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Roll with the times

Blending old and new industries in a global income portfolio can reduce a portfolio’s overall risk and make for more sustainable returns, says Jordan Sriharan, co-manager of the LF Canlife Diversified Monthly Income Fund.

At around 4%, UK dividends are highly attractive relative to other equity markets. But it is possible to have too much of a good thing.

A casual observation of large-cap UK companies reveals that the highest dividend yielding areas are the ‘old world’ sectors of materials, financials, energy and consumer staples, which together account for around 45% of UK large-caps.

One corollary of this is that an equity income investor who focuses mainly on the UK’s biggest dividend payers is restricted to a relatively narrow range of industries and companies. Consider also that around 80% of 2021’s UK large-cap dividend growth was generated by only 10 companies, and just 20 names delivered 73% of all UK large-cap dividend payments.[1] Whether in terms of sectors or individual companies, the potential for concentration risk is high.

A focus on the larger UK dividend payers can also result in a portfolio skewed towards highly cyclical companies – such as miners, oil companies and banks – which may produce volatile and ‘lumpy’ performance over the course of an economic cycle. In 2021, for example, three mining giants - Rio Tinto, BHP and Anglo American - provided around 50% of all the growth in UK large-cap dividends.[2] 

Then there’s the opportunity cost. UK-focused investors may be forgoing the potential for dividend growth that is on offer among newer industries, many of which are under-represented in the UK equity market. We see dividend growth as having an important role to play when keeping your income stream ahead of inflation.

Including newer industries in our income-focused multi-asset portfolios has other advantages, too. As some older industries inevitably decline, we will be looking to newer, growing and often more innovative industries to provide sustainable income streams for the LF Canlife Diversified Monthly Income Fund. They can also provide some welcome diversification away from cyclical companies.

Blending the best of old and new

As society changes, so does the world of investment. What is truly striking is the acceleration in the pace of change in recent decades.[3] This is primarily due to convergence, whereby innovations come together to produce further innovation. The poster child for this is perhaps the driverless car, which is made possible by multiple recent advances in semiconductors, AI, data management, sensors, batteries and mobile networks.

The industries at the forefront of today’s global markets include healthcare and biotechnology, cutting-edge manufacturers, communication services and, of course, technology focused on areas such as digitisation and automation. They are also currently more likely to reinvest their profits than pay out dividends to shareholders, but this should change as their businesses mature and long-term shareholders are rewarded.

When we are assessing the diversification and risk profile of the LF Canlife Diversified Monthly Income Fund we apply a distinctive risk management framework, part of which ensures that exposures are balanced across “old world”, high dividend paying companies and “new world”, lower dividend paying companies. This is a key component in constructing a well-balanced portfolio that avoids excess exposure to more cyclical elements of the global economy and ensures that volatility is more dynamically managed.

High-tech income

Technology companies do not generally spring to mind when looking for income investments. However, the technology sector has many radically different kinds of companies, including established global champions in their respective industries that also pay dividends.

Microsoft, a top 10 holding in the LF Canlife Diversified Monthly Income Fund, pays a small but reliable dividend, enabling us to receive income and also take profits as its share price rises. This allows us to recycle profits into other higher income-paying investments, whether in the form of equities, bonds or real assets like property or infrastructure.

Likewise, TSMC (also a top 10 holding) is a global leader in manufacturing the semiconductors that are increasing indispensable to our world – from cloud computing to microwave ovens – and therefore, like Microsoft, does not possess the cyclical profitability of, for example, miners and retail banks.

The dividends paid by TSMC are relatively small compared to traditional UK large-cap dividends, but they reflect a thriving business with a bright future and the potential to grow exponentially in years to come.

Dividends are, of course, not the only way to receive income from higher growth companies. In some cases, we have been able to receive higher levels of income from growth companies via the issuance of preference shares and mandatory convertibles. Naturally, corporate bonds are also an important element in generating income from both older and newer companies – however the key here is to always making sure that we resist over-reaching for yield.

 

Important Information

Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.

The LF Canlife Diversified Monthly Income Fund (the Fund) may invest in property funds that may be illiquid and subject to wide price spreads, both of which can impact the value of the Fund. The value of the property is based on the opinion of a valuer and is therefore subjective.

The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Asset Management.

This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at https://www.canadalifeassetmanagement.co.uk/

Canada Life Asset Management is the brand for investment management activities undertaken by Canada Life Asset Management Limited, Canada Life Limited and Canada Life European Real Estate Limited. Canada Life Asset Management Limited (no. 03846821), Canada Life Limited (no.00973271) and Canada Life European Real Estate Limited (no. 03846823) are all registered in England and the registered office for all three entities is Canada Life Place, Potters Bar, Hertfordshire EN6 5BA. Canada Life Asset Management Limited is authorised and regulated by the Financial Conduct Authority. Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

CLI02006 Expiry on 16/12/2022

 

[1] AJ Bell, Dividend Dashboard, Q2 2020

[2] AJ Bell, Dividend Dashboard, Q2 2020

[3] For a fast-paced and enjoyable read on this subject, look no further than The Future is Faster Than You Think by Peter H. Diamandis and Steven Kotler (Simon & Schuster, 2020)