28 Jan 2021
24/11/2020 | Dan Roberts, Global
Fidelity Global Dividend Fund portfolio manager Dan Roberts sets out the case for focusing on quality and sustainable businesses in 2021. He also discusses how his three key building blocks of returns are likely to shape up in the year ahead.
Key points
For our portfolio, we can assess the outlook for returns by looking at three key building blocks. Firstly, whether the dividend yield is attractive, at around 3% (in comparison to around 2% for the MSCI ACWI). Secondly, we expect dividend growth in mid-single digits, in keeping with the long-term growth rates for the strategy. Finally, and always hardest to predict, is any change in valuation for the portfolio and the market. Valuations are sensitive to unpredictable macro variables such as long-term interest rates and growth expectations. As such, valuations across the market could change meaningfully if expectations or central bank messaging changes.
The quality of the businesses we own in the portfolio, the defensive tilt to our positioning, and the significant valuation discount we see in our holdings should underpin an attractive long-term total return. This should also give us some protection if current expectations for a sharp recovery in 2021 prove overly optimistic.
It is harder than ever to make predictions for what will drive equity markets next year. We can expect continuing volatility as markets become more or less optimistic about the possibility of a vaccine rollout enabling a return to some degree of normality in parts of the economy most impacted by social distancing measures.
Valuations in the ‘big five’ US technology companies still reflect expectations for high levels of growth into the future, against a backdrop of weak global growth. The shine could come off these highly valued companies if and when economic activity increases and inflation expectations rise. This effect would be magnified if a Biden administration adopts an aggressive regulatory stance towards the technology sector.
There are two broad categories of company which are most exposed to future developments in infection rates and lockdown policy. Firstly, the main beneficiaries of a lockdown environment have been digital businesses, which explains the outsized outperformance of these companies in 2020 and the lofty valuations this price action has ascribed to them, leaving little margin for error or disappointment.
Secondly, the stocks most negatively impacted were those whose profits are directly correlated to levels of economic activity, and most dramatically, those companies who depend on the ability of people to meet and travel. Companies in this cohort, including airlines, physical retail and banks would likely outperform in the event of a quick end to lockdown and social distancing measures.
However, there is also a large group of companies where the impact from Covid-19 on profitability has been more modest one way or the other. We have built a portfolio of companies whose success is not determined by one or another vision of a post Covid-19 world. Given significant uncertainly around what this world will look like when it arrives, we prefer to remain focused on individual stock analysis, seeking out companies that can thrive in a range of economic scenarios.
Our aim is to produce resilient and growing income streams for our investors. As such it is important that the companies we invest in have sustainable operating models - only then can we have confidence in the sustainability of dividend distributions. Companies that fail to effectively manage environmental or social risks are more likely to experience negative ‘surprises’, which can cause significant declines in equity value and place dividends at risk.
In addition, the transition towards a more sustainable economy is having a meaningful impact on fundamentals for many companies, creating new opportunities for some and reducing opportunities for others. We take this into account when assessing the growth outlook for companies and determining a reasonable valuation that provides investors with some margin of safety.
We run a diversified portfolio with holdings across different sectors and regions. Our conviction is driven by stock-specific factors - we look for companies with resilient cashflows, strong balance sheets and seek to buy them at attractive valuations.
A key holding is currently TSMC - the largest independent semiconductor foundry in the world. Semiconductor manufacturing, particularly at the ‘leading edge’, is extremely capital intensive and demands continuous R&D. This gives TSMC a deep competitive moat around its franchise and means it should be able to reinvest capital at high rates of return well into the future. The company’s manufacturing process is enabling many of the most exciting technological innovations, such as AI, autonomous vehicles and the ‘Internet of things’. TSMC is exposed to these growth trends, but does not trade at the excessive valuations seen elsewhere among technology growth leaders.
Running an unconstrained portfolio, we avoid any company which does not meet our strict investment criteria. For example, we currently have no investments in European banks, energy or mining, discretionary retail, or real estate, to name a few. We have not found companies in these sectors which offer us the resilience we look for in investments.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. The Fidelity Global Dividend Fund can use financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The fund takes its annual management charge and expenses from capital and not from the income generated by the fund. This means that any capital growth in the fund will be reduced by the charge. Capital may reduce over time if the fund’s growth does not compensate for it. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes.