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Equity Perspectives

Dividends matter: High international dividend yields and a rigorous valuation approach can increase the potential for strong total returns.

Investment Objective
The Lord Abbett International Dividend Income Fund looks for undervalued stocks with high and sustainable dividends and that have the potential to produce strong total returns. The strategy seeks to outperform its benchmark, the MSCI All Country World Ex-U.S. Value Index over a full market cycle.1

Investment Philosophy
Long-run equity total returns are heavily influenced by reinvested dividends. The longer the investment time horizon, the more important is dividend income. Our international dividend strategy is based on extensive academic research, which reveals that high dividend yielding stocks are a key ingredient for international equity total returns2. Reinvested dividends contributed roughly 50% of any major equity market’s total return over any 10-year time period since 1900.2 We believe that a combination of above-average dividend yields3 and below-average valuations produce strong total return prospects.

International Opportunity Set Superior to Domestic
Historically, we have found that stocks in international markets have higher yields than U.S.-based companies. According to FactSet, 150 companies with market caps greater than $1.5 billion outside the United States offered dividend yields of more than 6% as of 5/31/2014, versus only 66 such companies in the United States. As a result, we are able to assemble a well-diversified portfolio without undue concentration from a sector standpoint.

Competitive Advantage
Our investment team has long understood the critical role that high dividend yields play over time. Vincent McBride, Lord Abbett Partner & Director, has 27 years of industry experience. Todd Jacobson, Partner & Associate Director has 26 years of industry experience. Harold Sharon, Lord Abbett Partner & International Strategist, has 31 years of industry experience. The 10 supporting members of the international dividend team average 17.1 years of industry experience. Armed with this knowledge, the team then applies a consistent investment process across the high-dividend-yield universe. We believe that an active approach is needed within this strategy; high dividend yields often accompany poor or failing business models.

Screening Process
Our initial potential universe is approximately 2,100 companies, all non-U.S. firms with a market cap greater than $1.5 billion and average daily volume greater than three million. We then rank these 2,100 companies by dividend yield, highest to lowest, and concentrate on the top quintile. 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.

Global/Sector Analysis
We believe that global sector research is the most effective way to uncover companies that are selling at a substantial discount to our bottom-up fair value assessment. Companies within a sector are valued on a consistent basis globally. This philosophy complements the increasing integration of world capital markets by approaching investment decisions according to global market sectors without imposing the limitations created by a single local-market view of risk and return.

Valuation Framework
Price targets are established using a combination of discounted cash flow analysis4 (DCF) and a suite of unique sector-specific valuation methodologies that the team has been developing since the 1990s. To allow for meaningful global comparisons, our DCF model inputs are standardized. There are more than 500 securities with fair-value targets in the proprietary database. The team compares each entry’s relative attractiveness and risk with the market’s view, looking for advantageous anomalies. Portfolio managers and sector specialists constantly discuss how these investment opportunities fit into the current investment strategies and macro environment.

Buy Discipline
Through extensive interviews with company executives in more than 1,000 management meetings each year, the team creates a particular bottom-up view of key global issues affecting each industry and sector. This is then coupled with our view of the economic, government, and regulatory issues affecting each sector. Through a synthesis of viewpoints regarding the key issues and critical success factors for relevant high-yielding sectors, potential investment ideas emerge for consideration among the team. Our position size will be determined by our price target and the stock’s upside potential. Position weightings will also be impacted by our risk management and liquidity constraints.

Risk Management
We attempt to make sure that we are getting compensated for the risk we take. We believe our process of looking at risk at three different levels, including hurdle rates at the stock level, differentiates us from other managers.

Each company we analyze is assigned a risk rating based on four sets of factors: the size and liquidity of the company, the cyclical exposure of their businesses, their macroeconomic environment, and the business plan and management track record. A low-risk, blue-chip stock in a mature industry with a stable macro environment would be ranked Tier 1, leading us to require a return of at least 15% over an 18-month time period. As we move out on the curve on the four factors, we will demand higher returns. By the time we get to the highest-risk companies, those in Tier 4, we demand a return of 30%, which is twice the upside of a Tier 1 company. The key is that our individual assessment of business risk, right down to the security level, translates directly into additional return that we will require before we would be willing to invest.

Sell Discipline 
Securities are continuously monitored and evaluated for sale when:

  • Price appreciation exceeds estimated business value/price target.
  • Fundamental changes occur to company, industry or country factors; or
  • A sector or country level exceeds risk management guidelines.

Emerging Markets
We employ a 20% guideline towards general emerging market equities, but also allow an additional 10% in foreign subsidiaries of large multinational corporations. These businesses generally have 80-100% payout ratios5 and very high dividend yields. In effect, we are receiving the same cash flow as the multinational parent corporation. We view these unique investments as being less risky than the broad universe of emerging markets.

The Bottom Line
The strength of Lord Abbett’s International Dividend Income Fund rests on three pillars: strong team history and experience; a record of consistent performance; and a disciplined, repeatable investment process. 

 

1  The MSCI ACWI (All Country World Index) ex-U.S. Value Index is subset of the MSCI ACWI Index ex-U.S index. The index is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed and emerging markets excluding the United States from a value perspective The MSCI Global Value indexes cover the full range of developed, emerging, and All Country MSCI International Equity indexes across all size segmentations. MSCI uses a two-dimensional framework for style segmentation in which value and growth securities are categorized using a multi-factor approach, which uses three variables to define the value investment style characteristics and five variables to define the growth investment style characteristics, including forward looking variables. The objective of the index design is to divide constituents of an underlying MSCI Equity Index into respective value indexes, each targeting 50% of the free float-adjusted market capitalization of the underlying market index. The index  is unmanaged, does not reflect the deduction of fees or expenses; and is not available for direct investment.
2 Elroy Dimson, Paul Marsh, and Mike Staunton, Credit Suisse Global Investment Returns Sourcebook 2009 , February 2009; and their previous book, The Triumph of the Optimists (2008).
3 Dividend yield is the percentage of return earned by the investor. The yield is calculated by dividing the amount of dividends per share by the current market price per share of stock. For example, if a stock’s market price is $20 a share and the annual dividend is $1.00 per share, the dividend yield is 5%.
4Discounted cash flow analysis is a widely used investment finance method of valuing a company using the concepts of the time value of money to estimate, discount, and value all future cash flows.
5A dividend payout ratio refers to the fraction of net income a firm pays to its stockholders in dividends.

 

RELATED FUND
The Fund seeks to deliver long-term growth of capital and current income by investing primarily in stocks of dividend-paying international companies.

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