Opportunity in adversity to wet appetites of fund managers

The global financial crisis played a major role in derailing the investment goals of many investors and fund managers. Not only was the investment climate during the crisis volatile, but the protracted recovery is forcing fund managers to rethink their investment strategies in order to achieve their clients’ goals.

While the crisis has proved challenging, there is a lot of room for opportunities, if one knows where to look. Like the saying goes, ‘out of adversity comes opportunity’.

Interest rate lifeline

One of the key economic indicators the public pays attention to is the interest rate. This is no different in the investment space. Rynel Moodley, Investment Analyst at Cannon Asset Managers, mentioned that in an era characterised by record low interest rates, the hunt for yield has become a rallying cry for yield-hungry investors.

“The need to generate income in an uncertain investment landscape with rock bottom interest rates in some of the largest capital markets has lured investors into riskier parts of the bond market or to the safer, and more traditional, money market route which delivers negative real returns. An attractive alternative for generating income is to invest in superior quality high dividend-paying companies that possess the characteristics required to weather uncertain economic climates,” said Moodley.

Amongst other attractive features, shares which offer a dividend reduce the need to chase speculative capital returns. The dividend payment acts as a shield against periods of high volatility. Moodley added that to this end, the global dividend strategy series, published by Credit Suisse, highlights the power of this investment approach. The research shows that across twelve countries for the period 1990 to 2008, shares with high dividend yields generally outperformed shares with low yields.

Avoid yield traps

“Investors need to be wary of yield traps when seeking out high dividend paying stock. These traps arise when dividend yields appear high and attractive but, in fact, are not sustainable. This occurs when the share price declines substantially relative to a past dividend or when a company with deteriorating earnings attempts to preserve its dividend,” said Moodley.

It is therefore critical that investors examine a company’s dividend sustainability and growth over time. To sustain and grow dividend payments, a company needs to reinvest a portion of its earnings and so cannot pay out all of its earnings. Growth prospects need to be reasonable, earnings have to be underpinned by cash flow and the balance sheet of the business must be unstrained by excessive leverage.

“Arguably, one of the most important metrics to pay attention to when seeking out dividend champions is free cash flow, and the stability of cash flow relative to earnings. This number gives a sound reflection of the amount of cash that is available after a company has covered all its expenses, including debt obligations and capital expenditures. A free cash flow number that is highly volatile from year to year, making the dividend amount and payment uncertain, introduces an element of risk for the dividend seeker. The higher the free cash flow a company is able to generate relative to earnings, and the lower the volatility of this ratio, the more attractive it becomes from a dividend yield perspective,” concluded Moodley.

Increase your international focus

Investors traditionally suggest that a good investment portfolio should include some exposure to international stocks. This serves as both a safety net against the local market suffering a significant down cycle, and to cash in on the strong performance of international stocks.

In light of the low interest rates, and the good uptake international stocks are seeing, investment specialist Marriot reports that there is a strong case for investors to increase clients’ international exposure as it is possible to invest in some of the largest and most recognisable companies in the world on yields in excess of local equity yields. These attractive valuations afford investors the opportunity to improve the overall quality of their personal portfolio.

However, it is difficult to convince local investors to invest offshore at present, especially after the experience of the last decade.

According to Marriot, the reality was that these investors had a miserable experience compared to those invested in local markets. For the decade that was before the investment rough patch, December 1999 to December 2009, the South African All Share Index significantly outperformed first world markets and many South African investors continue to adopt a strong local investment strategy.

Editor’s Thoughts:
There is no exact science in investing, and a characteristic of most investors is their ability to adapt to changing investment climates. A balanced approach between local and international investments still seems to be the best approach to follow. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts jonathan@fanews.co.za.

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