2012 was a good year for investors at both extremes of the risk spectrum. Gilts produced solid single digit returns and equities, having had a tough 2011, ended 2012 with firm double-digit numbers.
On reflection gains for gilts were at the expense of income as yields compressed in the face of rising capital values. Returns on equities were stronger, but carried the usual health warning about downside volatility.
For those investors willing to embrace this volatility, compensation by way of regular dividends provided a cushion. Indeed, the importance of dividends was amplified as it is now clear that we are living though an era of low interest rates.
Given the power of dividends, going into 2013, what sectors might be worthy of further examination by investors? Here are three themes we have encountered when talking to managers.
The S&P 500 rallied sharply following a working solution to the ‘fiscal cliff’. What was not so widely reported was that clarity was reached on the level of taxation for US dividends, with income and capital gains continuing to be treated at parity.
This is significant because an increasing number of US companies have chosen to pay dividends to shareholders, for example Apple last year. Leaving the tax regime unchanged should be supportive of these companies without US pension funds re-allocating capital out of high yielders. Advisors now have far more US dividend strategies to choose from than a year ago, as the sector has expanded.
There has been a pronounced proliferation in emerging markets dividend strategies. Twelve months ago, we analysed half a dozen vehicles, none of which had a three year track record. The universe has now more than doubled and whilst it continues to remain largely untested, the case for sustainable yield in emerging markets looks compelling.
Over a quarter of companies yielding over 3 per cent in the FTSE World index are listed in developing markets. One has only to look at the success of Asian income funds to see that emerging income might follow a similar path as more companies elect to pay dividends. In addition, we have seen some exchanges setting payout ratios.
Japan might also be worth monitoring. Given a backdrop of deflation, there has been no domestic demand for equities as Japanese government bonds provided a positive return year on year with enhanced purchasing power.
This may change as the Bank of Japan attempts to inject some much needed inflation into the system; this could provide the transmission of a movement from bonds into equities.
With the Topix now yielding broadly the same as the S&P 500, sterling investors might reappraise this maligned sector, and consider hedging their exposure to the yen.
To conclude, there are three areas that may be of interest to advisors looking to broaden out their equity allocations to support yield. Firstly, US policy is firmly accommodative for dividends. For the adventurous, emerging markets provide a furtive hunting ground and finally, Japan continues to be complex but could surprise on the upside.
Jason Day is senior analyst of MyFolio at Standard Life Investments