JAN 18

Equity income hunters eye up Japan

Laura Miller, news editor of FT Adviser

As large-cap share buy-backs and dividend increases have become more widespread in Japan, income-hungry investors have started to move towards Japan, Laura Miller reports.

Equity income seekers faced with large cap share buy backs in the US and UK are looking to Japan for the comfort of regular returns.

Fidelity International, AJ Bell, and Kames Capital have all cited the Asian giant as their preferred home for money trying to generate an income for investors.

The £434.7m Kames Global Equity Income fund moved to an overweight position in Japan in November to take advantage of higher dividends from the country’s corporates.

Over at Fidelity, George Efstathopoulos, co-portfolio manager of the firm’s multi asset funds, says Japan offers attractive dividend growth.

“Absolute yield levels are now more comparable to the US and they are well supported by earnings and strong balance sheets”, he says.

“In addition, Japan still has the lowest payout ratio among most developed countries, providing some cushion. The recent depreciation of the yen coupled with the ongoing quantitative easing from the Bank of Japan provide a good technical backdrop.”

Russ Mould, investment director at fund platform AJ Bell, comments that, through a combination of dividends and buybacks, Japanese stocks are returning around 5 per cent of their aggregate market cap to shareholders.

“That’s a huge figure for Japan and one that looks good in a global context,” he says.

Investors’ hunt for regular income is against a backdrop in the UK and US of corporate giants preferring to carry out share buy backs as a way of returning gains to investors, instead of through upping cash dividends.

Share buy backs see a company buy back its shares from the marketplace, cutting the number outstanding. The relative stake of each investor increases as fewer shares mean fewer claims on the earnings of the company.

“Investors like dividend increases as they get extra cash in their pocket or to reinvest”
- Darius McDermott

“Share buybacks have been characteristic of the post-global financial crisis environment, especially in the US market,” Darius McDermott, managing director of Chelsea Financial Services says.

“This has occurred in parallel with a pick-up in corporate indebtedness. It is an easy arbitrage for corporates: issue cheap debt in a zero interest rate environment; buy back expensive [to service] equity.”

US tech giant Apple, with its huge financial resources, has recently engaged in a series of mammoth stock buybacks, spending around $127bn so far of the $175bn it has earmarked for the repurchasing.

In November, Facebook launched its first ever buyback, stating it will buy back $6bn in shares.

It is a similar picture in the UK, where recent active buyers of their own stock include blue chips HSBC, BAE Systems, Smith & Nephew, Marks & Spencer, Next, BP and Shell.

Similarly FTSE 250 house builder Berkeley Group recently announced it will return capital to shareholders using a mix of buybacks and dividends, and National Grid will use some £4bn of the proceeds from its gas distribution sale to fund both a special dividend and share buybacks.

Equity income hunters eye up Japan

Buy backs

Buy backs can make investors feel wealthier in capital gains terms but are an irregular and less certain return than dividends, and can point to less favourable economic conditions.

“Those who don’t like buybacks view them as evidence of a more serious underlying economic malaise – namely corporates can find no productive use for record cash balances and their only recourse is share buybacks,” Mr McDermott comments.

For investors, share buy backs should mean the value of their holdings increase, but as Mr McDermott points out, “other factors can also affect the share price”.

“Investors like dividend increases as they get extra cash in their pocket or to reinvest,” he explains.

Dividend paying companies should also be scrutinised however, according to wealth adviser Investment Quroum’s chief investment officer, Peter Lowman.

“Investors should always ensure that any company increasing its dividend is doing so because the business is profitable, typically, a company pays out its dividend from after-tax profits.”

Back in June 2016, FTAdviser reported the fears of Standard Life fund manager Thomas Moore who warned the UK market was under threat from large companies increasingly using debt to pay their dividends.

At that time Mr Moore – who runs Standard Life’s £1.2bn UK Equity Income fund – said investors should be “wary” of many large UK companies using debt to maintain a level of dividend.

“Over the past five years there has been a trend of weakening earnings, so the dividend cover for some of the large companies has become tighter and tighter,” he said.

“Large cap dividends are under pressure, which is now coming to a head.”

Falling interest rates and bond yields have made it more difficult for income seekers.

Mr Lowman says the hunt for income has led to the equity income sector becoming a very crowded trade, “with many company share prices becoming rather expensive on a valuation perspective”.

“We are now expecting inflation, and probably interest rates, to rise over the coming years, which in turn, will mean that companies that deliver rising dividends and yields above cash and inflation will continue to be in demand, therefore, the hunt for income will carry on,” he adds.

Consensus is solidifying around the idea that pre-financial crisis investor expectations of 5 per cent returns a year need to be dispelled – or more risk taken on to achieve that figure.

Remain cautious

Cautious investors are being warned to learn the lessons of history and not swim too far from the shore.

“In the Economic History of Modern Britain, J.H. Clapham cites the railways boom and subsequent bust of the 1840s as a classic example of “blind capital seeking its 5 per cent” – in other words, investors over-reaching for yield and taking on more risk than they thought to get what looked like a safe and appealing yield at a time when interest rates were very low,” Mr Mould adds.

“Remember that 10 years ago UK 10-year Gilt yields were around 5 per cent - to get that now you have to buy emerging market government debt, some junk debt or take on some pretty substantial equity risk in some cases, or even look to new areas like peer-to-peer lending.

“Low rates and quantitative easing have forced income-seeking clients up the risk curve whether they like it or not.”

Alan Steel, chairman at wealth advice firm Alan Steel Asset Management, says he thinks the days of the mega cap success - and therefore index huggers or trackers - are over.

But he warns investors to take a long-term view: “The quality of dividend growth will reappear as interest rates rise and quantitative easing ends.

“Over all the years I’ve been in this business, the one thing investors should care about for long term real returns is to back companies who concentrate on growing their dividends from free cash flow.

“Anything else is short term window dressing and ephemeral.

“Where to find this? The Global and UK Multi Cap pond would be where we’d be fishing right now.

“The next thing is to be patient. Not something investors display these days, sadly.”

Laura Miller is news editor of FTAdviser