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I’m probably supposed to start by talking about how exciting my approach to global equity income is. The truth is, I think of global equity income as the epitome of “slow and steady wins the race”. I don't shy away from being called boring — to me, that’s a good thing. Consider synonyms for boring: reliable, stable, measured, consistent — in my view, these are qualities that translate well to the world of equity income, bringing tangible benefits to investors.
But what I also believe is that for investors seeking both income and attractive total returns, an allocation to equity income can prove rewarding. In today’s inflationary and cyclical environment, I also think an equity income allocation can provide an added element of downside protection.
These are a few ways I embrace a predictable, consistent and measured approach, and how I think it pays off for equity income investors:
I’m a natural sceptic, particularly when it comes to something the market is excited about. Early in my career, I covered Asian stocks during the ‘90’s Asian financial crisis. I covered technology, media and telecommunications during the dot-com bubble. When I moved to Wellington, I became a sector expert, working on banks during the global financial crisis.
I have followed my fair share of crises around, and it’s taught me two things in particular: firstly, to be very sceptical of exuberance, and secondly, the value of downside protection. It helped forge my stringent focus on valuation and balance-sheet strength. More often than not, I consider the downside case to be more important than the base case.
As a result, I favour companies that are more stable over the long term, resulting in lower turnover and a longer investment horizon. Being wary of what other investors are excited about can also help deliver differentiated views and potential lower correlation to the wider market, potentially providing downside protection over time.
Being cautious on exuberance is one thing. I like to go a step further and look at what the market is ignoring. The market ignores what it perceives as uninteresting, but overlooked businesses with underappreciated returns can provide a solid stream of compoundable income. I'd argue consistency is great when it comes to compounding too.
I see clear examples of this at the moment with companies in the health care and utility industries. In uncertain times, there’s usually a premium for defensiveness in these sectors. However, today there are names where I think the market is overlooking the attractiveness of the opportunity to provide potentially robust total returns and steady income, uncorrelated to the broader macroeconomic environment.
I believe if you focus on what isn't exciting and remain pragmatic, you can benefit from opportunities the market is overlooking.
There’s no easy shortcut to finding quality, reliable dividend payers. It might sound surprising, but I don't believe dividend yield should be the centre point of an equity income process. To me, it's an output, not an input.
Instead, I take the universe of dividend-paying companies and spend a lot of time looking for the intersection of quality and valuation, because that is where we find the best risk-adjusted returns and income reliability. This is where our global industry analysts — experienced specialists with deep knowledge of their sectors — are critical. Essentially, quality is subjective. I see quality as a company’s ability and willingness to pay and sustain dividends. We assess a company’s management, its capital discipline, its financial health and its economic moat. With the analysts, I welcome the debate across these dimensions.
From a value perspective, what I care most about is unlevered cash flow, as it can help us avoid value traps and provides a window on the ability to return capital. This metric is a lot more important to me than earnings. This free-cash-flow focus helped us avoid stocks like Vodafone, where optically attractive earnings and dividend yield masked unsustainable returns and material downside risk.
When you find that sweet spot between quality and value, especially if you’re able to capitalise on short-term controversy to find attractive entry points, I think you can achieve an attractive dividend income, along with upside potential, because we’re not overreaching for yield.
Being measured means I focus on the long-term picture. One example of this is our approach to ESG risk, where we want to understand any potential downside that might impact the sustainability of returns (dividends or otherwise). Plus, understanding ESG risk better than the broader market can create opportunities. Building a net-zero commitment into portfolios isn't something many other equity income investors do, but we think it's aligned with our risk management in the portfolio. It helps us identify a potential ESG risk that could impact returns, and we can engage to help minimise that. Our holding in US utility Duke Energy exemplifies this twin focus on ESG risks and opportunities. Duke's commitment to retire coal-powered generation will materially reduce GHG emissions, while investments in renewables and electrification should increase its growth rate over the next decade.
My emphasis on the long term also reflects my approach to cyclicality. I hope to hold companies through cycles by focusing on what matters: the quality of the company and valuation. We trust that an element of consistency can be achieved regardless of cyclical exposures, by investing in companies that have sufficiently high returns on capital and high cash flow to support dividends, even at cyclical low points.
As an investor, my consistent, cautious and pragmatic approach could be categorised as boring. However, I believe it gives me the best chance of outperformance, and personally, I don’t find that boring at all.
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