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Equity Perspectives

With dividend yields overseas historically much higher than those in the United States, the combination of reinvested international dividends and capital appreciation has been a key ingredient for long-term outperformance.

With dividend yields overseas historically much higher than those in the United States, the combination of reinvested international dividends and capital appreciation has been a key ingredient for long-term outperformance. In fact, the longer the investment time horizon, the more important dividend income is to an investor. The Lord Abbett International Dividend Income Fund spans the globe for companies that pay high dividend yields, but that are currently out of favor with investors despite the potential of these companies to generate attractive total returns over time. To mark the five-year anniversary of the Fund, Vincent McBride, Lord Abbett Partner & Director of International Equity, discusses the Fund's guiding philosophy, process, and investment strategies.

Q. Why are dividends such an important part of your investment strategy?
A. Many investors focus largely on share price movements and market momentum instead of dividends—not realizing the extent to which long-run returns have been influenced by dividends that are reinvested. In fact, reinvested dividends account for at least 40% of total return over any significant time period [see Chart 1], according to a study conducted by London Business School professors Elroy Dimson, Paul Marsh, and Mike Staunton.1


 
Chart 1. Long-Term Returns Have Been Largely Driven by Reinvested Dividends
Impact of reinvested dividends on cumulative U.S. and U.K. equity local-currency returns, 1900–2008

Source: Dimson, Marsh, and Staunton. All data as of December 31, 2008.
Past performance is no guarantee of future results.
This chart shows the difference in terminal wealth arising from reinvested income can be very large. The green line shows the total return from a $1 investment in U.S. equities in 1900, with all dividend income reinvested, would have grown by 582 times by 2009. The purple line shows the real return of a similar $1 investment in a trust fund that paid out all its income, rather than reinvesting dividends, would have grown by just six times over the same period. The remaining two lines show the equivalent figures for the United Kingdom. Thus, the longer the investment horizon, the more important is dividend income.

 

Q. How would you characterize the opportunities for dividend investors overseas?
A. Dividend yields2 have long been more plentiful and significantly higher in many overseas markets than they are in the United States [see Chart 2] and across almost all sectors [see Table 1]—and selecting markets by the highest yields has historically led to significant long-term returns [see Chart 3].


 
Chart. 2 International Dividend Payout Ratios Have Long Outpaced Those in the United States
Dividend payout ratio of the MSCI ACWI ex U.S. Index versus the S&P 500 Index,5
12/31/1995–12/31/2012

Source: Bank of America. Data as of December 31, 2012. The two charts above are for illustrative purposes only and do not represent the performance of any Lord Abbett mutual fund or product, or any specific investment. Information in charts is the most recent data available.
Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
Foreign securities generally pose greater risks than domestic securities, including greater price fluctuations and higher transaction costs. Foreign investments also may be affected by changes in currency rates or currency controls. With respect to certain foreign countries, there is a possibility of nationalization, expropriation or confiscatory taxation, imposition of withholding or other taxes, and political or social instability that could affect investments in those countries.
A dividend payout ratio refers to the fraction of net income a firm pays to its stockholders in dividends. Dividends are not guaranteed and may be increased, decreased, or suspended altogether at the discretion of the issuing company.


Table 1. International Dividend Yields Are Higher Than U.S. Dividend Yields in Nine Out of 10 Sectors

Source: FactSet and Bloomberg. Data as of June 7, 2013.
*2,283 companies.
† Screen: Market cap greater than $1.5 billion and average daily volume greater than three million (approximately 420 companies). Screening criteria are based on the team’s investment process, which first narrows its eligible universe of securities by identifying non-U.S. companies with market caps greater than $1.5 billion and trading volume greater than three million.
Total yield numbers in each universe referenced above reflect an average of the dividend yields of each company weighted by market cap.
For illustrative purposes only and does not represent any Lord Abbett mutual fund or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
Past performance is no guarantee of future results.
 


 
Chart 3. Selecting Markets by the Highest Dividend Yield Has, Historically, Led to Significant Long-Term Returns

Source: Elroy Dimson, Paul Marsh, and Mike Staunton.
Past performance is no guarantee of future results.
The chart above reflects a study of the long-term annual returns of 19 major equity markets, rebalanced annually, arranged into five quintiles based on the historical dividend yields of companies within each respective market. The two categories depicted above represent the lowest-yielding quintile and highest-yielding quintile of the five.
The data represented in this chart are for illustrative purposes only and not intended to predict or depict the performance of any Lord Abbett mutual fund or product, or any specific investment.
Dividends are not guaranteed and may be raised, lowered, or suspended altogether at the discretion of the issuing company.

 

Q. Please describe your investment goal and portfolio selection process.
A. The International Dividend Income Fund seeks to outperform its benchmark, the MSCI All Country World Ex-U.S. Value Index With Gross Dividends,3 over a full market cycle. Our portfolio selection process begins with a potential universe of more than 2,100 companies, all non-U.S. firms, each with a market cap greater than US$1.5 billion, and average daily volume greater than $3 million. Using a bottom-up, value-equity approach, the team looks for high-dividend-yielding companies with an emphasis on dividend sustainability, stable growth/high free cash flow, and significant potential for capital appreciation. The effective universe of high-yielding companies, at any point in time, is approximately 420.

Q. Since early May, 2013, government bond yields have begun to rise across most of the developed world. Given the recent popularity of dividend strategies, certain parts of the global equity markets (low-beta4 stocks across defensive sectors) have recently moved in tandem with government bond yields; first up and, more recently, down. How do you expect your non-U.S. dividend portfolio to react to higher bond yields from current levels?
A. The recent increase in government bond yields has created an initial negative shock to most yield-oriented investments. Higher yields on government bonds have pushed up yields on higher-dividend-yielding stocks [and prices have moved down]. We believe that high-dividend-yielding stocks without value will continue to be risky. We have moved the portfolio away from many of the areas that have done quite well over the past few years and which have become highly correlated with bond yields—namely regulated utilities, real estate investment trusts [REITs], and select telecom companies—and toward a number of economically cyclical businesses in the energy, industrial, and financial sectors.

Q. Where do you find the best opportunities?
A. We find our best ideas across three distinct corners of our potential investment universe. The first focuses on stocks with a current dividend yield greater than the current P/E [price-to-earnings] ratio.6

The second area of interest comprises companies where current dividend yields are higher than the yields on the corporate debt on their balance sheets. These tend to be solid companies with generous dividend policies.

Finally, the third area consists of companies, usually in emerging markets, that are controlled by a multinational parent company, but are still listed in the emerging market. The multinational parent company, not surprisingly, forces its listed subsidiary to pay out most or all of its earnings in the form of dividends. As minority shareholders, we have access to the same dividend flows as the parent company (assuming we are invested in the same share class). One representative example is a major metals and materials company that had a stock yield of 2.6% versus its majority-owned iron ore subsidiary that was yielding 7.3%.

Q. What investor misperceptions about the investment strategy did you have to overcome?
A. The most common misperception is the idea that we are just "clipping dividends" from higher-dividend-yielding stocks. This is not our investment strategy; we are investing in undervalued stocks that also carry relatively high dividend yields. And we have the flexibility to invest across small, mid, and large cap companies as well as in emerging markets and developed markets for optimal diversification. We believe investors should benefit in two ways: the compounding of reinvested dividends and the appreciation of the undervalued stock.

Q. How do emerging markets factor in this strategy?
A. Emerging markets have been a substantial contributor to our returns over the past five years. Many investors are surprised by the number of high-dividend-yielding companies that exist in the emerging market universe. Currently [as of June 30, 2013], approximately 10% of the portfolio is invested in emerging economies, across many markets, including Turkey, Hong Kong/China, Brazil, South Korea, and Taiwan.

Q. What sets the International Dividend Income Fund apart from other funds in this area?
A. The first major difference is philosophical. We understand that reinvested dividends have, historically, accounted for 40–60% of the total return of any major global equity markets over any 10-year time period since 1900. Armed with this information, we believe that our high-dividend-yield/low-valuation strategy sets us up to deliver competitive total returns.

Our international-dividend-yield/low-valuation approach is different from many international value investment strategies because they tend to focus on distressed/low-valuation companies that are no longer able to pay a dividend.

Q. How do you address the risk of dividend cuts?
A. Dividend cuts are cyclical, and generally ebb and flow with the global economy. We did see a number of dividend cuts and eliminations in 2009, but have not experienced many during the last three years as the global economy has recovered. In fact, the overall strategy has shown positive dividend growth over the past one- and three-year periods. We believe that the combination of rigorous bottom-up analysis and meetings with company management can yield well-informed opinions about the sustainability of dividends. In other words, active managers should be better able than passive managers to detect companies at risk of cutting their dividends.

Q. Please describe the discipline that goes into risk management.
A. We believe our process of looking at risk on three different levels, including hurdle rates at the stock level, differentiates us from other managers. At the stock level, the team developed a system in 1997 that integrates the consideration of risk into every investment we analyze. When it comes to stock selection, we do not simply look at the expected return of an investment. We want to know that we are getting compensated for the risk we take, and we believe our process accomplishes this objective.

Q. The bottom line?
A. Dividends matter. Reinvested dividends have accounted for 40–60% of the total return of any major global equity market over any 10-year time period for over a century.7 Foreign companies historically have had lower valuations, higher payout ratios, and persistently higher yields. The current environment is robust: it is possible to build a portfolio of companies internationally yielding over 5% without sacrificing quality or diversification.

—Reported by Steve Govoni


1 Elroy Dimson, Paul Marsh, and Mike Staunton, "The Triumph of the Optimists," Credit Suisse, 2009.
2 Dividend yield is equal to the dividend divided by the stock price. Dividend yield is one measure of a stock's value. A high dividend yield may indicate that a stock is relatively inexpensive.
3 The MSCI ACWI (All Country World Index) Index is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed and emerging markets. The MSCI ACWI Ex-U.S. Index with Gross Dividends approximates the maximum possible dividend reinvestment. The amount reinvested is the entire dividend distributed to individuals resident in the country of the company, but does not include tax credits. MSCI uses withholding tax rates applicable to Luxembourg holding companies, as Luxembourg applies the highest rates.
4 Beta is a measure of volatility relative to the market. A stock or portfolio that fluctuates more than the market has a beta above 1.0. A stock or portfolio that fluctuates less than the market has a beta less than 1.0.
5 The S&P 500 ® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.
6 Price-to-earnings ratio is the ratio of the share price to the earnings per share for the last 12 months. This ratio is one measure of valuation.
7 Dimson, Marsh, and Staunton. op. cit.

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