Savers and investors searching for decent income have been starved over the last decade as central banks have engaged in quantitative easing which kept interest rates artificially low.

The pandemic and the war in Ukraine have changed the landscape dramatically. Interest rates are now on the rise across the globe in response to persistent inflation and a strong rebound in economic growth.

Inflationary pressures reduce spending power and make fixed income investments look less attractive. Global bond prices are down around 12% year-to-date.

This new regime has changed the arithmetic and dynamics for dividend-paying shares too. After all, higher interest rates raise the costs of borrowing.

Beware of unsustainably high yields

Some analysts have argued shares are a good place to get inflation protection because companies have real assets which can rise with inflation.

The reality is more complex and even large companies with established brands such as Unilever (ULVR) have discovered they cannot always pass on higher costs without losing market share to cheaper alternatives.

Pressure on margins from cost inflation and higher interest payments could reduce the ability of certain companies to maintain dividends at the same level as before the pandemic.

Therefore, investors should be mindful of these factors when searching for decent income.

WHERE TO FIND MORE RELIABLE PAYERS

Later in this article we reveal a stock screen designed to identify companies which offer a more reliable income with the added potential of growing the dividend to keep pace with inflation.

One fund which specifically invests in companies which provide sustainable income is the Guinness Global Equity Income Fund (BVYPP13).

Managers Ian Mortimer and Matthew Page believe dividend payers outperform in the long term, and dividend growers even more so.

They also argue that dividend payers protect against inflation over the long term.

The fund has beaten its benchmark over the past three, five and 10 years, delivering annualised returns of 13.3%, 12.1% and 12.8% respectively.

The annual dividend paid over the last 12 months represents a yield of 2.2%, below the FTSE All-Share yield of 3.5%. However, the growth of dividends from the fund should also be considered as this is an important driver of returns over the longer term.

The fund has an ongoing charge of 0.8% a year. Top holdings include US pharmaceutical company AbbVie (ABBV:NASDAQ) which has a 3.9% prospective dividend yield. The company has grown dividends at a compound annual rate of 18% over the last five years.

Other top holdings in the fund’s portfolio include UK dividend stalwarts British American Tobacco (BATS) and engineering group BAE Systems (BA.). These companies have prospective dividend yields of 7% and 3.5% respectively.

UNDER NEW MANAGEMENT

James Harries and Tomasz Boniek are responsible for Troy Asset Management’s global income strategy. Troy was appointed investment manager of Securities Trust of Scotland (STS) in November 2020 and has turned around the fortunes of the investment trust.

Harries doesn’t have a strong view on the outlook for inflation but makes the case that his investment approach should deliver sustainable income in such an environment.

The trust aims to invest in a concentrated portfolio of exceptional, resilient companies and deliver above-average returns with below-average volatility.  

Importantly for income investors, the trust aims to grow the dividend backed by genuinely surplus cash flow generated by the companies in the portfolio. It has an historic dividend yield of 2.5% and an ongoing charge of 0.92% a year.

Unlike open-ended funds, investment trusts can use revenue reserves to maintain or grow dividends during periods when there is a shortfall from investee companies such as we saw during the pandemic.

Harries and Boniek find their investment opportunities by focusing on sectors which display low capital intensity and low cyclicality. These sectors tend to produce higher returns on capital.

A good example in the consumer goods space is US drinks and snacks group PepsiCo (PEP:NASDAQ) which generates consistently high returns on equity.

Harries believes PepsiCo has good pricing power due to the nature of its brands which tend to be characterised by ‘repeat purchases’ of impulse-driven goods.

For example, nobody thinks twice about the price of a bag of PepsiCo-owned Lay’s or Walkers crisps when they are on the move and fancy a snack, argues Harries. PepsiCo’s shares have a dividend yield of 2.7%.

Other types of companies in the portfolio include platform businesses such as options and futures exchange CME Group (CME:NASDAQ) and capital-light property group InterContinental Hotels (IHG).

For investors who prefer a cheaper broad-based passive approach to investing in global income, the Vanguard FTSE All-World High Dividend Yield (VHYL) exchange-traded fund looks like a strong candidate.

The highly diversified $2.7 billion fund invests in approximately 1,800 stocks across the globe and has a dividend yield of 3.2% and an annual charge of 0.29%.

GLOBAL SHARE PICKS

Shares has used Stockopedia’s platform to screen for high-quality companies which have consistently grown their dividends and have a decent yield.

We have broken the universe into the UK, Europe and the US to gain a wider exposure to global income shares.

Rather than looking solely at the level of the yield we have also considered the potential to grow the dividend to counter the pernicious effects of inflation.

The criteria include unbroken growth in the dividend of at least five years and a return on equity in the top quartile (25%) of the market.

UK TOP PICK

BAE Systems (BA.) – 749p – Yield: 3.3%

Leading defence contractor BAE Systems (BA.) has grown its dividend every year over the last 20 years representing an annual compound growth rate of 5% a year.

Excluding the 2002 financial year when the company maintained its dividend, BAE has an unbroken record of dividend growth going back to 1993.

The track record is testament to the company’s diverse portfolio and robust execution which has allowed it to generate strong, reliable cash flows.

The company has an unbending focus on margin expansion and sustainable revenue growth.

Investment bank Berenberg estimates BAE will generate between £1.68 billion and £1.98 billion of free cash flow in each of the next three years, versus the £689 million earned in 2020.

This means growth in future dividends looks secure and could be bolstered by share buybacks down the line.

The defence sector is benefiting from a significant tailwind in the near term as countries around the world bolster their military spending in response to Russia’s invasion of Ukraine.

Jefferies has estimated that if all NATO members were to raise defence budgets to 2% of GDP it would imply a 25% increase in overall spend, excluding the US, which would trigger significant benefits across the entire industry.

US TOP PICK

Texas Instruments (TXN:NASDAQ) – $176.20 – Yield: 2.5%

The world’s largest manufacturer of analog microchips, Texas Instruments (TXN:NASDAQ) has an unbroken record of increasing its annual dividend which stretches back over 30 years.

Over the last six years the company has increased its dividend well above the inflation, clocking up compound annual growth of 21% a year.

The company throws off oodles of cash and has delivered an average return on equity of 55% over the last six years, supporting the dividend payment which is covered 2.5 times by earnings per share.

The company supplies its microchips into a vast array of markets which provides diversification and underpins the reliability and durability of its revenues and cash flows.

The firm’s relatively cheap but essential components convert real-world signals, such as sound, touch and temperature, into digital information.

They are also used for power management, especially useful in batteries for mobile devices. That hints at future growth opportunities as more electronics become mobile.

Costing just a few cents per chip, the company retains surprising pricing power because its chips are typically designed into new electronic products.

Supply agreements tend to be for the lifecycle of a product which means customer switching costs can be prohibitive.

Durable economic advantages and a steady growth outlook makes Texas Instruments an attractive candidate for reliable income portfolios.

EUROPEAN TOP PICK

Roche (RO:SWX) – CHF 374 – Yield: 2.6%

Pharmaceutical company Roche (RO:SWX) has increased its dividend by a compound annual growth rate of 10% a year over the past two decades.

The diversity of the company’s drug pipeline and high return on equity have provided reliable cash flows to support the dividend as well as invest in future drugs.

Returns on equity have averaged 40% a year over the last five years.

Spending on healthcare by governments has generally kept pace with, and even eclipsed, inflation over the last few decades. This means the healthcare sector is an attractive option for investors looking to protect themselves from rising prices.

Roche has reached a turning point in the lifecycle of its drug pipeline where the growth in sales of new drugs is more than compensating for the loss of sales when patent protection expires, which leads rivals to sell copycat drugs more cheaply.

Roche’s Alzheimer’s drug Gantenerumab recently received FDA breakthrough therapy designation and stage three trial data is on track to be released in the second half of 2022.

‹ Previous2022-05-12Next ›