18th November 2022
In the main, the past decade has not been a happy one for investors that have required a consistent yield generated from their investments. In an era of ever lower interest rates and falling bond yields, broad markets have shunned income investing in favour of capital growth. Investors have learned to not fight the Fed. Many woke up in cold sweats in the middle of the night with a fear of missing out. Trust had been established that they could close their eyes to valuations and buy growth stocks at any price, ride meme stocks to the moon, and make a fortune trading cryptocurrencies.
This year however, investors needed to forget recent history. Speculative growth investing of recent years is on the ropes. The tide of ever lower bond yields has gone out, and several growth favourites have been caught naked. The ARKK Innovation ETF has collapsed over 60% this year. Scottish Mortgage is down around 40%. The crypto industry is in meltdown, exacerbated by the latest scandal that has seen one of the largest cryptocurrency exchanges FTX collapse.
Fanatic growth investors are not yet throwing in the towel, instead for most of this year they have continued to flock to the darlings of the recent past on any whisper of a Fed pivot or the prospect of lower government bond yields. Eventually, there will be a blow that is one too many. Income is approaching with the boxing gloves on.
We believe that the opportunity set for income investing is the best in years (possibly decades). That is reflected in the fact that the yield on offer today on all three of our funds is elevated relative to history. The prospective yield on our Distribution fund has risen to 4.7% at the end of September – for context over the past 10 years the yield on Distribution has hovered in the 3.5% to 4% range. The yield on our Vanbrugh fund is close to 3.5%, and for our Global Opportunities fund is over 2.5%. Neither of them has an income objective. The income the Funds are churning out is purely a function of where we are finding the best total return prospects going forward.
Despite the derating of growth stocks over the past year, earnings expectations remain elevated, and misses will likely cause further pain. We have seen this in recent results from growth darlings. Many are now scrambling to cut costs, starting with their workforces, as growth stumbles.
We find much better value in UK equity income funds on single digit price to earnings (P/E) ratios offering 4-6%+ yields covered several times over and with rock solid balance sheets. It is rare to find dividend yields in excess of P/E ratios: but opportunities abound today. In the UK, nearly 20% of the largest 350 companies had dividends in excess of P/E ratios at the end of September. The ratio has only been higher in the depths of the GFC and covid drawdown.
In Asia, we are finding portfolios that have dividend yields significantly more than P/E ratios. Portfolios that are at trough valuations relative to all of history with dividend yields of over 8% and portfolios on sub 8x P/E ratios. The ‘E’ used in the P/E ratios is also often at close to trough levels (not peaks that we see in much of the western world after earnings roared back in 2021) given the Covid lockdowns over the past 3 years, most notably in China.
Recently, exposure to attractively valued corporate bonds has been introduced, taking advantage of the rapid repricing of bond markets. Exposure is across the credit spectrum, where we can cherry pick the most attractive risk/reward opportunities. This includes an AA rated RMBS fund yielding nearly 8%, an investment grade rated sterling corporate bond fund yielding over 12% and a high yield fund yielding nearly 16%. Staggering.
Income is approaching growth on the ropes for the knockout blow with one question on the lips: do you yield?
Dan Cartridge – Assistant Fund Manager
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