The popularity of global equity income funds is a fairly new phenomenon. One or two fund management groups attempted the concept more than 20 years ago, but it failed miserably because most overseas markets provided little dividend income compared with the UK. However, times have changed. Many more areas of the world have now embraced a culture akin to the UK, where there is widespread commitment by companies to provide investors with increasing dividends.
One company that has recently celebrated three years in this sector is M&G, courtesy of their Global Dividend fund managed by Stuart Rhodes. Statistically three years is quite a short period. To get an idea of a fund, or more importantly a fund manager, you really want to see a record of seven years or more. That said, Mr Rhodes has certainly got off to a fine start and when I met him a couple of weeks ago I was impressed with his philosophy regarding equity income investing.
The argument behind investing in companies with growing dividends is well-rehearsed but worth a reminder as too many investors have a time horizon of only a few months. In contrast, the equity income philosophy is very much to get rich slowly. The compounding of dividends over the years to buy more shares has an extraordinarily powerful effect – providing of course you regularly reinvest your income. Growing dividends is a considerable financial discipline for a company too. It requires good management to increase payouts while allowing enough money for investment. Indeed dividend policies can act as a balance, preventing companies wasting money on unproductive projects and instilling a focus on the most profitable ones.
In finding suitable companies for the fund, Mr Rhodes looks for resilient businesses able to survive difficult economic times while growing dividends more or less in line with inflation. He is also vigilant to avoid any company that has become a slave to its own dividend policies, clinging to a record of dividend growth that is ultimately unsustainable. Out of a universe of around a thousand companies, he produces a list of 200 that broadly meet his criteria, and from this he selects a tight portfolio of only 50 names.
For the core of the fund (representing 50 per cent to 70 per cent) he buys good-quality companies, dominant in their respective areas. Although these companies are dependable and likely to see him through good times and bad, they often lag behind when markets rise. To counteract this he likes to invest 20 per cent to 30 per cent of the fund in asset-backed, cyclical companies whose fortunes are much more closely related to global GDP growth. These are more responsive to market moves and include mining companies such as BHP Billiton. Finally, he dedicates approximately 10 per cent of the portfolio to companies growing quickly and increasing dividends very rapidly – albeit from a low base. These are often emerging markets stocks and are frequently expensive, so he attempts to pick them up when markets wobble.
It is from these more economically sensitive areas that the fund has derived its performance edge over the sector since launch, though there will clearly be times when the strategy works less well. It also means something of a compromise in terms of income. At 3.2 per cent, the fund's yield is behind a number of rivals, who produce up to 4.5 per cent. However, I believe Mr Rhodes is an impressively deep thinker regarding income, and is aiming to build a truly long-term record of dividend growth alongside growth in capital. In the long run this strategy could produce better total returns than funds targeting higher yields.
While the fund has increased rapidly in size, Mr Rhodes does not feel constrained by this and believes there is plenty of capacity to grow it further. Clearly it has already proved popular, and it does seem to me to be the type of fund many investors should be looking for, particularly those in retirement, where funds providing income that broadly rises with inflation are highly desirable as part of a retirement portfolio. It also offers important diversity away from the more traditional UK equity income funds that tend to dominate investors' portfolios.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent