24 May 2021
17/05/2021 | Dan Roberts
The market rotation from working from home winners to reflation and recovery has left behind a number of high-quality dividend-paying companies. Fidelity Global Dividend Fund Manager Dan Roberts reviews this overlooked opportunity set and highlights the compelling investment opportunity it has created.
Over the past year, the market’s rotation between the consecutive themes of ‘stay at home’ and ‘reflation and reopening’ has left behind many stocks which don’t obviously play to either of these themes. This investor apathy means that the valuations of some high-quality companies with good dividend prospects are now very low, particularly when compared to the heightened levels of other parts of the market.
This unusual backdrop offers investors an excellent opportunity to increase the quality and resilience of their equity portfolios at appealing valuations, and in doing so access attractive income streams alongside prospects for long-term capital appreciation.
The past 12 months can be split into two different market regimes. The first period, covering the onset of the pandemic and subsequent lockdowns, saw returns concentrated in a narrow group of digital platforms deemed to be the winners of the ‘stay at home’ economy. Such was the magnitude of their outperformance that even defensive sectors relatively unaffected by lockdown, such as utilities and consumer staples, underperformed the index.
Leadership patterns changed in November, with positive vaccine updates and Biden’s victory in the US presidential election fuelling demand for exposure to the ‘reflation and reopening’ theme - stocks expected to benefit most from a recovery in economic activity. Again, defensive shares, with less exposure to the anticipated recovery, underperformed.
Although these were two very different market environments, one trait remained common in both - the increasing risk appetite of many investors. In the ‘stay at home’ regime, investors were effectively taking on incremental valuation risk as the stock prices of technology platforms outpaced their earnings growth.
Latterly, the assumption of fundamental risk has been handsomely rewarded as money has flowed into the stocks of companies whose profits are the most sensitive to economic conditions and therefore the most obvious beneficiaries of reopening and reflation.
Resilient income generation and prudent risk management are two key features of our strategy, so in our investment process we take care to manage both valuation risk and fundamental risk. As such, the stocks that have benefitted most from this increase in risk appetite are not natural holdings for us.
On the other hand, apathy towards the ‘quality defensive’ companies that form a core component of the portfolio has left many of them trading at unusually low relative valuations, creating an exceptionally attractive entry point. In recent months, the portfolio has traded at the largest discount to the market since launch.
Unusually large portfolio valuation discount
This valuation discount has materialised despite a persistence in our quality bias, and an unwavering focus on sustainable income generation. The income growth the portfolio generated in 2020, when compared to the declines across the broader market, demonstrates the resilience of our portfolio and the defensive cashflow streams we access in the fund. This combination of high-quality assets and a large valuation discount gives us confidence in the medium and long-term performance outlook for the fund.
Our high conviction in today’s portfolio means we have been comfortable increasing position sizes in existing positions which have seen relative share price weakness. For example, US consumer staples giant Procter & Gamble (P&G) has significantly de-rated relative to the market since November 2020, despite strong fundamental progress, as investor attention has shifted to more economically sensitive companies.
P&G has one of the longest dividend track records in the portfolio, very little debt in comparison to other staples businesses, and a management team doing the right things to improve earnings sustainability. For these reasons, we see a very attractive risk adjusted return in P&G shares today.
Market prices now reflect optimistic assumptions about earnings recovery in 2021 and beyond. However, high expectations can create the potential for disappointment and downside risk in companies with more volatile earnings or particularly high valuations. The history of the stock market tells us that periods of excessive risk-taking do, sooner or later, come to an end.
Quality defensives are priced so appealingly today that we believe that they will provide attractive investment outcomes more or less independently of which direction the economy takes from here. All that is required is some patience.
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.