Focus on North America – Franklin equity group’s Edward Perks on generating income from US investments
Our income strategy has had a significant shift over the past couple of years away from fixed income securities and towards gradually increasing our equity investment in the form of dividend-paying common stocks as well as some convertible securities.
Though the US equity market has been volatile and fixed income yields have depressed, the actual underlying macroeconomic environment, particularly company earnings and dividend growth, has been much more consistent in our view.
Additionally, mutual fund industry flows have had some impact on the direction of the markets to the extent that generally one will see large inflows when economic news is positive, driving up stock prices and vice versa.
During times of market volatility, such as these, we have found opportunities to take profits when markets are up and to focus on other areas that become attractively valued when markets retreat.
Convertibles, which are bonds that can be converted into a company’s stock, have been appealing to us because of the opportunity to participate in the movements of the underlying common stock while getting some downside protection from the fixed-income component.
Our greater focus on dividend-paying equities is a function of what has happened to long-term interest rates and yields gradually coming down in the overall fixed-income market.
We are currently seeing dividend yields on many equities that are very similar to high-quality fixed-income yields.
There are some very high quality companies that have dividend yields higher than the yield available on those same companies’ long-term debt – something we do not typically see.
There might be an occasional sector like utilities in which that dynamic plays out more often, but today it is present in a broader range of high-quality companies across most sectors.
We evaluate a dividend-paying investment by leveraging both our equity and credit research teams to try to gain a holistic view of the capital structure of a company to determine where to invest to help us meet our strategy’s objective of maximising income while maintaining prospects for capital appreciation.
We try to consider the broader opportunity that might be there rather than singularly focusing on yield.
There may be something that we have high conviction in that has a relatively low yield-yet perhaps over time we believe there may be substantial dividend growth. Or maybe there is a company that offers a decent stock dividend that we could combine with some exposure that same company’s fixed income securities to get a little bit higher overall yield.
Ultimately our goal is to find the best income-producing investment opportunity in any given environment.
Looking ahead, we believe at some point the US economy will likely be in a stronger growth environment and perhaps inflationary fears will rise, creating vulnerability for longer-term fixed income investments.
Therefore, at present we have an opportunity to focus on the stock of companies, many with reasonable valuations, that pay attractive dividend yields relative to their longer-dated corporate debt securities – and these dividends have the potential to increase as companies benefit from a healthier economic environment.
Edward Perks is senior vice president and director of core/hybrid portfolio management at Franklin Equity Group.