US stocks offer most attractive income, says Investec

Emma Wall  |  03/08/2016Text size  Decrease  Increase  |  

Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Blake Hutchins, Manager of the Investec Global Quality Equity Income Fund.

Hi, Blake.

Blake Hutchins: Hi. Good morning.

Wall: So, your fund is global in its name and in its nature, but there is a large proportion of the fund in US and UK stocks at the moment. Why is that?

Hutchins: Yeah, we take very much a quality approach to our income investing and that means that we're focused on companies with sustainably high returns and very cash-generative, capital-light businesses with good growth potential, and then we look for them to pay a proportion of their growing cash flow as a dividend.

And it just so happens that we find the best opportunities for those kind of companies in the US. Actually, if you look at the aggregate quality of the various indices, the US actually have the highest quality indices. They have the highest returns in that market, followed by the UK and then Europe and then it falls away towards emerging markets and Japan. So, I don't think it should be a surprise that we find the most opportunities for these kind of investments in the US.

Wall: And then looking then at the US and the UK, they've got quite different prospects for rates but they've had a similar history in that for seven years now we've seen record low interest rates in the UK. We may well even get a cut on Thursday this week, which of course, has driven investors into equities, into income-paying equities because they can't get returns on cash or bonds. This has made some of these stocks quite expensive. How have you folded that into your investment philosophy?

Hutchins: Well, I think, you're right and the outlook for bond investing is challenged in that I think there's $13 trillion of sovereign and corporate bonds that are currently having negative yields. And you say that equities are expensive, but I put that in the context of the free cash flow yield, so the yield that we would value the fund on of the Global Quality Equity Income Fund, is actually close to 5 per cent, in line with that of the wider market.

So, if you compare a free cash flow yield of 5 per cent supporting a dividend yield of 3 per cent compared to some of these low yields from corporate and sovereign debt that we're seeing, we actually think the relative valuations are reasonably attractive.

And then on absolute terms versus their history, we see them as roughly in line with their history. So, we're not at bargain basement anymore. We've rallied quite hard from the bottom of the market. But we're not necessarily looking for a re-rating of the companies that we invest in. They have natural growth. So, if we can get close to double-digit free cash flow growth with a good starting dividend yield, we still see decent prospects for our total returns.

Wall: At this point in the market though, are you looking at different sectors than you may have been sort of five years ago bearing in mind the rally that we've seen since the lows?

Hutchins: We still think there's value in some of the sectors that have performed very well. I get asked a lot, as you'd expect, about the valuation of consumer staples, for example, other quality sectors that we invest in such as healthcare or IT. And we actually see when you adjust for cash flow, cash generation, which is absolutely crucial to us, and debt levels, the valuation of those kinds of companies are more or less in line with that of the wider market. And as I've said, on the fund in general, we have a free cash flow yield in line with the market.

I look at Nestlé as an example. It has about a 4.5 per cent free cash flow yield. It had the same free cash flow yield 5 years ago, 10 years ago, 15 years ago. Now, I think that the actual relative merits of those companies in today's world of low-growth and high volatility still warrant that kind of attraction. So, we're still finding the same opportunities, albeit what we like with an income approach if you do it right and I emphasise if, you are rotating at the margin into stocks that are a little bit expensive into stocks that are a little bit cheap. And that buy low sell high mentality is obviously a good one.

Wall: Blake, thank you very much. This is Emma Wall for Morningstar. Thank you for watching.

Video Archive...

What returns should you expect from markets?
01/12/2016  As market risks rise, investors must adjust their profit expectations--gone are the days of 8 per cent returns. But there are still growth opportunities out there if you know where to look.
Why healthcare stocks got a bump from Trump
28/11/2016  Australian healthcare and pharmaceutical companies continue to enjoy a purple patch, and for various reasons including the recent US election result, explains Morningstar's healthcare equities analyst Chris Kallos.
Equity and hybrid investors react as bond prices tumble
24/11/2016  The negative correlation between bonds and equities is reasserting itself following the US election of Donald Trump, according to John Likos, Morningstar's senior credit analyst.
2 global themes that are finding favour among ETF investors
15/11/2016  Australian retail investors are increasingly turning to ETFs for specific tactical exposures to global themes, particularly in the context of large-scale market events such as US election 2016.
Maintain discipline and stick to fundamentals when selecting stocks
14/11/2016  Steer clear of fads, maintain a disciplined approach and focus on company fundamentals in building and maintaining your investment portfolio, says Anton Tagliaferro, investment director, Investors Mutual
How Trump could impact economic growth
10/11/2016  Slowdowns in trade and immigration could hold back the US, and infrastructure spending could boost GDP, but it's too early to make any major changes to our economic forecast, says Morningstar's Bob Johnson.
President Trump: What should you do?
10/11/2016  Donald Trump has beaten Hillary Clinton to become the 45th US president. What should investors do?
Software companies worth watching amid tech deployment phase
08/11/2016  Kate Howitt, portfolio manager at Fidelity International discusses some of the core phases in technological disruption and identifies software companies among those currently presenting opportunities.
Kerr Neilson hot, cold and tepid on Europe, US and China
07/11/2016  Platinum co-founder and CEO Kerr Neilson explains his views on the major global markets and outlines where he sees opportunities--and where he doesn't.
Is Inghams a moat-worthy investment?
02/11/2016  Morningstar's Ravi Reddy discusses the upcoming float of poultry product producer Inghams, and whether it's in investors' interests to subscribe for shares in the IPO.
3 best ideas in healthcare
26/10/2016  Morningstar's Chris Kallos looks at some of the most compelling ideas in Australian healthcare, while also reaffirming the importance of the uncertainty rating and how it pertains to the sector.
Exercise caution and let some cash build
24/10/2016  Morningstar's Peter Warnes provides a near-term outlook for equities markets, while also sharing his thoughts on the upcoming Ingham's IPO.
Bogle forecasts low stock and bond market returns
21/10/2016  Warning of "much lower market returns" ahead, Vanguard founder Jack Bogle urges investors to seek low-cost investment products. From Morningstar US.
Finding the right flavour ETF amid expanding ETP menu
13/10/2016  From a relatively vanilla selection of exchange-traded funds (ETFs) on offer in the early 2000s, Australian investors can now choose from a wide range of exchange-traded products to suit various tastes.
Bright outlook for Aussie banks despite parliamentary committee and looming Basel IV regulations
12/10/2016  Australia’s ‘big four’ banks’ share prices have held up after their CEOs recently fronted a parliamentary committee, and have already absorbed the potential impact of more stringent capital requirements
Dividend, cashflow challenges hit investors but yield opportunities remain
06/10/2016  Technology, healthcare and telecoms hold opportunities for global equity investors even as utilities and energy stocks disappoint, says Jane Shoemake, director for global equity, Henderson
No place for set-and-forget asset allocation
04/10/2016  A 2016 company reporting season overview and explanation of why dynamic asset allocation is so important, from Dr Shane Oliver, chief economist and director of investment strategy, AMP Capital.
The search for bond yields
27/09/2016  Morningstar's Hybrid Handbook: Navigating the Australian Hybrid Market pulls back the curtain on corporate and bank hybrids, as John Likos, Morningstar's senior credit analyst, explains.
Here's which stocks will be the real winners in FY17
15/09/2016  Morningstar's Peter Warnes reflects upon the most recent corporate earnings season and shares his thoughts on which stocks could deliver strong performances in the near term.
Resolution Capital Global Property Securities
13/09/2016  Morningstar's Ross Macmillan examines a number of outstanding qualities that sets Resolution Capital apart from other managers.