Lower interest rates are here to stay. It is likely the UK base rate will remain at 0.5 per cent for at least another two to three years. Ben Bernanke, chairman of the US Federal Reserve, has actually stated he won’t raise interest rate rises until at least 2015.
This presents a dilemma for investors. Returns on cash deposit are below the rate of inflation so the purchasing power of savings is diminishing. Cash is an essential component of any portfolio. It can be accessed instantly and be used to pounce upon a bargain, whether it is consumer goods or an investment opportunity following a fall in the stock market. However, it isn’t a great long term investment. Those who relied on cash since 1990 have seen interest rates fall from 15 per cent to 0.5 per cent; hardly a safe form of income.
Effectively central banks and politicians are trying to force investors out of cash into financial assets to support markets. A fall in base rates makes the yield from shares look attractive if you can stomach the volatility and take a long-term view.
This brings me on to the M&G Global Dividend fund which is just over four years old. It is managed by Stuart Rhodes who has chosen to house the fund in the IMA Global sector, rather than the Global Equity Income sector. This is because he does not want to be tied to a specific yield target. This strikes me as eminently sensible. In many cases the companies with the highest yields aren’t the best place to be. Income fund managers need to consider the potential for growth in income. Concentrating purely on achieving the highest possible income with no thought to future growth normally ends in disaster. As fund managers chase ever higher yields and become tempted to use alternative techniques to boost dividends, it becomes more likely they will have to cut dividends to a more sustainable level in future.
Stuart Rhodes looks at three types of company as he believes having a balance will help the fund outperform in different market conditions; keeping up to an extent in more racy bull markets, but maintaining a defensive element for when markets fall. Between 50 per cent and 60 per cent of the portfolio is generally invested in what he calls quality companies; those with a disciplined approach to dividends and reliable growth. Secondly, he invests between 20 per cent and 30 per cent in more economically sensitive companies which are backed by a strong portfolio of assets. This provides a degree of security as their share prices are generally more volatile. Finally, he looks for rapidly-growing companies which could have exposure to faster-growing emerging markets or be developing an exciting new product line. Around 10 per cent to 20 per cent is generally invested here.
The fund’s biggest weighting is in the US and Canada at 44 per cent followed by Europe at 26 per cent and the UK at 14 per cent. The rest is spread over South East Asia, Australia and a small amount in Brazil. In the latter he has recently purchased Vale, the world’s largest iron ore producer. The company’s prospects are likely to vary with the outlook for global economic growth and demand for iron ore, but he believes it is backed by strong assets. In the quality category are McDonald’s and Sanofi, the French pharmaceutical company. Both have international exposure and products that could remain in demand regardless of economic conditions. Elsewhere, he believes Tod’s, the Italian luxury shoe and leather goods brand, is capable of continued strong growth as it targets increased sales in international markets, including faster-growing Asian economies.
Elsewhere, Stuart Rhodes is less positive on telecommunications and utilities companies. The main rationale is that he struggles to see how these types of companies will grow and he believes dividend pay-out ratios will ultimately drop. In addition, with utilities in particular he is concerned about the amount of the debt they have which he believes contributes to volatility in earnings.
Perhaps most important for investors and particularly baby boomers approaching retirement is growth in income. The fund has grown its dividend each year since launch and Stuart Rhodes estimates growth in the region of 5 per cent for 2012/13. It is growth in dividends and therefore income to the investors that I believe is vital for the future. With annuity rates seemingly forever falling, funds like this have the potential to grow your income for the next 20 years plus. This fund is certainly worth considering and could provide an element of diversification to a more UK-focused equity income portfolio.
Mark Dampier is head of research at Hargreaves Lansdown