What you can expect from dividends, tech and Taiwan in 2022
Epoch Investment Partners' John Tobin is adamant he's not a stock-picker, but he's certainly backed a couple of winning global businesses over the last few years.
Having managed Epoch's Global Equity Shareholder Yield strategy since 2012, a diversified portfolio with more than 100 positions, Tobin sticks to a strict holding policy to ensure that no one position can contribute to more than 3% of the fund's total income target.
"We believe that holding a diversified portfolio of high-quality companies increases the likelihood that we can consistently deliver the strategy's objectives of high and consistent income, low volatility, good upside participation, and excellent downside protection," he said.
In this way, the fund isn't betting on a few high conviction ideas to deliver portfolio outperformance, but instead, delivers market-like (or better returns) with less volatility and consistent income.
That said, he's been investing in Nutrien (a major potash producer) and BAE Systems (a defence contractor) since 2015. But both companies have soared on the back of the recent Ukrainian/Russian conflict.
"We have owned both of these stocks for several years based on our expectation that they would continue to generate growing cash flow and that management would continue to allocate capital appropriately, with attractive and growing dividends," Tobin noted.
"They have been top performers recently, but of course, we did not buy Nutrien or BAE Systems with a view that the Russian invasion of Ukraine would be a catalyst for higher fertilizer prices or increased defence spending."
In this Q&A, Tobin shares his thoughts on the sell-off in tech, as well as why he is investing in semiconductor stocks as his preferred play. He also outlines the outlook for dividends through to 2023, and explains why he believes it is unlikely that China will invade Taiwan.
Having worked in academia for a period, in between your time at HSBC and joining Epoch, what prompted that shift and how did this experience feed into your current role?
My "sabbatical" in the world of academe was prompted by the GFC—specifically, by the decision at HSBC to eliminate several investment teams in 2009. I had been teaching part-time in the economics department at Fordham University for several years, one evening class per week, and I was happy to be offered a full-time position as a lecturer.
This was meant to be a bridge until economies and financial markets recovered; I hoped that I would have an opportunity, at some point, to return to the world of investing. In one of life's "serendipity moments," that opportunity presented itself in 2012, when I was invited to join Epoch and re-connect with some of the professionals that I had worked with earlier in my career (in particular, Bill Priest).
My experience in the classroom teaching undergraduates about the way economies work, and sometimes don't work, enriches my capacity to assess the environment in which our portfolio companies operate.
It also allows me to participate in Epoch's Investment Policy Group, offering insightful observations and commentary that is valuable (at least occasionally, I hope) to other portfolio managers and strategies at Epoch.
How is your portfolio positioned currently - are you still highly leveraged to the tech sector? And what are your favourite parts of this very broad sector?
Well, I would not say that we are "highly leveraged" to the tech sector. We strive to have a diversified portfolio and avoid sector, geographic, and individual stock concentrations. However, it is true that tech is currently the largest sector weighting within the portfolio. Although it is worth noting that we are underweight the sector relative to our broad market benchmark.
Keeping with how we select stocks in all sectors within the portfolio, our preference in technology names is towards industries that exemplify a good combination of shareholder yield characteristics.
Most of our exposure within the sector currently is to semiconductor stocks, as these firms tend to have dividend and capital allocation policies that direct large portions of free cash flow back to shareholders.
What’s your view on the sell-off we’ve seen in some parts of tech since the end of last year?
Going into year-end 2021, we began seeing an acceleration in rotation from growth to value in response to hawkish signalling from central banks. Equity duration became an important factor to consider as interest rate hikes loomed, and the present value of future cash flows was set to become more heavily discounted.
Stocks with earnings and cash flows primarily further out in the future tend to have longer duration, carrying greater interest rate risk. Conversely, dividend-paying stocks with substantial present-day cash flows tend to have shorter duration and, therefore, should be more resilient in a rising rate environment.
The selloff we've seen year to date has been largely in tune with this line of thinking. Many tech companies fall in the category of growth, and growth stocks will generally have longer durations by nature.
Your portfolio is highly diversified, with more than 100 individual stocks…why so many? How does this compare to your average number of holdings over time?
Over time the average number of holdings in the portfolio has varied between 90 on the low end and 115 on the high end, so at present, we are leaning slightly towards the higher side of normal.
The benefits of diversification in regards to managing risk are widely known, however, the breadth of holdings in the Global Equity Shareholder Yield strategy also serves to diversify our sources of income. We maintain a policy in managing the portfolio so that no one holding should contribute more than 3% of our total income target, and by doing so, we are able to maintain a more stable portfolio level yield.
More generally, we believe that holding a diversified portfolio of high-quality companies increases the likelihood that we can consistently deliver the strategy's objectives of high and consistent income, low volatility, good upside participation, and excellent downside protection.
Company payouts (dividends, specials, buybacks) have soared in the last 18 months and are widely expected to pull back in 2023. How are you positioned for this possibility?
The recent increase in payouts should be seen in the context of the COVID pandemic in 2020 which caused many companies to cancel share buyback programs, hold dividends flat, reduce dividends in some cases, and cancel dividends altogether in some cases.
This was a truly extraordinary period, with public and regulatory pressure on companies to scale back shareholder distributions. However, we anticipated that companies would generally continue to follow sound capital allocation practices and that dividends and share buybacks would resume once businesses started to recover from the pandemic.
That is, indeed, what has been observed. Any "pullback" in 2023 or beyond should be seen in this historical context—as a normalization after a period of catching up.
With businesses around the world continuing to recover from the pandemic, we are confident with our outlook that companies will be well-positioned to continue to grow dividends and utilize excess cash flow for share repurchases or debt reduction.
What positions have you been adding to in recent months? And where have you been taking profits?
Despite the volatility in recent months, we've remained comfortable with our positioning and have not made material changes to our holdings. One example of a company we've added recently is Bridgestone (TYO: 5108), one of the world's largest tire manufacturers.
The company is set to benefit near-term from investment in technology to increase the range of electric vehicles and a focus on larger-size tires. Bridgestone returns capital to shareholders through a progressive dividend policy as well as periodic share repurchases.
An example of a position we recently closed is PepsiCo (NASDAQ: PEP), which we chose to exit in order to fund higher-yielding opportunities. The shareholder yield strategy is not a "stock-picking" strategy where success is determined by individual stock outperformance. It's a diversified portfolio with strict position-size limits.
Success is determined by delivering a portfolio solution: market-like or better returns, with lower-than-market volatility, high and consistent dividend income, and good downside protection.
How does your turnover - of around 26% over the last 12 months - compare to previous periods?
Turnover for the last 12 months has been in line with recent years, and slightly below the longer-term average of around 30%. Turnover tends to be low because, as long-term investors, we seek out companies with a track record of growing cash flow, attractive and growing dividends, and evidence of sound capital allocation practices. As long as those features are expected to remain in place, we tend to hold onto those investments.
How long have you held Nutrien and BAE Systems - which have recently been among your top performers?
Agrium, one of the two companies that merged in 2018 to form Nutrien (TSE: NTR), was initiated in the portfolio in 2015. BAE Systems (LON: BA) has also been in the portfolio since 2015. Both companies have experienced tailwinds resulting from the conflict in Ukraine.
Nutrien is a major producer of potash, which has seen a steep rise in its commodity price as sanctions have been levied against Belarus, a major exporter of the chemical. Meanwhile, BAE Systems, a leading defence contractor in the UK, has benefitted as the Ukrainian conflict has spurred a precautionary rise in international defence spending.
As noted earlier, shareholder yield is not a stock-picking strategy. We have owned both of these stocks for several years based on our expectation that they would continue to generate growing cash flow and that management would continue to allocate capital appropriately, with attractive and growing dividends.
They have been top performers recently, but of course, we did not buy Nutrien or BAE Systems with a view that the Russian invasion of Ukraine would be a catalyst for higher fertilizer prices or increased defence spending.
On the macro front, what’s your view on the potential for Russia’s invasion of Ukraine to set off other conflicts, such as between China and Taiwan?
We hesitate to make predictions about geopolitics—that is not our specific area of expertise, and it's hard enough making predictions about individual company cash flows and capital allocation. Of course, we must be mindful of how geopolitical developments can affect the global equity investing landscape. With that caveat in mind, we would offer the following thoughts about China and Taiwan.
The conflict in Ukraine has certainly caused a rise in geopolitical tensions and may well have dealt a blow to the long-term trend of increasing globalization. Whether this will lead to more direct conflicts remains to be seen.
Regarding Taiwan specifically, the country's position relative to China bares surface-level parallels with Ukraine and Russia. However, we believe that the strategic importance of Taiwan's semiconductor production to the West means that an invasion by China would be far more likely to prompt direct military intervention from the US and its allies.
In our view, this, coupled with the rapid and severe response from a united West to Russia's incursion, will weigh heavily on a decision by China to invade.
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