High yield utilities equities good for the long-term – Pictet

Long term returns from high yield utilities equities makes them an ideal investment option in the current uncertain economic climate, according to Bruno Lippens (pictured), senior investment manager at Pictet asset management equities (PAM Equities).

The approach followed by Pictet is to identify and choose companies that pay regular dividends with a minimum yield of 3%, that have a predictable and stable cash flow and that are in sectors seen as likely to offer solid long term performance. Portfolios are constructed from global investments, including emerging markets, and based on a mix of currencies.

Further refining of research has led to focus on infrastructure and utilities, namely electricity, gas, water, pipelines, toll roads, waste management, transport and telecoms.  “In good or bad times, there is always demand for these,” said Lippens.

Some private equity funds make it difficult for companies to diversify or they fail to pay a dividend, and that is a key condition, he said. “What we have found, is that companies that pay a dividend are much more profitable than those that don’t.”  Besides giving an annual income, dividends force companies to be more efficient. “It puts pressure on the management to perform and not be lazy.”

These are soft factors but they translate into hard data, he said. “Such companies are better managed and ran in a more profitable way.” Utilities can face regulatory pressure and that is a downside, but overall the advantages outweigh the potential risks.

This investment strategy avoids both the more volatile parts of traditional sectors, companies in the financial, pharmaceuticals and consumer goods sectors, and the illiquid and non-cash generating parts of traditional infrastructure.

In a downturn, companies are very cautious, they cut their staff, reduce inventories and this has to be built up again when the economy picks up. “Our companies don’t have these inventories,” he said. High yield utilities equities also tend to out-perform in a down market.

Annualised returns for Pictet’s high dividend portfolio selection since 2005, including the severe downturn caused by the 2008 financial crisis, stood at 5.9% at the end of 2010, compared to 4.7% for MSCI world utilities and 1.7% for MSCI world portfolios.

Lippens said the strategy works in the current environment of slow global economic growth, low interest rates and low inflation with salaries depressed by high unemployment. In the energy sector electricity prices are bottoming out after two years of decline and heading higher. Coal prices are softening due to slower economic growth and demand for natural gas is likely to pick up as users switch from other energy forms and as governments phase out or reduce the role of nuclear energy.

In this climate, Lippens said, global high yield infrastructure equities have a stable business structure  with solid cash flow generation. High and rising dividend income provides a stable source of returns and portfolio diversification gives protection against inflation. “I don’t see anything that would make us change our strategy,” he said.

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