Equities Recast as 'New Bonds' After Tough Decade

Thursday, 13 Oct 2011 10:50 AM

 

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After a decade of poor equity returns and facing years of slow global growth, a growing number of investors are recasting equities solely as a yield-bearing asset to help manage risks and keep their portfolios diversified.

Despite their billing as attractive long-term investment, world stocks have had a rough ride in the past decade.

This year alone they lost 26 percent at one point after hitting a 3-year high in May, and over the last 10 years the total return on equities is 26 percentage points less than on bonds on a rolling basis, Reuters data shows.

Fund managers have increasingly moved to low-yielding bonds, but they cannot afford to invest everything in fixed income and cash if they are to retain some sort of diversification.

As a result, many are looking at dividend yields on stocks, some of which fetch 7 or 8 percent, as a sustainable source of income that bears fruit if you hold on to shares in the medium term to ride through a volatile period on stock markets.

Dividend strategy has been popular for some time, but focusing mainly on the yield perspective of stocks may help give the underperforming asset class a new place in investment portfolios and potentially shield the market from the ebb of risk-on, risk-off flows.

"Investors are looking at equities more as a dividend-paying play than a capital growth story. This is a particularly attractive strategy for pension funds for a longer-term horizon," said Alan Higgins, head of investment strategy in the UK at private bank Coutts.

"We have become more defensive, focusing on high-yielding equities. High-yielding equities tend to be very defensive."

Coutts' strategy involves underweighting equities and overweighting bonds, but it likes high-dividend stocks such as Vodafone, Royal Dutch Shell and Glaxo SmithKline, whose dividend yields are above 5 percent.

The MSCI developed world dividend yield stands at 3.1 percent, much higher than core government bond yields from the likes of the United States, Germany or Britain.

Higgins said income strategy is more attractive for investors with a 10-year plus investment horizon.

"On a 3-5 year horizon, while it is still attractive, the advantage from income approach is more marginal when you shorten your time horizon. This is a strategy recommended for an investment horizon of 10 years plus," he said.

According to Credit Suisse, companies including Pfizer, Kraft Foods, Philip Morris and Merck have credit default swaps below government's and dividend yields above risk-free rates.

Growth and Returns

The prospect of slower global economic growth in the next few years argues against strong capital appreciation in stocks, whose returns are closely correlated with world output.

The IMF said in its latest forecast that it expects the global economy to grow 4 percent in 2011 and 2012 compared with 5.1 percent in 2010. Advanced economies are expected to expand an unimpressive 1.9 percent this year.

"In the ... past 20 years or so, investing in equities was mostly about finding high growth companies. Now we think steady cash flow — often evidenced by high dividend rates — is a better way to find value in equities," said Kevin Lecocq, chief investment officer at Deutsche Bank Private Wealth Management.

"In developed markets, equities are becoming more like a cash cow, back to where we started: What can they return to shareholders? In the lower growth environment which we are in now you want profit returned to shareholders."

Deutsche PWM recommends that investors "shorten duration" in equities, or move away from cyclicals and look at high-dividend stocks. The focus on the equity income stream allows investors to earn money in the shorter term than waiting for capital growth to come back.

The growing trend of treating equities almost like a bond may also be attractive for those who want to keep exposure in emerging and frontier markets, many of which have underperformed their developed counterparts this year.

Qatar's stock market, for example, previously one of the best-performing frontier markets, has fallen 4.5 percent this year. But its expected dividend yield stands at 4.3-5.4 percent, the highest in the Gulf region after Oman, with some companies paying as much as 6-7 percent.

"Dividend payment is becoming very important, and a high yield play is already there in Qatar," said Sandeep Nanda, fund manager of Qatar Investment Fund, which is 10 percent owned by the Qatari sovereign wealth fund.

"It's a sustainable dividend growth story."

© 2014 Thomson/Reuters. All rights reserved.

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