Newton Investment advocates active approach for real returns
In the current state of financial repression investors need an active and flexible investment approach to generate real returns, says Newton Investment Management.
At the Newton 2012 Investment Conference in London today delegates discussed the ways to achieve these real returns and at the same time avoid exposure to high market volatility.
The global economy is going through a period of financial repression, which means incomes are below inflation at the moment. At the same time, there is an impeding threat of inflation.
In this environment, it makes sense for investors to focus on real return strategies instead of absolute return strategies, because they seek to get a return after adjusting for inflation, while absolute returns do not take inflation into account.
Suzanne Hutchins, manager of Newton’s real return fund, said the strategy aims to achieve a annual return 4% above Libor, and has made 6% per year on average over the past few years.
Financial repression means that safe haven assets and cash are yielding below inflation levels. Investors are therefore pushed away from their traditional comfort zones to riskier assets, such as equities, higher yielding corporate bonds, emerging market and alternatives.
In order to generate real returns from these assets, one must follow a number of strategies. Hutchins points to an active and flexible approach that focuses on income and capital protection, a global outlook, careful selection of investment characteristics and high diversification across capital structures.
When trying to extract income form equities, Newton prefers to seek out dividend-paying companies, instead of looking for capital returns. This is because dividend returns tend to be more stable. Over the last century, between 41% and 60% of total equity returns have come from dividends, on average.
But income investing takes time and patience. Andrew Lapthorne, a global quantitative strategist at Société Générale, says he likes the dividend approach precisely because it is “boring.”
Nick Clay, investment manager for Newton’s global funds, adds: “People are drawn to the sexiness of growth companies, but many of them fail. The income approach steers you away from these failures.”
Newton believes there are compelling income investment opportunities in emerging markets, traditionally viewed as growth markets. Clay points out that nearly 29% of the stocks in the FTSE Wold index yielding above 3% are located in the Asia Pacific region (ex Japan).
Caroline Keen, investment manager for Asia Pacific ex -Japan Equities singles out Australia and Taiwan as the countries where the highest yielding and best quality stocks can be found. Korea and India, on the other hand, are avoided.
So is the US, where dividend pay-out ratios have gone down in the last few years, from around 40% to 30% or 20%, on average. In Europe and Asia, on the other hand, these ratios have been on the increase.
Clay says: “A dividend is like a marriage. In times of trouble, you tend to work on it. Share buybacks are like dating. If it isn’t working, you just stop doing it.”
The panel also debated the advantages of an active approach to income investing. Despite the higher costs compared to passive approaches, speakers pointed to the recent poor performance of income indices compared to active portfolios.
This is because usually, a high yielding stock means the company is distressed, Clay explained. For example, investing in an income oriented index in 2007-08 would have meant holding a large proportion of UK banking stocks.
Clay concluded: “Actively managed portfolios tend to have lower beta than other products, because you need to see the difference between the good quality companies and the distressed ones.”