Newton Investment Management’s CEO Euan Munro discusses why he believes the backdrop for equity income investing is favourable in 2023, and what this means for DC investors.
After more than a decade in which markets have been dominated by growth, investors could be forgiven for overlooking the benefits of dividend-focused equity strategies. Until very recently, many of the leading technology stocks were on valuations that implied the growth they would experience as large companies would be almost as rapid as their historic trajectory. Some investors committed capital to areas that appeared to offer almost boundless opportunities, such as cryptocurrencies, private equity and parts of the property market.
However, over the last 12 months it has become increasingly clear that market participants need to face up to a very different regime. Rising interest rates and high inflation have created an extremely challenging environment across all major asset classes. Many of the high-growth technology-related stocks that were the big winners over the last ten years, and particularly during the Covid pandemic as we all worked and shopped virtually, have seen precipitous declines. Areas of the economy where speculative bubbles have formed - such as private equity and cryptocurrencies - have started to look increasingly vulnerable as the tide goes out.
Many investors may be hoping that their current portfolio will lead them out of the downturn, but while history may not repeat itself, a look back at previous cycles suggests to us that market leadership can change dramatically in such instances. Internet and telecoms stocks, for example, formed the dot-com bubble in late 1999, but did not lead the recovery when the market finally found its bottom in 2003.
With the potential for slower growth and lower capital returns from equity markets, making the income component of returns more significant, we believe the backdrop for income stocks is favourable. Post Covid-19, balance sheets have been repaired and although dividends have recovered, earnings have recovered faster, so payout ratios have come down and dividend cover is pretty good.
Inflation protection and attractive valuations
Taking a long-term view, it is noteworthy that during previous inflationary periods, income stocks have proved an attractive proposition for investors looking for inflation protection and defensiveness at a reasonable price. While we may have reached peak inflation and appear to be nearing a high in global interest rates, we do not expect interest rates to start to come down quickly, despite some market participants' apparent clamour for a pivot from the US Federal Reserve. Instead, we expect inflation to prove relatively sticky in response to long-term trends such as deglobalisation, decarbonisation and rising wages.
We believe another supportive factor is the attractive valuation of income stocks. At the time of writing, above-average-yielding stocks trade at a substantial discount to below-average-yielding stocks on price-to-earnings and price-to-book bases. Even after a period of much better performance from income stocks in 2022, we see them as inexpensive relative to non-income stocks. In our opinion, this is because investors are keen to do what they have always done (at least in the years since the 2008 global financial crisis), which is to own growth equities.
However, when considering the desired investment outcome, we think investing in income equities could often make more sense than a growth or value-centric approach. Beating the Nasdaq is unlikely to be the right objective for a retiree in their 60s or 70s who is looking to protect their portfolio from inflation risk. As dividends tend to be more stable than markets, company profits or economies, a focus on the dividend income can provide a more durable dimension to any investment strategy seeking to navigate challenging or volatile markets. Nevertheless, individual investors may be deterred by industry platforms which in many cases only highlight the capital gain realised from an investment, rather than showing the total return which also includes dividend payments over a period.
To the long-term investor, attractive equity returns are derived not simply from the receipt of dividends, but from the accumulation of shares as a result of the reinvestment of those dividends. Over the very long run, the impact of dividend reinvestment on total returns is extraordinary; since 1900, 99% of US equity total return has been driven by dividends and their reinvestment.[1] As Albert Einstein said: "Compound interest is the eighth wonder of the world. He who understands it, earns it... he who doesn't... pays it".
As we enter a new investment era likely to be defined by uncertainty and volatility, we believe an active, discerning approach to equity income could be key in helping DC schemes achieve attractive outcomes for members.
Learn more about Newton Investment Management.
Euan Munro is CEO of Newton Investment Management.
Important information
This is a financial promotion. These opinions should not be construed as investment or other advice and are subject to change. This material is for information purposes only. This material is for professional investors only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell investments in those securities, countries or sectors.
Issued by Newton Investment Management Ltd. ‘Newton' and/or ‘Newton Investment Management' is a corporate brand which refers to the following group of affiliated companies: Newton Investment Management Limited (NIM) and Newton Investment Management North America LLC (NIMNA). NIMNA was established in 2021 and is comprised of the equity and multi-asset teams from an affiliate, Mellon Investments Corporation. In the United Kingdom, NIM is authorised and regulated by the Financial Conduct Authority (‘FCA'), 12 Endeavour Square, London, E20 1JN, in the conduct of investment business. Registered in England no. 1371973. NIM and NIMNA are both registered as investment advisors with the Securities & Exchange Commission (‘SEC') to offer investment advisory services in the United States. NIM's investment business in the United States is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request. Both firms are indirect subsidiaries of The Bank of New York Mellon Corporation (‘BNY Mellon').
[1] Source: Professor Robert Shiller, Yale University, August 2020. Credit Suisse, Global Investment Returns Yearbook (2011) and Elroy Dimson, Paul Marsh and Mike Staunton, Triumph of the optimists: 101 Years of Global Investment Returns (Princeton University Press, 2002), with updates from the authors; February 2012. Copyright © 2011 Elroy Dimson, Paul Marsh and Mike Staunton.
This a sponsored article from Newton Investment Management
