Income investing around the globe, September 2016

Low interest rates are a problem for investors in many ways: they have pushed down savings account rates, bond yields continue to fall, and many companies are struggling to meet their employee pension payments.

This is obviously not good for the workers who are relying on this money in retirement. It is also problematic for the companies' shareholders, whose dividends (which may also be a source of retirement income) will be squeezed as spare cash flow goes first towards meeting pension fund deficits.

We recently caught up with Liontrust's income investment team to get an update on how they are dealing with these challenges and where they are finding income around the world.

In the UK

Stephen Bailey, lead manager of Liontrust Macro Equity Income fund, says an estimated 84% of defined benefit pension schemes are now in deficit¹. According to him, this makes some UK companies un-investible.

“Take the example of BAE Systems [a technology-led security company]. Given the heightened need for global security, you'd think this company is an attractive option, but it has a pension deficit and about a third of its workforce retiring in the next 10 years. So any cash they have should be going to top up the pension fund. It's the right thing to do for employees but, from a yield perspective, it's one to avoid.

“BT is another example of a company with a big pensions deficit. However, there is one big difference: it has a lot of corporate debt that was issued five to ten years ago at decent interest rate levels, which will need refinancing in a couple of years' time. This could mean a huge saving of £500–800 million, which would be more than enough to satisfy pension trustee requirements. The future of its dividends looks a lot better.”

As the name suggests, the Liontrust Macro Equity Income fund first identifies promising macro economic themes, from which Stephen then makes his stock selections. At the moment, he believes the most sustainable dividend opportunities are in global telecoms, global health care, wealth and asset managers, and life assurers.

Telecomms he likes, for example, because of the growing trend for wearable technology and mobile video consumption, both of which are driving data demand. The most promising business models have good capex projects, appealing content offerings, and 'multi-play strategies' that bundle services and cross-sell. In this vein, Stephen is holding companies such as BT, AT&T and Vodafone. 'Traditional' high yield sectors such as incumbent banks and mining, on the other hand, don't feature in the portfolio.

In Europe

Eurozone stock market yields are now on par with those in the UK at around 3.9%² and there are three times as many companies to choose from, says Liontrust's European Income fund manager, Olly Russ. There are also very few European equity income funds, he says, meaning there is less money chasing the idea.

Olly reckons European stocks are a good way for UK investors to diversify their income streams at the moment. His European Income fund looks for stocks that are yielding at least 3.5%, or will be within a couple of years, and divides companies into three buckets: value ('the unloved' – consistent high yielders); growth ('the beautiful' – fast growing companies that require very little capital to finance this growth, leaving earnings to be paid to shareholders) and special situations ('the mysterious' – those undergoing restructure or with scope to pay a significantly enhanced dividend in the future).

He identifies areas such as Italian banks, which he says, if the Italians do vote for reform in their upcoming referendum, could get a boost. He also notes European bank performance is very correlated to US yields, meaning if the US Federal Reserve does start to raise rates at the end of the year, it could also signal a good opportunity to invest in the banks. Valuations are currently back to crisis levels, so they are very cheap and there is the potential to make good money – although, of course, as with all 'cheap' shares, there is also always the risk they may just get cheaper. If prime minister Matteo Renzi does not get the referendum outcome he hopes for he has promised to stand down, in which case Italy's (and Europe's) fortunes could move in a very different direction.

However with an investing universe of around 800 stocks to choose from, Olly remains confident there will continue to be opportunities.

In Asia

Co-managers Mark Williams and Carolyn Chan launched the Liontrust Asia Income fund in 2012 when they saw what they describe as “the best opportunity in this area since the end of the tech bubble”. Asia is second only to the US in terms of the number of liquid companies with both growth and yield³, and with regional interest rates between 6.5% (Indonesia) and 1.4% (Taiwan), it is one of the only areas in the world where countries have scope to cut rates should a boost to economic growth be needed.

Mark and Carolyn consider 12 different countries for investments, with China currently comprising around 40% of the portfolio – a figure far higher than many other Asian income funds in the market, although Mark says they are monitoring their exposure carefully. Looking 6–12 months ahead, he says he thinks China has sufficient currency reserves to deal with the debt issues it may confront within that time period. And the government is likely to continue to control inflation and employment, so Mark and Carolyn believe many of their industry peers may have been too negative on China. You can still invest, says Mark, you just need to avoid certain areas of the market. Although, he does note both he and Carolyn were disappointed when the government tried to manipulate the equity market last year and if the country's debt level continues to grow they will re-assess.

Thailand tourism is another strong theme in the portfolio. Tourist arrivals have doubled over the past five years and the industry accounts for 10% of Thai gross domestic product (GDP)⁴. The fund is most definitely an active fund and its top 20 holdings are very different to its benchmark. It has a bias towards small and mid caps, which is where Mark says they have been able to add the most value.

¹Pension Protection Fund, PPF 7800 Index as at 31/7/16 (Figures quoted in Liontrust Income Investment Dinner 2016 presentation, 21/9/16.)
²JP Morgan, UK dividend yields as at 29/6/2016 (Figures quoted in Liontrust Income Investment Dinner 2016 presentation, 21/9/16.)
³Bloomberg, Liontrust data as at 31/7/16. (Figures quoted in Liontrust Income Investment Dinner 2016 presentation, 21/9/16.)
⁴World Trade Organisation 2015 data. (Figures quoted in Liontrust Income Investment Dinner 2016 presentation, 21/9/16.)