Newton introduces ‘large cap laggards’ theme

Newton Higher Income fund‘s ‘large cap laggards’ theme focus is on what Newton considers to be larger cash-generative companies with strong balance sheets and relatively stable end-demand.

Examples include blue-chip companies such as: 

• GlaxoSmithKline
• Centrica
• Tesco
• Vodafone
• British American Tobacco
• Unilever

 Sales and earnings expectations for these companies have tended to be relatively modest, but importantly, they also tend to be relatively stable.

Tineke Frikkee, the manager of the Newton Higher Income fund, focus is on dividend income. She expects a prolonged period of low and volatile growth with significant earnings risks looking into 2012 and beyond. In such an environment, the importance of dividend income is likely to rise significantly.

Frikkee believes that “concerns about sovereign debt levels seem set to persist. The sheer scale of the accumulated debt means that how deleveraging occurs – whether in orderly fashion or not – as well as the effect of offsetting actions by authorities, will be critical for all aspects of the investment outlook.”

“With this in mind, we anticipate a prolonged period of relatively low and more volatile growth in many economies as debt is reduced to more manageable levels.

“In this low growth environment, we believe there is significant earnings risk looking into 2012 and beyond, as growth expectations have generally been set too high.

Past low-return periods lead the way

 “As equity returns are likely to be lower in this environment than during the long economic boom seen during 1980 to 2000, we believe the importance of dividend income is likely to rise significantly.”

“During similar past low-return periods, dividend income has typically contributed around 80-90% to a total return, as an increase in multiple tends to be difficult to achieve (and maintain) when future growth opportunities remain uncertain.

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“UK equity dividends have declined for the past three years, but dividend growth has resumed in 2011 and we expect it to continue in 2012.

“On average, we consider company balance sheets to be relatively strong and there is a reasonable amount of headroom in the dividend cover of most companies, giving us confidence that we will see another year of strong dividend growth. However, this is likely to tail off further out”

Downside protection

“In this higher volatility environment, we believe that reducing downside volatility – offering greater capital protection – will be critical in delivering attractive equity returns,” says Frikkee.

“Equities with a higher-than-average dividend yield tend not go down as much as their lower-yielding peers, given the importance of dividends to total returns. As such, we have a bias towards defensive high yield equities, resulting in a portfolio beta below one.

Most of the ‘large cap laggards’ fall into this category.

“As we go through this deleveraging transition, we believe that investors would do well to reduce their risk by focusing on greater earnings certainty,” She concludes, “Dividend income investing provides an attractive option in such an environment.”

We agree!