Investors selecting shares for an equity income portfolio need to choose stocks that are likely to pay a growing dividend over time and not just a high yield currently, a leading fund manager advises.
Portfolio manager Michael Price says there is a common assumption that high dividend yields imply future earnings and dividend growth. He says the assumption does not hold.
Price is the portfolio manager in charge of the Ausbil Active Dividend Income Fund. He says: “On average, the top dividend yield companies actually see low, or even negative earnings growth going forward, compared with the fourth to seventh decile of companies. This has been true for the past 20 years.
“An active dividend income strategy can increase income from companies whose dividends are healthy but maybe not the highest, because they are also investing earnings into a growing business. Hence their better earnings growth in the years ahead.”
The fund holds CSL, which trades on a low dividend yield. Price says: “CSL has transformed itself into a global leader in biotechnology, largely by balancing the payment of dividends with significant reinvestment in the growth of the business. The actual dividend payment has grown 10-fold over the past 10 years.”
Equity income funds have been solid performers over the past year, with average total returns of close to 19 per cent over the 12 months to the end of May. Income-oriented Australian share funds have had their ups and downs over the past few years, as the bank and telco stocks that have been their mainstays have underperformed.
According to the latest Mercer Investment Survey, income-oriented Australian equity funds produced a median return of 8.9 per cent over the 12 months to the end of May. The S&P/ASX 200 Index was up 11.4 per cent over the same period.
Top-performing funds over the year include Martin Currie Australian Real Income (up 16.6 per cent), Plato Australian Shares Income (up 14.9 per cent), Acadian Australian High Yield (up 14.1 per cent) and JB Were Income equity (up 11.5 per cent).
The Ausbil Active Dividend Income Fund is a newcomer to the sector. It was launched in July last year. Its performance for the three months to the end of May was 4.5 per cent, putting it just behind the index.
Price says the fund is targeting minimum income growth of 7 to 8 per cent a year (including franking credits) plus capital growth of around 2 per cent.
“Clients do not want high yield at the cost of a low total return. We actively manage our sector and stock selections and we are active around dividend payments dates,” he says.
The portfolio is overweight banks at a time when many investors are still bearish on the sector. Price says the bank’s valuations make them appealing.