Investing in controversy: a global dividend strategy

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I am Staci West, and today I am joined by Nick Clay, manager of the Redwheel Global Equity Income Strategy. Nick, thanks for joining me.

[00:08] Thank you for having me.

So income payments hit a first quarter record this year with dividend growth. Can you just set the scene a little bit for global dividends? What’s contributing to this growth that we’re seeing?

[00:22] I think there’s two factors. I think oddly enough, even though it seems like it was a long time ago, we are still seeing some recovery from the pandemic impact on dividends where a lot of companies cut their dividends or reset them far lower, and now that they’re functioning better as businesses and more normal environment, then those dividends are returning back to some of the levels that we saw pre-pandemic.

But the second, and probably more dramatic impact today, is inflation. And companies can put up their prices, they can therefore grow their cash flows as they put up their prices, and that allows them to grow their dividends. And it’s something that we’ve seen historically through time, which is that when we’ve been in inflationary periods, dividend growth from companies does pick up; simply because of that they can put up their prices and therefore they’ll grow their dividends. And I think you are seeing that impact today as inflation has been much higher recently and therefore that’s come through in growth in dividends.

And this strategy’s philosophy is to ‘buy the controversy and sell the consensus’. So maybe just explain that a little bit and if you have an example that you can share as well.

[01:39] Yeah, certainly. So, you know, naturally, like everybody else the strategy is trying to buy a good quality company. But equally we want to do it when that good quality company is attractively valued. We don’t obviously want to buy them when everybody loves them. And when valuations are expensive, and of course you only get that good quality company at a good valuation when something’s going wrong, when there’s some kind of short-term controversy surrounding that company. And of course then our job is to understand whether that controversy is temporary and an opportunity, or whether it’s permanent and therefore a trap and you don’t want to invest.

And a good example today, we would argue would be in the luxury retail sector where obviously the controversy today is that one of the main consumers of western luxury brands are the Chinese consumer. And of course, China is struggling to come out of its pandemic, it’s struggling with a property problem and therefore the consumer is being very lacklustre in its return to buying luxury goods. Now obviously that is weighing on luxury goods companies, but what it means is some of the valuations of those companies are implying that Chinese consumer would never buy luxury goods ever again. Well, we think there’s quite a lot of evidence that you can find that supports that that’s probably a temporary thing, not a permanent thing. You know, mainly because it’s very difficult, for example, China to come up with a replacement or an alternative to a Gucci handbag or to a Cartier bracelet. And therefore we just think it’s a temporary thing and eventually they will come back.

And then what’s good, particularly from this strategy’s point of view, is those companies pay us a dividend whilst we’re waiting for that controversy to be proved temporary and not permanent. And so, that’s a really good example of today of something that we think the market is obsessing with something that they think is permanent, but the reality is, it’s probably just temporary.

I think you’re right. I think it will be hard for designer bags and diamonds to not come back in fashion.

[03:57] Yes, and it’s also difficult to replicate them as well. You know, and that’s not the case in everything. You know, China is, for example, making it very clear it can replicate the iPhone with their own smartphone. So you have to be careful that those products that you feel, that a big part of a consumer wants to be able to buy can’t be replicated by something else. And the thing about luxury brands is, it’s the heritage, the tenure of those brands, et cetera, that gives them that protection and makes them very difficult to replace.

Brilliant. Well, markets are also very concentrated at the moment. We have US equities accounting for something like 70% of the MSCI World Index, and this fund has always had a decent position to the US I believe, it’s usually around a third. So has your approach changed at all to reflect this concentration or are you seeing something different?

[04:58] So, we have some disciplines imposed upon us that means we can only buy companies when they have a dividend yield that is 25% greater than the market. So the world market today yields around 1.8%. So anything we buy must yield 25% more than that. What that discipline does is it stops us from following the herd into very concentrated positions. And today’s a great example of that, you know, by definition, because over 70% of the world market is based in the US today, within the US itself, just five companies, it may be even just one company – NVIDIA – makes up a very large percentage of that market. And those disciplines that are implied upon us stop us from following the herd into what we would consider to be dangerous and bubble-like valuations. And that’s why we have those disciplines.

You know, we are no stronger human beings than anyone else. We would be just as likely to want to follow the herd and find comfort in that. And so what this strategy does is stops us doing that and therefore forces us to look elsewhere for our ideas. And of course, as we sort of said in the question before about looking for controversies, there is obviously no controversy surrounding NVIDIA and AI today. Everyone loves it. Everyone is convinced it’s going to take over the world and everybody believes it’s the only way that you can make money. Well, that’s not a controversy. And so we can’t invest over there; we have to invest where we think the market has a short-term problem going on with a company.

And so those disciplines force us to do something different. And we think that that is important because if you do the same as everybody else in the market, you’re not going to deliver a different result to everyone else in the market. You have to do something different. But obviously that’s not a natural human trait. Natural human trait is to follow the crowd and find comfort in consensus. And so those disciplines we impose upon ourselves, force us to do something we think is very appropriate today and to try and deliver a total return in a different way.

Well, with that in mind then, what is your view for the second half of the year? Where are you finding those controversies perhaps, and what is the outlook for dividends for investors?

[07:31] So, what we see going forward, whether it’s just for the second half of the year or a bit longer than that, is that we do not think that this obsession with what we call AI Goldilocks, ie. nothing goes wrong – Goldilocks not too hot, not too cold – nothing goes wrong. And of course then you’ve got the fairy dust of AI sprinkled on top of that, meaning everything’s going to be absolutely wonderful for a very small number of stocks and therefore they’re the only stocks you want to earn: the Magnificent Seven, maybe it’s six, maybe it’s five. And we think that that view has a very low probability of turning out to be true. And in fact more likely is that we see an outcome either of a recession because we’re forced to keep interest rates higher for longer and because inflation is proving a bit stickier and not coming down to the levels that we want it to come down to, particularly in the US. Or that we do cut interest rates and therefore actually inflation comes back. And we think that either of those two scenarios are more likely.

Therefore you have to think of what kind of companies you want to invest in to be able to suffer in that environment. They have to be good quality companies. They have to be companies that can cope with inflation. They can raise their prices, as we talked about at the beginning, to be able to grow their dividends. But more importantly too is that you have to have a discipline on the valuation you pay for your investments because if you pay a very high valuation and things become more volatile – a recession or a return of inflation would increase volatility – you need to do something more about dampening down that volatility, not losing as much when things go down rather than obsessing about how much money you can make when things go up. And today everyone’s obsessed with making money on the way up because the markets seem to only go up.

We think that that’s a dangerous precedence and a dangerous assumption to think that that lasts forever and therefore things could become more volatile, and therefore doing things about not losing money is more important than not making money. And that requires you to not overpay your companies in the first place. And it requires how you are going to generate your total return for your client between the capital side – prices going up and the compounding of the income. Well, everybody’s obsessed with the prices going up at the moment; we think the shift will move back to the compounding of the income.

And that’s what this strategy does. All our companies generate a dividend. All of our companies pay us that dividend for us to compound back into the portfolio. And it’s the largest driver of the total return over a long period of time. And we think that shift in focus goes back to that compounding of income over the next few years. Not necessarily is going to happen in the next six months, but over the next couple of years. And therefore, again, going back to what we said in the last question, having the disciplines to focus us to focus upon, that’s the way we’re going to generate the return through the companion of the income and not chasing prices is something we think that’s very appropriate for this strategy in the current environment.

Well Nick, that’s brilliant. Thank you very much for sharing your views on quite a lot of what’s happening, but also the mentality that you don’t have to follow the herd, you can do your own thing, which is brilliant. So thank you very much for joining me.

[11:18] Thank you so much. Thanks for having me.

And for more information on the Redwheel Global Equity Income Strategy, please visit FundCalibre.com.