Looking for income? Three reasons to go global
By adopting a U.S.-centric approach to income, investors may unwittingly heighten their exposure to certain key risk factors and limit their diversification.
The income problem may last for decades
To some, the evolution of demographics is like watching paint dry. To fiscal planners, the image that may come to mind is more of a slow moving train wreck. Irrespective of one’s perspective, the aggregate statistics are largely indisputable. In the U.S., the next couple of decades will see substantial increases in the number of retirees, with the total almost doubling from 2012 to 2050.
This phenomenon is not unique to the United States, as dependency ratios are set to rise throughout much of Europe and Asia as well.
With many millions of households worldwide shifting from the accumulation phase of the investment lifecycle to the distribution phase, there is likely to be continued strong demand for income-generative assets.
With this strong and rising underlying demand, income generative assets may continue to display premium valuations for decades and income investors may be vulnerable to new product issuance that seeks to exploit the global income need. One example of this in the United States was the Master- Limited Partnership (MLP) bubble of 2014, where volatile energy businesses were able to raise capital at high valuations by portraying themselves as stable income sources.
The importance of looking beyond the U.S.
While the United States offers very deep and rich capital markets, U.S. equities are deficient in many respects as a hunting ground for income investors. As a result, income seekers can suffer some unintended and potentially adverse consequences by focusing too narrowly on the U.S. We would like to highlight three key contrasts between the U.S. and the rest of the world.
#1 – A numbers game
Simply put, the proportion of business that pay high dividends is much higher outside the U.S. Almost 40% of the non-U.S. MSCI World stocks pay 3% dividends or more, compared with barely 20% in the United States.
When viewed in absolute numerical terms, the contrast is even more striking. There are simply many more opportunities to find attractively valued income streams outside the United States.
The reasons for this discrepancy are debatable, but one explanation could be the historical tax advantage that capital gains enjoyed in the U.S. over dividends. Although the introduction of qualified dividends in 2003 addressed this disparity, buybacks continue to be used as a prominent way to return capital in the U.S.
#2 – Geographic diversification is industry diversification
In addition to the numerical disparity, the composition of dividend payers varies considerably by geographic area. In particular, many of the U.S. high dividend payers tend to be clustered in “bond proxy” sectors where investors may be exposed to significant interest rate risk.
Traditional bond proxy sectors (such as REITS, Utilities and Telecommunications shares) along with defensives (such as food and tobacco firms) make up more than half of the U.S. high dividend payers, versus only one quarter of the dividend payers outside the U.S.
When one adds in the energy sector (which includes the pipeline stocks and MLPs mentioned above), the total grows to over three quarters of the U.S. dividend universe.
The picture is the almost mirror image outside the U.S., where there are many more cyclical, industrial and commercial businesses offering attractive yields.
To summarize, for income investors, geographic diversification is industry diversification.
#3 – Cultural conservatism
Another possible reason for the disparity in income payers is the preponderance of family-controlled public companies outside the U.S. Controlling family shareholders often rely on dividend distributions to meet their liquidity needs, creating alignment with income investors. These businesses often tend to be conservatively managed and eschew financial leverage.
Conversely, in the U.S., public markets have been shaped by the corporate raiders of the 1980s and the activists of today who favor debt-funded buybacks as a way to crystalize returns quickly. If timed well, these measures can indeed create value. However, the levered capital structures they leave behind, may not be suitable for income investors with more subdued risk appetites.
A value filter is key
Income investors may continue to face an environment where yield is in high demand and the financial industry is eager to sell it. A value approach focused on a margin of safety can help identify when to say no to income and differentiate between attractive cash flow and “yield traps.”
An investor should consider the Fund’s investment objectives, risks, and charges and expenses carefully before investing or sending any money. This and other important information about the Fund can be found in the Fund’s prospectus or summary prospectus, which can be obtained at www.johcm.com or by calling 866-260-9549 or 312-557-5913. Please read the prospectus or summary prospectus carefully before investing. The JOHCM Funds are advised by J O Hambro Capital Management Limited and distributed through FINRA member Foreside Financial Services, LLC. The JOHCM Funds are not FDIC-insured, may lose value, and have no bank guarantee.
Investors should note that investments in foreign securities involve additional risks due to currency fluctuations, economic and political conditions, and differences in financial reporting standards. Smaller company stocks are more volatile and less liquid than larger, more established company securities. The small and mid-cap companies the Fund may invest in may be more vulnerable to adverse business or economic events than larger companies and may be more volatile; the price movements of the Fund’s shares may reflect that volatility. Fixed income securities will increase or decrease in value based on changes in interest rates. If rates increase, the value of the Fund’s fixed income securities generally declines. Other risks may include and not limited to hedging strategies, derivatives and commodities. The views expressed are those of the portfolio manager as of August 2018, are subject to change, and may differ from the views of other portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. Sources for all data: JOHCM/Bloomberg (unless otherwise stated)
Duration as a diversifier: Giorgio Caputo, Senior Fund Manager of the JOHCM Global Income Builder Fund, provides an update on portfolio positioning.Read More 29 July 2018
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