MAY 2012 Attention shifts to the US
J.P. Morgan believes its US Equity Income fund, with its “quality first” approach, is offering investors a wider choice than before by tapping into the opportunities of the US market.
CLARE HART Fund manager, J.P. Morgan
strong return from their decisions. All the companies in the portfolio have to yield a minimum of 2%, but she is more concerned that all stocks in the portfolio should be able to grow their dividend rather than their absolute level of yield.
Ten years ago, the UK was considered the only place for an equity income portfolio, but increasingly investors have started to look further afield. Partly this is a reflection on the limi- tations of the UK equity income sector – over-concentration in a few sectors, over-reliance on a few “problem” areas such as financials or oil – but it is also a reflection on the huge opportunities available elsewhere.
Investors have embraced global equity income as they have realised that they do not have to sacrifice access to higher growth economies in the interests of maintaining yield. The US market in particular com- bines a mix of strong dividend paying companies and wider economic growth. With this in mind, J.P. Morgan believes that its US Equity Income fund, managed by Clare Hart, is uniquely suited to the current envi- ronment.
Paying a yield of 2.23%, the fund takes a straightforward “quality first” approach, targeting companies with durable franchises, consistent earn- ings and strong management teams. There is a focus on valuation, ensuring that the managers do not overpay for companies. Hart is are supported by a team of 29 analysts.
In the three and a half years since its launch in the UK, it has provided protection against much of the market volatility and remains top decile since launch. In the US, the fund has an even longer track record and has had simi- lar success.
Hart believes volatile markets and low interest rates have made it hard for investors to participate in any market upturn, while benefiting from down- side protection and a reliable income stream. She suggests this fund has delivered on all three of these areas. Hart’s approach sounds simple, but it is a robust and disciplined approach. She focuses on companies’ free cash flow and debt levels. She wants to find management teams with a history of successful investment and allocation of capital, which have generated a
Although there are yield targets, Hart is still keen to see a low payout ratio. She wants to ensure companies are reserving some cash to grow the business for shareholders and there- fore to increase payouts in future. She will avoid those companies eating into capital to pay higher dividends. She is willing to be contrarian, aim- ing to capitalise on times in the market when a stock may be unpopular. As long as its weakness is not related to a company’s long-term fundamental prospects, she is happy to buy into a falling share price.
One recent example was Snap-On, which makes tools, equipment, diag- nostics, repair information and sys- tems solutions for professional users. The company had been under pressure because of unwillingness by its end- customers to upgrade their tools, but the substantial fall in the share price did not reflect the relative strength of the business.
Hart is also, in general, a long-term holder of companies. She is looking for companies that can deliver incremen- tal returns over the longer term, rather than those with triple-digit upside. This is a fund that is equally focused on what it might lose as well as what it might gain.
The case for dividends in the US market is similar to elsewhere. There is a natural contrarianism and valua- tion discipline to dividend investing. Companies that pay dividends tend to have stronger cash flows, better finan- cial discipline and lower valuations. Dividends have been an important con- tributor to overall returns in the long term. It is only in the 1980s and 1990s that capital returns became a stronger contributor to return.
Overall, dividend paying stocks offer strong growth potential with below average volatility
The credit crisis has refocused attention on to dividends over capital growth. Those companies that have retained their dividend yield have retained credibility with investors and are more highly prized as a result. They have also proved defensive in tur-
bulent markets. The current climate has proved that dividend-paying com- panies are not simply stodgy defen- sives but “inherently healthier companies”, as Hart says. Dividend yields enhance total return and gener- ate income.
There are certain attractive quali- ties about the US at the moment. First and foremost, of all developed mar- kets, it is still seeing some economic momentum.
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Hart wants to find
management teams with a history of successful investment and allocation of capital, which have generated a strong return from their decisions
Although growth rates – at 2-2.5% - are below historic norms, they are still better than the majority of other devel- oped markets. Corporate earnings growth remains robust and, as Hart defines it, “corporate America is in great shape”. She also believes fiscal and monetary policy is supportive of continued growth in the economy. The US has a plethora of companies that have a multi-decade history of div- idend growth. Coca-Cola, for example, has paid a rising dividend since 1970. Proctor & Gamble and McDonald’s have proved similarly reliable. Equally, dividend paying companies in the US are more diverse than in the UK. Rather than simply a blend of oil, pharmaceuticals and utilities, US div- idend strategies can incorporate sec- tors such as technology, materials and consumer discretionary stocks. Many US companies have global exposure, including exposure to the higher growth markets of emerging economies such as Latin America and Asia. Foreign sales are as high as 30% of the market in larger cap US companies. Equally, valuations in the US mar- ket do not look stretched. The average price to earnings ratio for all US cor- porations over the past 60 years is 13.7x. It now sits at 12.5x.
There are still some significant unknowns in the global economy, such as the fate of the eurozone. However, this is where an equity income strat- egy should offer some defence. The largest holdings in the J.P. Morgan US Equity Income fund do not tend to be economically sensitive – Pfizer, Merck and Verizon, for example.
Investors are being offered increased choice when looking outside the UK for income. In the present mar- ket, the US looks like the solid, depend- able choice of the developed markets and the J.P. Morgan US Equity Income fund is a solid dependable way to invest in that market.
FUND PROFILE
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