Every year in July, I conduct a review of most of the IMA yielding sectors, on Lipper, to identify trends in distribution yields.
The data for one year to both July 2010 and July 2011 has revealed that all such sectors have had consistent and significant falls in their dividend yields during this two-year period.
Whilst significant falls in dividend yields are not entirely surprising given the market events and economic backdrop of recent years, what is surprising is just how far yields have dropped, and that this has occurred in some of the most popular IMA sectors. To give some examples -
IMA UK Equity Income has fallen by 33%, down from 5.8% to 3.9%. One has to ask why dividend yields have fallen in a sector which has seen nominal dividend payouts rise quite substantially. In our view the appreciation of share prices has overwhelmed the prospect of improving dividend payouts. However, one needs to be careful not to extrapolate too much, and looking ahead this sector has the potential to recover if dividend growth continues to remain in positive territory, as we expect it will.
The IMA Corporate Bond yield is down 19%, falling from 4.7% to 3.8%. Consensus now is that interest rates are likely to stay lower for longer than originally anticipated, a view which we share. For the moment, we believe there is very little prospect that these yields will improve for existing investors. Should we have a situation where inflation returns at a time when rates are rising, new investors can benefit from an increase in yield within this sector; however, this will not be so beneficial for incumbent bond holders, as capital value will concurrently drop.
IMA Strategic Bond yield fell 30%, from 5.3% to 3.7%. This we believe reflects outperformance for the sector generally in addition to the impact of falling interest rates, although that affects this sector to a lesser extent than corporate bonds.
IMA Property yields have dipped 47%, falling from 4.3% to 2.3%, although in some cases the yield is brought lower simply as some funds within this sector do not distribute. Nevertheless the trend downwards is representative in our view.
Yield has always been and remains a highly popular and perennial requirement of investors. However, the evidence above shows that it has become harder to get decent yields over the last two years despite the improving economy, stockmarket and bond market.
In contrast, the Thames River Distribution Fund yield remains at 6% in July 2011, as it was two years earlier in July 2009.
We believe the reason that we have been able to maintain the yield on the Distribution Fund at a decent level over that period is that we invest across a diverse range of asset classes and typically hold between 20 and 30 individual funds with access to around 700 income-producing assets. By sourcing our income across geographies, sectors and individual companies, we believe this blend has helped us avoid the falls in income levels.
In the short term, relative to cash, we believe that yields can increase from here. This is particularly true for the IMA UK Equity Income sector - it is important to bear in mind that the data above is historic, reflecting a period when this sector was in ‘repair' mode. Balance sheets are relatively healthy, profit margins are high and cashflow generation is strong once again. We believe payout ratios will increase from here, having already shown signs of this in recent months. As a result we have been adding to funds in this sector. Similarly, we are heavily weighted towards the IMA Strategic Bond sector as we believe the flexibility these funds offer means they should avoid interest rate issues.
We believe that the Thames River Distribution Fund will continue to offer an attractive income relative to broader alternatives such as cash, fixed income and equity funds through a blend of diversification and flexibility, which should ensure an income which remains consistent over the long term.
Rob Burdett
Co-Head, Thames River Multi-Capital
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