How Global Income Funds Differ
September 26, 2017
Funds in the Global Equity Income category are expected to share one characteristic: Their portfolio dividend yield should be higher than the yield offered by the broader market.
Yet, how funds arrive at the portfolio yield can differ. Some funds like Kempen Global High Dividend apply an absolute dividend yield hurdle, 3% minimum dividend yield at initiation, for their portfolio candidates, while others like Newton Global Income apply a relative yield screen, considering only stocks that have a prospective dividend yield of 125% of its FTSE World Index benchmark.
Fidelity Global Dividend aims for a portfolio yield that should exceed 125% of the yield for the MSCI ACWI Index, but can invest in stocks that yield below the market yield as long as it meets the portfolio-level target.
These are subtle but important differences in investment philosophy. Some funds in the universe allow themselves more flexibility. NN (L) Global High Dividend relaxed its dividend-yield requirements in 2014, switching from an absolute dividend-yield hurdle to a relative sector and regional hurdle.
Furthermore, NNIP’s managers can, like some other funds in the category, invest in low or even non-yielding stocks, when they think a dividend will be paid in the future. The different approaches create various flavors of dividend funds, some putting more emphasis on dividend yielders, while others favor stocks that pay relatively low yields but are expected to grow their dividends.
The median three-year average dividend yield of our sample of global dividend funds clocks in at 3.81%, which indicates a yield premium of 115 basis points versus the MSCI World Index, but 16 basis points less than the three-year average dividend yield generated by the MSCI World High Dividend Yield Index.
When sorting the 91 funds in our data set on their three-year average dividend yield and comparing this with the dividend yields of the MSCI World Index and the MSCI World High Dividend Yield Index, we observe that all but two global dividend funds have a higher portfolio dividend yield than the MSCI World Index.
The two outliers on the low dividend-yield side are United Global Dividend Equity, which has a three-year average dividend yield of 2.64%, just two basis points below the yield offered by the MSCI World Index, and HQ Trust Dividend, which yields 52 basis points less than the broader market three-year average dividend yield. In contrast, Lazard Global Equity Income is among the highest-yielding global dividend funds, with a three-year average yield of 5.8%.
This is the result of its focus on the high-yielding segment of the investable universe. The fund targets a portfolio dividend yield of 5%. The team, led by Patrick Ryan, argues that investors often assume they need to sacrifice capital growth potential to increase the income generation of equities. In their view, the market is underappreciating the potential of high-yielding stocks.
They point out that higher yield compounds over time, and that mean reversion is also helping as cash-generative but out-of-favour companies typically rebound once their undervaluation is recognised. Consequently, they view high yield as an indicator for mispriced securities. Looking at portfolio dividend yield is just one way to demonstrate how dividend funds differentiate.
How Dividend Funds Target Certain Types of Stocks
Global dividend funds have an above-average exposure to companies with a Morningstar Economic Moat Rating. This means that they prefer companies which have established a strong and sustainable competitive advantage, obtained through a combination of cost advantage, network effect, intangible assets, switching costs, and efficient scale. The average factor exposure to economic moats amounts to 0.84, with 31% of funds achieving a score higher than 1.
Among the funds with a higher three-year exposure to economic moats are some of the largest funds in the universe. BGF Global Equity Income tops the table with a score of 1.34, just ahead of Fidelity Global Dividend, DWS Top Dividende, and Newton Global Income.
These funds also score above average on Financial Health meaning stocks with sound balance sheets. Considering their strongly negative scores on Ownership Risk, based on stocks owned by riskier funds, they can be characterized as conservative quality equity income funds. These funds also rank high on traditional quality measures like Return on Equity and Return on Assets.
The focus on quality comes at a price, though, as both the traditional Value-Growth factor and the Morningstar Fair Value factor point to relatively rich portfolio valuations. Valuation Uncertainty Another finding is that global dividend funds generally prefer stocks that have a low Valuation Uncertainty score. This factor measures the level of uncertainty embedded in a company’s quantitative fair value estimate, where higher scores imply a wider distribution of potential fair value outcomes, which equals higher risk.
Companies with lower scores on Valuation Uncertainty have a better predictability of sales, better visibility on how operating and financial leverage affect income, and a lower probability to be influenced by contingent events. As dividend sustainability is a key element in a dividend strategy, it is not surprising to see the tilt towards below-average scores on this factor. The Global Risk Model underscores that stable businesses with sound balance sheets and reliable cash flows are the backbone of many dividend funds.
Source: Morningstar. Jeffrey Schumacher, CFA | 26/09/2017
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