At the start of the year we put forward three regions that advisers should consider given the growing importance of dividends in a low growth environment. These were: the US, emerging markets and Japan. Given the extraordinary moves in bourses to date, it is worth revisiting performance as we look towards the second half of the year.
In the US, clarity surrounding the impact of the ‘fiscal cliff’, the ongoing improvement in the housing market, firmer employment numbers and positive retail sales have propelled the S&P 500 to a record high.
Despite being in bull territory from the lows of last November, over the first quarter of the year it was surprising to see ‘defensives’ lead the charge, with healthcare, consumer staples and utilities registering the strongest gains. In context, the S&P 500 posted an impressive gain of around 18 per cent (GBP) yet the SPDR S&P US Dividend Aristocrats ETF delivered around 23 per cent.
Appetite for companies with bond-like characteristics seems to have driven this unusual dispersion between classically less beta orientated areas with steady dividend characteristics in contrast to economically sensitive sectors such as financials and IT. This trend continued through April, but in May, we have seen ‘cyclicals’ starting to break-out on the upside. Nonetheless, investors in dividend strategies have made significant gains.
Given the backdrop, emerging markets equities would be expected to rally sharply as traditionally, developing markets are highly geared to the US.
This has not been the case. In dollar terms, the MSCI Emerging Markets index was actually negative over the first quarter. However, if we examine strategies that have outperformed over this period, EME dividend managers stand-out.
Newton Emerging Income to take one example, outperformed by over 5 per cent against the MSCI Emerging Markets index return to the end of April. These strategies may be well placed to continue to deliver in a low growth environment.
Companies that have strong capital allocation disciplines, such as paying dividends, may be better equipped than those that focus on increasing margins which are under pressure from both wage inflation and falling external demand as developed markets contract.
Finally, we noted that Japan could surprise on the upside given a change of leadership in December and the desire for an expansionary policy. The resultant magnitude of the stimulus announced has been remarkable. The MSCI Japan returned a staggering 27 per cent, in sterling terms, to April and around 40 per cent in local currency. Yen weakness is providing an uplift in earnings expectations given the export dependent nature of the economy. Given that Japanese Government Bonds now face negative real yields as the economy reflates, companies may react positively by increasing dividends.
Unlike the US and emerging markets, Japan has not been in vogue since the global financial crisis and choice is limited in dividend centric strategies. In February, Coupland Cardiff launched the Japan Income & Growth fund with a target yield of 4 per cent in an area dominated by Jupiter Japan Income and CF Morant Wright Nippon Yield.
To conclude, market dynamics year to date are supportive of the thesis that in a low growth environment, sustainable yield is not only a useful source of immediate income but can be a significant component of total return. Investors have a range of dividend funds available to them across US, emerging and Japanese equities with which to obtain regional exposure; these could continue to work well for them in the year ahead.
Jason Day is MyFolio senior analyst at Standard Life Investments