Nick is leader of the Newton Global Equity Income strategy. He has been a member of the global equity income team since 2012. He is a member of a number of investment groups, including chairing the equity income group. Nick studied economics and philosophy at Leeds University. Summer holiday jobs at Sun Alliance (now the RSA Insurance Group) led to Nick joining the company full-time as a trainee investment analyst in 1991. From 1994-2000, Nick worked as deputy head of life, UK equities for Morley Fund Management, now Aviva Investors. He joined Newton in 2000 and was the lead manager on a variety of global multi-asset strategies until 2012.
Nick’s interest in investing was inspired by his economics teacher at school, who brought stock market investing to life by asking students to compete in fantasy investment portfolios.
How does philosophy lend itself to fund management?
The philosophy component of my degree has been extremely useful in my career as a fund manager as it taught me to test assumptions. Philosophy involves breaking down an argument into base assumptions and then testing those assumptions to establish whether the argument follows a logical path. An example of testing assumptions in investing would be examining whether a business depends on operational or financial leverage and if it is sustainable in the long term.
A significant challenge is avoiding the ‘noise’ of the market and a background in philosophy, with an emphasis on logic, helps me with this.
Warren Buffett said that “Investing is simple but not easy”. In my view, investing with an income focus captures the essence of this. The ‘simple’ part of Buffett’s aphorism is the logical part – a focus on sustainably generating a number that grows every year. Albert Einstein noted that “Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it”. The reason that this is not ‘easy’ is because one has to invest in companies that demonstrate specific characteristics in order to generate a sustainable income flow.
What do you look for in stocks?
Given that investment is inherently probabilistic, our process is designed to focus us upon those companies that are ‘statistically attractive’. We believe that a statistically attractive company is one that demonstrates a discipline on capital allocation. This drives the return on invested capital (ROIC) a company generates and the sustainability of that return. It further determines the allocation of surplus cash generated to sustain future growth and dividend. We believe that focusing upon companies that pay a sustainable dividend aides us in finding these kind of attractive companies.
Many companies are poor at allocating capital, with most driven by the desire for growth over and above returns. One of the most obvious examples of this dynamic is that merger and acquisition (M&A) activity tends to peak at the point valuations are rich (or overpriced). Logic would dictate M&A activity should peak at the troughs in markets.
Many companies erode returns and value in their business when investing for growth. A study of the US equity market from 1946 to 2001 shows the correlation between dividend pay-out ratios ( i.e. how much of the cash flow a company returns to shareholders in the form of dividends) and how much of the cash flow is retained and invested in the company. The study found that the higher the pay-out ratio, the better the company’s next 10-years earning growth.
Source: Arnott and Asness (2003) ‘Surprise! Equity Dividends = Equity Earnings Growth’ FAJ vol 59, no. 1
How do you identify those companies?
Our idea generation/portfolio construction for the Global Equity Income strategy is guided by the following disciplines:
1. Investment themes. Core to our identity and investment philosophy, our global investment themes ensure the discipline of perspective, orientate us to a longer-term view and are a key source of idea generation.
2. Yield requirement. The strategy has a yield discipline which ensures that every stock must offer a premium dividend yield to the market. This discipline imposes patience upon us. We have to wait for the valuation to become attractive and it also forces us to look for ideas in out of favour areas in the market. It further requires us to establish that the dividend (and hence the yield) is sustainable. In addition, we employ a sell discipline, if the yield falls below that of the market then we sell the shares. This keeps us honest on the valuations of our holdings and ensures that we don’t fall in love with stocks where expectations have run ahead of the valuation.
3. Valuation. Valuation (or the price you pay for earnings) is perhaps one of the most important factors in determining the return from a security compared to the associated risk. We apply a range of valuation analysis to ensure we are not overpaying for an investment.
4. Fundamentals and ESG analysis. Our desk analysts and global industry analysts look for companies exhibiting quality (high returns on capital), high barriers to entry and strong management teams. In general, companies that are financially robust (strong balance sheets, sustainable profit margins in all conditions, strong cash conversion of profits) have the most appeal. ESG considerations are a critical part of our analysis (conducted in collaboration with our Responsible Investment team) and contribute towards the risk/reward calculation.
What are the common perceptions of income investing?
Many people believe income investing just focuses on boring, no-growth, ‘bond-like’ companies. Our focus on the disciplines noted above allows us to gain exposure, in a deliberate fashion, to very different companies and end markets.
The companies that we focus on can be placed into four conceptual 'buckets' (subsets of the market):
1. High ROIC companies exhibiting growth. Companies with high barriers to entry around their businesses thus enabling a high and sustainable ROIC with continued opportunity in their markets to grow.
2. High ROIC going ex-growth. Here the end markets of the companies have matured and are slowing or declining in growth.
3. Mean reversion. This is where the capital cycle is at its low imposing capital discipline upon the companies.
4. Special situations. E.g. regulatory change, spin offs or hidden assets. This may also capture asset intense businesses, such as telecommunications and financials.
Our fundamental analysis and valuation work then combines to produce the specific investment ideas. We focus on probabilistic outcomes, margins of safety, what downside or upside is priced in, asymmetric return profiles and adopt a disciplined approach.
The first two buckets are very well known, so we need to buy in at a good opportunity when there is a temporary problem or ‘controversy’ that the market prices in for the long-term and we believe is only shorter-term in nature.
What we exclude is just as important. We try and avoid ‘broken’ buckets: statistically unattractive companies; ‘fads’ with no durability; structurally broken companies; companies at unattractive points in the cycle; and special situations such as accounting frauds.
The value of investments can fall. Investors may not get back the amount invested. Income from investments may vary and is not guaranteed.
Objective/Performance Risk: There is no guarantee that the Strategy will achieve its objectives.