Analysis of the past four extended periods of low economic growth going back to 1988 shows that quality income investing performs strongest against corporate bonds or other equity strategies in these environments.
Bond yields are historically low at the moment, and the strategy of developed countries to inflate away their debt puts pressure on fixed income investors’ real returns. High-quality equity income investing, by contrast, offers some protection against inflation through investments in steadily growing businesses in the least volatile areas of the equity market. European equities especially offer some strong opportunities.
Since Mario Draghi’s ‘whatever it takes’ speech in July of last year, there has been significant changes in allocations by global investors into European equities. They’ve realised that Europe is cheap when compared with other regions, that European equities are extremely attractively valued against corporate bonds, and also on a historical basis. Europe’s valuation previously reflected the fear of a potential euro break-up, but politicians have now taken steps to address that.
Investors are beginning to look at Europe and recognising that while there are still challenges ahead, Europe is now attractively valued when you consider the quality of some of the European headquartered companies.
Fundamental analysis shows that Europe is home to some first-rate companies, with attractive exposure to global growth, excellent management and with very strong competitive positions.
Interestingly in terms of risk to dividend income, European companies outside the financials sector have growing levels of cash on their balance sheets that they are returning to shareholders via special dividends and rising pay-outs. In 2012, European corporates did 31 special dividends, more than any year since 2008.
One example of a company that paid a special dividend in 2012 is lift manufacturer Kone. Headquartered in Finland, this company made more than €5bn (£4.3bn) sales in 2011, and currently makes over a third of its sales in the Asia-Pacific region. In September it announced its second special dividend in two years, great for shareholders who’ve already enjoyed ordinary dividend growth of more than 15 per cent for each of the past five years.
Already in 2013 Swiss Re has announced a special dividend. Unlike many other Insurance companies, Swiss Re is in the position of having a significantly overcapitalised balance sheet. This not only allows growth of the underlying business, and therefore ordinary dividends, but also opens up the potential for special dividend payments while maintaining strong solvency ratios.
Interestingly, Europe has the added bonus of greater diversification than the UK for equity income investors. In the UK, the top-10 dividend payers represent more than half of all dividend income, whereas in Europe, the top 10 represent less than 30 per cent of all dividend income.
Andreas Zoellinger is co-manager of BlackRock Continental European Income fund
