Most of 2020 was a struggle for dividend investors, with the first quarter suffering one of the biggest quarterly drawdowns in history as the Covid-19 crisis took hold. But the final three months saw a dramatic rebound in the wake of positive news on the efficacy of the Pfizer vaccine and confirmation of Joe Biden’s victory in the US presidential election.
“In our view, this signalled the beginning of the recovery,” Tom Buckingham, portfolio manager of the JP Morgan Europe Strategic Dividend Fund, told FSA.
Yet, valuation spreads on dividend stocks across Europe remain wide: using an earnings yield measure, value spreads are in the 97th percentile historically, he said. “We’re even finding dividend ideas even within sectors typically perceived as growth sectors.”
Although dividends were cut by around 25% year-on-year at the aggregate market level, much of this dividend drawdown was driven by regulatory and management prudence rather than stressed underlying company fundamentals. Buckingham expects European dividend growth of around 15% a year for each of the next two years.
Sectors such as materials, banks and autos are delivering the strongest earnings momentum, according to Buckingham.
“Financials continue to look cheap and we believe they will be able to return capital to shareholders when regulators allow,” he said.
Europe will also get a further tailwind as the EU Recovery Fund should will start to affect economic activity positively in the second half of the year. Energy and digital transformation initiatives will likely receive a large part of the total allocation and JP Morgan’s European equities dividend strategy should benefit, as it owns names such as Schneider Electric and Siemens.
“Moreover, corporate capex is expected to accelerate this year given strong corporate profitability, and this will shift the focus to organic growth after years of cost-cutting,” said Buckingham.
European dividend stocks also look attractive compared with other asset classes and regions, he noted.
“Free cash flow yield (FCF) compares favourably to the prospective yield across fixed income on our “through-the-cycle” forecasts and the opportunity to compound this FCF over time remains compelling,” he said.
He forecasts that European stocks will yield about 3.0% on a 12-month forward view, “which is again significantly more attractive than the yields on offer in any other equity regions or indeed across the corporate bond, government bond and money markets sectors”.
Asia yield premium
Yet, on the other side of the world, “the opportunity set for high dividend yielding equities in Asia ex-Japan is significantly outsized relative to any other equity region globally,” Jeffrey Roskell, portfolio manager of the JP Morgan Asia Equity Dividend Fund, told FSA.
As of the end of May, there are 237 companies based in the region with dividend yields of more than 3% included in the MSCI AC World Index, compared with 112 in Europe and only 91 in the US, he noted.
In terms of overall asset class yields, emerging markets high dividend paying equities yield on average approximately 4.6%, as of the end of June, with Asia ex-Japan high dividend equities yielding 4.4% on average.
This compares with just 3.4% average yield for developed market high dividend equities and only 2.4% for broader European equities.
“Asset classes such as Asian high yield debt offer higher income (about 7.4%), but are accompanied by default risk, while higher yielding alternative asset classes can be illiquid and may not be suitable for all investors,” said Roskell.
However, “it is important to maintain diversified exposure and to look across several sources of income and total return, so our investment strategy encompasses quality, low beta and value stocks that are geared to perform across different market environments,” he said.
For example, among low beta stocks Roskell sees opportunities in some infrastructure sectors, such as toll roads, and logistics Reits.
Among stocks with value characteristics, he likes some banks, insurance companies, property developers and energy/materials companies.
Meanwhile, for dividend paying companies that offer quality at a reasonable yield, he favours select names in consumer services, tech services and consumer goods, and has identified telecoms companies that share characteristics of all these categories.