The problem with growth investing

Nick Clay, Newton Investment Management

“Most people, when they are investing in equities, think it is all about capital growth. Because of that, they go toward the growth companies all the time,” Clay told FSA in a recent interview. He is investment manager for global equity income at BNY Mellon affiliate Newton Investment Management.

According to data from FE Analytics, investors favoured growth stocks last year, especially in the US. The S&P 500 Growth Index returned -0.01%, which compares to the S&P 500 and S&P 500 Value’s -6.24% and -10.12%, respectively,

However, the problem is that most of these growth companies are not paying dividends, Clay said.

“The reality is they don’t have dividends because they are growing, which means they focus on growth, not profitability,” he said. He believes, therefore, that these companies have a tendency to misallocate their capital.

Clay manages the Newton Global Equity Income Fund, which invests in companies that pay sustainable dividends, a criteria he believes singles out businesses with “the right governance structure”.

The income strategy

The fund’s historical dividend yield in December 2018 was 3.38%, according to the factsheet.

The investment strategy requires that stocks have dividend yields 25% greater than the FTSE World Index average, according to Clay.

“For every company that we hold in the portfolio, if they suddenly yield less than the market, we have to sell it,” he said.

The sustainability of dividends is more important than dividend growth for Clay. He said he makes sure that invested companies have an adequate and stable cashflow that enables them to consistently pay dividends.

“We go back to a company’s history a lot, as well looking at other companies with similar products, and try to see how the cashflows work through different cycles. We also look at their debt situation and see whether they can still sustain dividends when things get bad.”

He added that sustainable dividend payers also must have attractive valuations. “We can only buy these companies when they are out of favour and cheap.”

Clay acknowledged that the fund may not outperform in certain periods because of its dividend and quality bias, especially during a market rally.

“When the market goes up, we tend to underperform, but we are not bothered about this. When the market has a wobble, we tend to outperform.”

Discreet annual performance (%)

Source: FE Analytics. Note: The fund is not available for sale to retail investors.

Europe and IT exposure

The portfolio has sizable investments in Europe including UK (42%) and in the IT sector (18%), both of which have become areas of caution for other fund managers.

The biggest risk in Europe is its debt, especially in Italy, he said.

“Everyone is obsessed with Brexit at the moment and I think that is slightly missing the point. Italy has a debt greater than the size of its economy. The cost of its debt is also higher than the growth of its economy.”

Because of the debt problem, Clay is not invested in any financial stocks in Europe. Instead, he is focused on cash-generative companies in the region, such as pharmaceutical companies, which he believes have revenue growth driven by Europe’s aging population.

Turning to IT, Clay noted that he doesn’t invest in the “FAANG type” of companies because they don’t pay dividends.

“Yet we can still invest in technology by being invested in the mature tech companies. When you look these mature companies, you can see that they have recurring revenues as they are very much embedded in their client’s technology framework.”

He added that because of the market’s obsession with growth and FAANG stocks, mature tech companies have largely been forgotten, driving down valuations and providing attractive investment opportunities.

The Newton Global Income Fund versus its benchmark

Source: FE. In US dollars.