Newton Global Income update Q&A
Now that the new team has taken ownership of the strategy, how have they been handling its management?
Although the Covid-19 crisis might appear to provide a ‘baptism of fire’ for Global Income’s new management team, it’s been very much business as normal. In testing circumstances, continuity has been very helpful.
That should be no surprise: the ‘new’ team has a total of 60 years’ experience at Newton, and we worked extensively with our predecessors to ensure a smooth handover of responsibilities.
So, while we’ve had to cope with challenging markets and the adjustments that come from working at home, the overall experience has been one of stability – as reflected in the income portfolio.
All of us know the stocks now held in the strategy well. Some we knew before taking over global income as they were on Newton’s global analyst recommendation list. We have spent time over the past months getting familiar with those we didn’t know and the rationale of the outgoing team for buying them.
How are you making decisions on buys and sells?
We’re working together to discuss the rationale behind each and every holding. We have some intense intellectual debate in our team meetings, as sometimes you have to take personal views in stock selection.
Our great strength is that, as an experienced team of senior investors, we all run the portfolio; it is good to have some strong opinions but also good to have differing perspectives.
Another key strength of the team is the investment process we inherited, which has been used consistently in managing the global income strategy since its launch in 2005. Our income focus blends with Newton’s broader top-down thematic approach and the bottom-up fundamental research carried out by our global research analysts.
This collectively-driven approach has created a repeating pattern of opportunity over the last 14 years.
The 31-strong research team is considered the engine room of Newton’s idea generation and there are plans to add selectively to the team to strengthen it further.
Have you made any changes to the strategy since taking over its management?
We have made a few changes to the portfolio. In May we sold cosmetics manufacturer Coty. Its third quarter results revealed a 20% fall in organic sales and increased leverage. While the company has suspended its dividend like so many others have, in this case we had doubts about its ability to resume payment once the Covid-19 crisis ended.
We initiated a position in German automotive supplier Continental, what we see as a good quality German automotive supplier that derives c50% of its profits from the replacement/aftermarket. The company is undergoing a corporate restructure, spinning off its troubled power train business. We believe this should lead to a better return on invested capital and cash-flow returns for the remaining business. Our view is that the downturn across the divisions is predominantly related to the lockdown and demand will snap back as movement restrictions are lifted.
The purchase was funded by a reduction in Harley-Davidson, where we took advantage of a jump in the share price. The structural headwinds facing the business, as identified by our population dynamics and Earth matters themes, were accelerated by the pandemic, reducing our confidence in the sustainability of the company’s dividend.
That we have made such few changes since taking over management of the strategy underscores the strength of the portfolio we inherited and our confidence in the names we now hold.
For instance, we have maintained the strategy’s positioning in the health care sector, which initially offered some ballast against volatility. However, in May, as markets rallied, these stocks have lagged and our holdings in Roche, Novartis and Merck dragged on performance.
Unusually for an income fund the strategy also remains overweight in technology. Although our yield discipline prevents us from holding Microsoft and the FAANG stocks, which have been strong performers this year, companies such as Qualcomm, Maxim and Cisco Systems have all contributed positively.
What has the suspension of dividends meant for finding new opportunities?
In response to the Covid-19 pandemic and the economic disruption it has entailed, many companies have reduced, suspended or deferred their dividends. This has come about for a variety of reasons, many of which have little to do with individual capital strengths and earning prospects.
For instance, many companies are reluctant to reward shareholders at a time when they are having to lay off employees.
It is this social pressure, rather than it being mandated by governments as seen in the banking sector, that has probably impacted the portfolio the most. This is because we have seen it most frequently in the consumer discretionary sector where we had a high weighting. For instance, the clothing retailer Inditex was among the first to suspend its shareholder payments despite having a strong balance sheet. (Note that at its latest results announced on the 10 June, the company said it will resume paying later in the year, albeit at a lower level). In fact in May, Inditex was a good performer for us, improving on the back of the anticipated reopening of many economies.
As a result, a key focus of the team is on making an assessment as to whether dividend payments for those companies that have suspended them will be able to resume once the Covid-19 crisis is over or whether there will be a permanent structural impairment to a company’s ability to pay. To date we have just assessed one (Coty) as falling into the latter.
How many of the fund’s holdings have cut or suspended their dividends?
The strategy’s positioning has cushioned it from the worst impact of the crisis. The portfolio has a zero weighting to travel and leisure, cruise liners, airlines, pubs and casinos. It has also been underweight in the global sectors considered most at risk of dividend cuts: financials, industrials and commodities (including oil and gas).
Of the 45 securities currently held in the portfolio (as at 31 May 2020), 11 companies have announced cuts or suspensions, although one of those, Inditex, has also announced that it will resume paying. There may be more to follow, but with lockdown now being lifted and news on both the treatment of the virus and a potential vaccine encouraging, we believe that those companies most likely to take action, have already done so.
These companies make up approximately 19% of the portfolio by weight. We had initially assessed the risk to dividends on a financial basis, with 10% of the portfolio classified as ‘high risk’. The actual number is higher because some companies have suspended their dividends for the social and regulatory reasons outlined above rather than because of financial considerations.
In what other ways are you responding to the deteriorating environment for dividends?
Even against the current backdrop for equity income, we do not intend to make any compensatory changes to the portfolio to specifically target a higher distribution, such as covered call writing. Nor do we intend to add to ‘safe’ dividend payers that are trading on unattractive valuations.
We are, however, making a temporary but pragmatic change to our dividend discipline. In normal times, this requires us to sell any holding if its prospective dividend yield falls below the average market yield. Such falls can occur for two reasons: the stock can perform very strongly, so that its yield falls steeply as a proportion of its share price; or the company can cut its dividend.
In light of the pandemic and the pressures that it is putting on companies around the world, we have opted to override our discipline when companies cut or suspend their dividends solely as a result of Covid-19. This overriding is a temporary measure and one that we adopt only when we have every reason to believe that the company will resume payment of the dividend once the Covid-19 crisis is over.
We have adopted this override mechanism because we do not believe that we should be forced to sell stocks at a time when doing so would be disadvantageous for our clients.
What is your strategy for the year ahead – and what is your outlook on the equity market?
Although we are never complacent, we believe the strategy is exposed to strong companies with the ability to survive the current environment and thrive over the longer term. Yet we are also cautious on the outlook for financial markets and the global economy as a whole. Governments and central banks have promised to inject and spend amounts of money never seen before outside of a war environment, in a dramatic extension of the ‘financialisation’ trend that has prevailed since the 2008 global financial crisis. Despite this support, market sentiment remains febrile, and we feel it is highly unlikely economies will experience a V-shaped recovery.
Accordingly, we are focused on investing in companies we believe can survive the current downturn and return to growth once business conditions normalise. Although the crisis will cause some weaker firms to disappear, we think strong companies have the opportunity to emerge even stronger.
¹ Investment Managers are appointed by BNY Mellon Investment Management EMEA Limited (BNYMIM EMEA), BNY Mellon Fund Management (Luxembourg) S.A. (BNY MFML) or affiliated fund operating companies to undertake portfolio management activities in relation to contracts for products and services entered into by clients with BNYMIM EMEA, BNY MFML or the BNY Mellon funds.