Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
High-yield equities strategies as a tilt to value
While many investors are watching the overall rotation of growth versus value – is it really a rotation? how long will it last? – there are various tilts to value which are also worth watching.
One such tilt is a portfolio of stocks constructed with high dividend yields in mind, such as that offered by Epoch Investment Partners, a New York-based global equities shop owned by the Toronto Dominion Bank, which presented an update for Australian and New Zealand investors via webcast last week (March 17).
Another, perhaps unintended tilt to value by investors, is a small-cap portfolio, which will usually have a positive correlation with value in most markets. When tilts come together, they can accelerate a trend (see separate report on Research Affiliates’ trade of the decade, this edition).
Dividend yield-orientated portfolios will usually be more stable than others tilted to the overall value indices. As Epoch demonstrated in its recent presentation, dividends are resilient.
John Tobin, a managing director, portfolio manager and senior researcher at Epoch – distributed in Australia by GSFM – said dividend-paying income strategies, along with other value tilts, were disadvantaged last year. It was a year of extremes.
Epoch’s example of the narrowness of the market surge led by big tech companies was of the ‘Fab Four’. They are Apple, Microsoft, Amazon and Tesla. Their combined weight in the global equities index jumped from 4 per cent in 2016 to 11 per cent by December 2020. Their contribution to the index return has gone from 0.5 per cent to 7.3 per cent over the same period. They now make up almost half of the MSCI’s total return, covering all 1,600 stocks, of 15.9 per cent.
Tobin said: “It’s hard for us to invest in stocks like them. Amazon and Tesla, for instance, don’t pay any dividends.”
But in the last four months of 2020, the gap between high-yield portfolios and the broader market narrowed, with Epoch’s portfolio of approximately 100 stocks returning 9.2 per cent from the end of August to the end of December, compared with the MSCI World’s return of 10.0 per cent.
That pattern had continued through to March, Tobin said. Historically, you should get good upside participation and good downside protection in such a market, which it did.
One reason for this is the resilience of dividends. In April last year Epoch held an investor webinar called ‘Death of Dividends Greatly Exaggerated’. Tobin said: “From our perspective the predictions were too dire. In a recession, earnings go down and so do dividends, but dividends go down less than earnings. That reliably repeated itself last year.”
During the nine recessions back to 1955, the average decline in company earnings was about 20 per cent but the decline in dividends was only 10 per cent, which is about what happened last year too.
Over the 15 years since the strategy’s inception, it has outperformed 72 per cent of the time in down markets, with an average outperformance of 3.3 per cent. When the markets were down by more than 5 per cent, the portfolio outperformed 83 per cent of time with an average outperformance of 4.54 per cent.
On the outlook, Tobin said: “We’re not out of the woods yet, but we think the worst is behind us. The vaccine rollout is going well, especially in the US everyone is surprised to see… We see GDP growth being weaker in Q1 but we think it will increase throughout the year and will be well supported by monetary and fiscal policy.”
