward? I mean, obviously your fund, one of the big features of it, it has got a very strong track record of growing the dividend over time. Can we expect that going forward?

And do you have any views on a global slowdown, on a potential recession? Could that, would that [be] likely to impact the fund at all or do you not really worry, you worry less, I think about the macro factors, don’t you?

[06:49] Well, <laugh> I mean, everyone in my kind of position, we always have to be aware of the macro factors because they’re obviously incredibly important. But the premise of what we do is to try and find companies that we believe can grow their dividend, in both good times and in bad times. So, it’s critical that we get robust businesses that are generating cash flow, because life won’t always be good. There’s always something lurking around the corner that will provide a challenge. And what we don’t want to do, is give our clients access to businesses that aren’t capable of paying their dividend at the first sign of difficulty. 

So, I mean, in reference to your question sort of directly, it does look as though those things are slowing down a little bit and the next couple of years could be, you know, potentially quite hard work for certain parts of the market. And we want to make sure that we’ve got business models that are robust enough to deliver our dividend profile through that. 

You know, the fund has been going since 2008. We’ve had two very significant sort of dividend tests: the global financial crisis straight out the gate, and then obviously Covid in 2020 were very difficult dividend markets – well, the two worst since the second World War. So, you know, we’ve got quite a lot of experience now of dealing with dividend profiles through more difficult phases. And I do expect the next sort of 12, 15 months to propose some challenges. But I do think we’ve got an underlying portfolio that will continue the track record of just delivering dividend growth. 

The key aspect to that question, I think is specifically around balance sheets. So, we do need strong balance sheets. You know, if I think about why dividend cuts normally occur, it’s because balance sheets can sometimes get stretched, and that is where almost all of the dividend cuts come from. So, we need to make sure that the balance sheet profile of the fund is strong and that will put us in really good stead to survive any difficult period.

And looking at the fund it’s very different to the benchmark. So, how do you go about finding your ideas Stuart, and can you give us some examples?

[09:08] Sure. So, you know, what we do is we construct a portfolio from our investible universe of names where we’ve done a lot of work in the 15 years’ we’ve been running the fund, on identifying companies that we think can grow the dividend through thick and thin, really. So, you know, companies that do have the ability to grow the dividend profile, even in more difficult markets.

And to put some context around that, when we launched back in 2008, that investible universe was about 180 names. Today it currently sits about 240. So, there is gradual growth to the list that we choose from. And really, identifying those names is quite simple. It’s looking at companies that have demonstrated a track record of growing the dividend in recent years and showing there is a willingness and capability to grow that dividend in more difficult times as well as easier times when the macro is growing.

And so, that’s what we do kind of all day, every day, is test that universe, either by trying to see if there are any names that are on that list that really shouldn’t be, or if there are new names that we’ve identified, that should be candidates to be put onto that list. And really, it’s a pretty broad list across geographies and sectors. Yes, there are some sectors that are easier than others – consumer staples and healthcare, for example, there are lots and lots of candidates that qualify for our list. The US is a great region to find dividend ideas, but there are some other parts of the world, Canada, Australia, Western Europe, etc. that really do have some excellent dividend track records too.

So, that’s kind of where we really start from. We don’t start from the index and, directly answering your question, because we don’t start with the index, we’re much more interested in finding companies from the bottom up, that we feel will give our end client essentially that growing dividend into perpetuity. So, there will be some big names in there. For example, you know, we own Microsoft [Corporation]. Broadcom [Inc.] is one of our largest holdings that’s a very significant technology semiconductor company in the US. So, we do have these investments that are well-known, famous household names, etc. 

But then we will also have names that perhaps aren’t that familiar. So, I’m thinking about Amcor [plc] is one of our largest holdings and has been for some time. That’s an Australian packaging business that has an exemplary dividend track record, [it] has grown every year for many, many years now. Pretty defensive kind of business. So, that would be sort of 15 to 20-billion-dollar market cap company that not many people have heard of, or certainly, when I talk about it, it’s not one that people have a view on. So, that would be a classic example of a company that fits exactly what we are looking at, that maybe isn’t that well known. 

I’m thinking of another company called Keyera [Corp.], which is in Canada. It’s an oil and gas infrastructure business, so, owns storage caverns, pipelines; critical pieces of infrastructure that allow energy to be brought out of the ground and delivered to the end consumer. And these are businesses with fantastic dividend track records, very solid cash flows based on contracts that are honoured, again, in more difficult times. 

So, these are the kind of businesses that we are interested in, and we are happy to invest in them if they’re famous big mega cap names, or actually down the market cap spectrum at 10, 20, 30 billion dollars – as long as they deliver the dividends that we want, then if they’re attractively valued, then they’ll find a way onto the fund.

That’s really interesting, Stuart. Well done in 2022 and hopefully the fund will continue to do well going forward! Thanks very much for joining us today.

[13:18] Not at all. Thank you for having me.

And if you’d like to learn more about the M&G Global Dividend fund, please visit FundCalibre.com