Stephen Thornber, Portfolio Manager of Threadneedle’s Global Equity Income strategy, reviews the developments of the past ten months or so and outlines how the team has responded to recent challenges.
Style rotation
April and May of this year witnessed a significant movement away from growth stocks and into their value and defensive counterparts. Threadneedle’s positioning in more growth-oriented dividend stocks meant that it did not benefit from this rotation, unlike the more traditional, low-growth dividend strategies, which did gain an advantage.
Threadneedle continues to believe that its long-term strategy of investing in growing companies with high and sustainable dividend yields should generate superior returns. While it expects interest rates to increase only slowly, Threadneedle says we should be wary of low growth ‘bond proxies’ in the current environment.
Regional allocation
A diverging economic performance has seen US equities significantly outperform those in Europe and Asia this year. Additionally, the dollar has strengthened against the euro and most global currencies. Threadneedle’s Global Equity strategy has been positioned underweight the US, partly due to the fact that American stocks traditionally offer relatively low dividends.
Over thirty per cent of the portfolio is invested in the US, and Threadneedle could increase this exposure either through taking larger positions or selecting additional American stocks. However, they will continue to construct the portfolio from the best individual high-dividend stock ideas, which means that it is likely that they will remain structurally underweight the US market relative to the benchmark.
Sector allocation
The portfolio has been underweight the technology sector, which has outperformed this year. It has also been overweight the telecommunications sector, which has underperformed.
Thornber states that the portfolio will continue to be constructed by picking individual stocks on their merits rather than allocating by sector. In the past the team has had considerable success by investing in Asian technology companies with high dividend yields such as Delta Electronics. But the majority of US technology stocks, (even dividend payers such as Microsoft), remain well below their yield threshold for investing in a stock. The strategy will thus likely maintain its bias against technology. Within telecommunications, Threadneedle continues to avoid highly-indebted legacy, fixed-line operators, but favors exposure to younger, mobile-focused players, and those in faster-growing economies.
Exposure to China
The authorities in Beijing have tightened credit restrictions in order to cool China’s overheated property market. Consequently, sentiment towards companies with both direct and indirect exposure has weakened. The portfolio has been overweight Asia, and some of the more economically-sensitive Asian stocks to which they have exposure have underperformed.
Exposure to beta within Europe
Within the portfolio’s overweight position in Europe, exposure has been concentrated in Scandinavia, Germany, France and Switzerland. Unfortunately this has not shielded the strategy from deteriorating confidence, particularly following events in Ukraine. Positions in the media, financials, construction, industrials and telecoms sectors have all underperformed. Threadneedle continues to have confidence in the outlook for other investments held in Europe, but they are reviewing the scale of their overweight positioning given the softening outlook.
Acknowledging the positives
Notwithstanding the challenges outlined above, the strategy has benefited from positive investments this year. Highlights included the purchase of L Brands (Victoria’s Secret), in February, when the stock was depressed following weather- affected December results. The original investment case was based on both improving results in the US, as the economy brightens, and its global store roll-out plans. Since investing, the stock has paid two dividends, and gained c.20% on improved sales results and sentiment.
Elsewhere, UK healthcare stock AstraZeneca has outperformed following a takeover bid from Pfizer, which was ultimately rejected. Threadneedle recognized the attractive free cash-flow generation and improving prospects for the large cap pharmaceutical sector as early as 2012, as a number of companies moved towards or through patent expiries on major drugs. With fresh innovation, particularly in the area of immunoconcology, and tax-driven M&A, investor appetite for the industry has dramatically improved. We think AstraZeneca remains an attractive stand-alone investment, but would not be surprised should Pfizer return to the deal-making table in the future.
Conviction in the strategy remains intact
While recent performance has disappointed, the strategy has built an excellent long-term track record over the last seven years by patiently investing in ‘Quality Income’, i.e., companies with high, sustainable and growing dividends. Threadneedle plans to continue pursuing the approach that has underpinned this performance and is working hard to ensure that the good record is maintained. Thornber notes that investors should be aware that the portfolio has a defensive bias, and therefore its best relative performance usually occurs in weaker periods for the market. In that respect, he would remind investors that the last two years have been very rewarding, and that caution should be exercised in extrapolating recent trends over a longer period. It is also important to note that the strategy acts on a two to three-year view when taking investment decisions, and is prepared to ride out periods of underperformance to deliver its long-term objectives.
For Elena Santiso