With the ongoing compression of yield spreads in global bond markets, income-seeking investors are having to defect from fixed income to equity income streams, as evidenced by flurry of activity within the asset class through 2015.
However, Gosden, manager of the Artemis Income Fund, warned that when it comes to picking their stocks, investors must be cognisant of the fact that seemingly healthy yields do not necessarily represent a robust investment.
“We need to be careful in equity income,” he said. “Although the headline number for yield in the market looks fine, you need to check that companies in your portfolio for coverage i.e. the ability to pay that income, otherwise there will be slightly illusory valuation methodology going on.”
Citing a market dividend pay-out ratio of 55% – close to the post-2008 crash figure of 61% – Gosden explained that while dividend coverage is not worrying in itself, investors must heed the balance sheets of potential buys.
“The cover on dividends is not too peculiar,” he said. “It is not as comfortable as 50%, which is the longer run average, though that can be explained by the oil price. Still, dividends are less well-covered than they were 50 years ago.
“Dividend is a decision made by the company boards somewhere down the line – it is the cash generated each year that enables that decision. When looking at a company, do not look at anything except the cash it generates.
“If cash flow is going down each year then the dividend being paid is not real. Sure, it is cash and can be paid, but you will then see management put it into a stool pattern and keep the dividend constant. They are not able to grow it – they are not even able to start affording it, and as a consequence that dividend is then cut and you are out.”
One of Gosden’s recent buys is Ashmore Group, the emerging market debt investment manager, which, despite current market reticence over EM debt, he says is representative of why a company does not necessarily have to be growing to warrant an investment.
“A company does not have to be doing well to deliver yield,” Gosden expanded. “Ashmore yields about 5.5% and they have three-years’ worth of cash on its balance sheet to pay the dividend. No one is interest in investing in emerging market debt at the moment, but that is exactly the point.
“Ashmore is losing assets – down from around £90bn to around £60bn – and the nets print is probably not going to be that pretty. But this is why we invest and the shares yield around 5.5%; we are investing for when people do get interested in emerging market debt again and AUM grows.
“The share price has dropped from £4 to £2.70 a share – it is an acknowledgement that EM debt is not as attractive as it was two years ago, and we think the spread between EM debt and developed market debt is big enough to warrant putting money into that company now. “
