A reliable income stream proves it mettle in tough times

Duggan Matthews, investment manager, Marriott

Duggan Matthews, an investment manager at Marriott, explains how the Dividend Growth Fund has earned itself a Top 5 slot among all SA equity funds over the past year and gives tips to investors looking for stability in uncertain times

Until recently resource shares have been the place to be for investors looking for good returns. Driven by a buoyant global economy and what seemed to be endlessly increasing commodity prices, resource businesses in South Africa were able to generate significant growth in earnings and dividends, with prices following suit. Unfortunately little recognition has been given to the fact that the dividend track records of these businesses clearly pointed out that if history counted for anything this trend could not continue forever. Investors have been reminded of this fact with the recent announcement by Anglo American that it would not be paying its final dividend for 2008.

Commodity prices are currently significantly off the highs experienced during the middle of last year, and it is likely that future dividend announcements from resource businesses will disappoint shareholders. This is far from an ideal scenario for a retired investor deriving a portion of his/her income from local equities, and is precisely the reason why Marriott does not invest in the resource sector.

The Marriott Dividend Growth Fund is currently ranked in the top 5 of all equity unit trusts in SA over a 1 year period, and has outperformed the All Share Index by an average of 2.5% per year for the last 5 years. The fund managed to achieve this through a process of seeking out fundamentally sound JSE listed companies that currently pay dividends and possess the ability for consistent and sustainable dividend growth into the future. Although the fund’s track record is highly impressive today, this has not always been the case.

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Above is a graph showing total performance of the DGF versus the All Share Index from 23 March 2003 to the 23 March 2009. What is apparent in the graph is the divergence and underperformance of the Dividend Growth Fund relative to the Index in the period highlighted on the chart. Reliable businesses with proven track records can quickly become out of fashion and boring in a bull market. It is only in uncertain and challenging times that the value of these businesses becomes most apparent.

During the last 12-month period the All Share Index has lost more than 30% of its value. During this same period the Marriott Dividend Growth Fund produced a positive outcome for its investors in terms of total return. The dramatic contrast in performance is demonstrated in the chart below.

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Going forward the fund is ideally positioned for the challenges of 2009 and offers potential new investors the opportunity to invest in some of the biggest and best companies in South Africa at unusually high dividend yields. More importantly, the businesses that the fund invests in have what it takes to grow their dividends, or at least maintain their dividends at current levels. These businesses include household names like Mr Price, Spar, Altech, Tigerbrands and Massmart. Businesses that are well established with sustainable competitive advantages enabling them to retain and increase customers, maintain margins and raise their dividends dependably.

The value of a reliable income stream is often overshadowed by the pursuit of unrealistic returns. It is important for investors to remember that resource producers’ profits are completely dependent on prices and volumes; and that no single producer can influence the price of and demand for commodities. They are “price takers” as opposed to “price makers”. It is therefore not surprising that the dividend track records of businesses – like Anglo American – are far from a picture of reliability. Finance teaches us that a share’s value should be equal to the present value of all future dividends. For an investor looking for a more predictable experience from his equity investment, the value of a reliable income stream cannot be underestimated. For a retired investor looking for an inflation beating income stream, reliability income streams become even more important.