Viewpoint - Stephen Thornber, Columbia Threadneedle
The fund manager on what makes companies attractive, the interest rate impact on stocks and regional differences in dividend behaviour.
Can you explain the importance of dividends to your investment approach?
We think dividend-paying companies are fundamentally attractive. Companies which allocate capital partly to generate growth and partly to reward shareholders are likely to be much more disciplined in their approach to acquisitions and investment, as dividends are a long-term commitment.
What dividend characteristics are you looking for in your investments? For example, do you have a minimum and maximum yield level for companies you invest in?
We are focused purely on the high-yield universe. The world market yields an average of 2.5% but we have a firm hurdle rate of 3%. We will not buy a stock with a dividend yield below that and we will sell if it drops below that level. We have no maximum and will invest in very high-yielding stocks on a case-by-case basis. We want to make sure the dividend is sustainable and can grow, which is why we look for growth in dividends and earnings of at least 5%. Lastly, the company should not have high levels of debt.
“Robust growth in the economy is generally positive for equities”
Interest rates are expected to rise in the US within the coming months. What impact will this have on dividend-paying stocks?
Historically, if interest rates increase because of inflationary risk, it is bad for equities. If it is because of robust growth in the economy, that is generally positive for equities. We feel there is currently very little risk of inflation; if anything, there is deflation. Therefore, when the US and the UK raise interest rates it will be because their economies are healthy and growth is robust.
At the start of the year, we expected US interest rates to be increased twice by the end of the year and once in the UK. Now, we think the UK will remain at 0.5% and the US may see one rate rise, but there will not be increases elsewhere. Rates are not going to go very far very fast, so equity yields of 3%, 4% or 5% will still look attractive. Balance sheets are also healthy, so dividend growth can be maintained.
Are there regional differences in dividend behaviour? Which countries have the best track record of paying dividends?
There are big regional variations. The standout example is the US, where companies are addicted to buying back their shares rather than increasing dividends so the cash yield is much lower. In the UK and Europe, there is a strong dividend culture. Here, if a company increases its dividend, that is seen as a good sign. In the US, shares will often fall after a dividend increase as the market views it as an indication that the company has nothing better to do with its cash. There is also a very strong dividend culture in Asia, with many companies having a good yield and payment discipline. Japan has never had a dividend-paying culture but that is beginning to change. Prime Minister Shinzo Abe has devised a new index that measures shareholder return to encourage companies to invest or pay dividends, but change is slow.
Where are you finding the best dividend opportunities?
We are underweight in the US, partly because there are fewer companies yielding more than 3%, and if they are it is often in industries we do not want to invest in. We have also reduced our exposure to Asia because we do not think countries in the region can escape the impact of the slowdown in China. Australia, Europe and the UK we like, and we’ve been adding to our exposure in Japan. We like consumer-facing companies where growth may be slow but it is coming. That includes US companies like L Brands – the owner of Victoria’s Secret – and Six Flags, which owns theme parks, and Hugo Boss in Germany. We also like infrastructure companies. Ferrovial may be a Spanish company but its two biggest assets are 25% of Heathrow and the toll ring road in Toronto. These are quality assets. Sydney Airport is a fantastic quality asset – passenger numbers are increasing, particularly of Chinese tourists who typically spend three to five times as much in duty free as other nationalities. The airport has designed its retail business to be particularly attractive to these customers.
How do you view the risk of dividend cuts? How do you protect the fund against them?
We think utility and commodity companies are particularly at risk from dividend cuts because of falling commodity prices. We sold some energy stocks a year ago and they have cut their payments in the past few months. We think our disciplined approach means we should see dividend income for our fund/portfolio growing over time. If we do not sell before a cut then we seek to meet the management as soon as possible. If the yield on the shares falls below 3% after the cut, we will always sell. If we do not think the dividend has been cut enough, we will sell.
“We like consumer-facing companies where growth may be slow but it is coming”
The opinions expressed are those of Stephen Thornber and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.
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