As inflation hits 10%, stagflation is in play and worries of recession are making headlines, thoughts and reflections of the past begin to resurface. Some things were undeniably better in the 1970s and 80s – the music for a start! Other features of this era are certainly more debatable; the flares, the shoulder pads, the even bigger hair, and few people will care to recall the 17% UK interest rate of 1979. Stock markets laboured under the pressure of it all, but to us one investment strategy shone through the gloom and provided retail investors with decent returns and a realistic income to boot. The investment strategy in question proved resilient in the face of difficult stock markets too.
The investment concept adopted by earlier generations with the slogan “spend the interest not the capital” makes some sense when interest on savings is meaningful. Rarely does this protect underlying capital, let alone distributed income against inflation. A mixed asset portfolio should offer the ability to create a sensible yield and protect long term capital within a tolerable risk framework. As bond yields have typically fallen year-on-year for the past 30-years culminating in stock offering negative yields it has been difficult to include lower risk fixed income. Of course, equities have performed strongly fuelled by central bank liquidity driving a decent total return. As such, many advisers have adopted a total return approach where capital is harvested each year to provide withdrawals as “income” for those clients requiring it.
The post pandemic era has seen some dramatic shifts in the investment landscape so far. Inflation has returned, standing now at a 40-year high and equity markets have re-rated downwards as liquidity is finally withdrawn with the biggest impact hitting growth-oriented firms. Bond yields have risen as monetary policy tightens with the 10-year Treasury nudging 3.5%. Whilst equity values have typically fallen, those stocks with strong free cash flow and seasonally robust revenues such as energy, miners, banks, utilities, and food have offered greater stability and a reliable and attractive flow of regular income to shareholders in the form of dividends. In fact, over time, dividends have made up a decent percentage of total return (comprising around 30% of S&P 500 returns from 1940 to 2020) with dividend paying companies amongst some of the better performers over the long run. Today, pay-out ratios are modest offering attractive upside scope whilst strong free cash flows underpin valuations more robustly than many growth-oriented companies whose share prices have come under further stress as the cost of borrowing increases and earnings stutter. One major advantage the 2020s offers us is a global environment for dividend paying companies with a larger number of viable options for managers to research and select.
As at: 30th June 2021
So, the environment looks supportive for dividend investing to make a viable return. The concept of a balanced risk mixed asset class portfolio offering a sensible and reliable income quite distinctly whilst capital can remain invested in real assets with the ability to protect against inflation over the long run supplemented by the ability to harvest a natural income rather than surrendering a total return.
A portfolio manager must of course avoid those companies over-paying and creating an income trap. Selection and monitoring are important to ensure generated income is sustainable and long lasting. A portfolio should ideally have to ability to smooth income although this is easier said than done with many equity dividends arriving early in the year. Fixed income coupons are paid on a regular “flat” basis helping the process. Overall risk must be monitored and balanced to ensure it aligns with the portfolio objective. Charges are always an important consideration with fees taken from capital or 50/50 from capital and income being probably most sensible. A sustainable yield of around 4 - 4.5% per annum should be within reach with overall risk well controlled.
The uses and applications of this investment approach will be recognised by Financial Advisers – where dividends can be rolled-up to generate a smoother total return profile, a natural yield taken by investors to supplement other retirement income and/or the yield percentage calculated to meet the required long term personal withdrawal amount for clients in drawdown. All of which will provide viable and attractive planning opportunities for investors – many of whom will no doubt be fearful about their investment future set against an impending recession and inflation ravaging cash savings. The selection of a retail platform with the ability to pay-out natural income from a portfolio will be on the due diligence list for professional advisers.
Financial Advisers recognising this viable approach may wish to consider the Alpha Beta Balanced Income Portfolio which is specifically designed and managed to deliver a natural income of 4 – 4.5% per annum, whilst investing in a balanced risk multi-asset portfolio designed to protect long term capital in real terms.