The recent rally has left one core part of the market ignored by investors.
It tends to be the case that high dividend-paying stocks are also value and cyclical stocks. As a result, when markets face a sell-off, such companies tend to underperform.
This could be seen in the poor performance of several income-focused funds and ETFs in 2020. For example, last year we highlighted how the SPDR® S&P Global Div Aristocrats ETF GBP (LSE:GBDV) was one of the worst-performing income ETFs due to its heavy value and cyclical tilt.
This was particularly acute in the 2020 sell-off when the best-performing companies were so-called stay-at-home stocks, namely tech and e-commerce companies seen as being able to continue to do well, or perhaps better, when large parts of the world were forced to stay at home due to lockdowns.
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Dan Roberts, manager of Fidelity Global Dividend fund, a member of interactive investor’s Super 60 list, notes: “The first period, covering the onset of the pandemic and subsequent lockdowns, saw returns concentrated in a narrow group of digital platforms deemed to be the winners of the ‘stay at home’ economy.”
But since around November last year there has been a sustained rally in value and cyclical stocks, with stay-at-home stocks falling out of favour. This was primarily due to an increased bullishness about the prospects of the vaccine putting an end to the Covid-19 pandemic and resulting lockdowns.
Roberts explains: “This fuelled demand for exposure to the ‘reflation and reopening’ theme, meaning stocks expected to benefit most from a recovery in economic activity. Again, defensive shares, with less exposure to the anticipated recovery, underperformed.”
This, in turn, has benefited many income-focused funds and ETFs, especially those focused on value. The SPDR® S&P Global Div Aristocrats ETF GBP (LSE:GBDV), for example, has returned over 12% in sterling terms year-to-date.
While these two periods for the market were very different, they were both driven by a similar investor psychology, says Roberts. He argues: “Although these were two very different market environments, one trait remained common in both: the increasing risk appetite of many investors. In the ‘stay at home’ regime, investors were effectively taking on incremental valuation risk as the stock prices of technology platforms outpaced their earnings growth.
“Latterly, the assumption of fundamental risk has been handsomely rewarded as money has flowed into the stocks of companies whose profits are the most sensitive to economic conditions and, therefore, the most obvious beneficiaries of reopening and reflation.”
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All this, however, has left one core part of the market ignored by investors: quality defensive. Roberts argues: “Companies that don’t obviously play to either of these two themes have been unfairly left behind in the recent market rally.”
Robert’s Fidelity Global Dividend fund focuses on high-quality income payers. And this apathy towards quality growth has taken a toll on the performance of the fund. Year-to-date, the Fidelity Global Dividend fund has retuned 4.5% in sterling terms. In contrast, the Investment Association Global Equity Income sector has returned 7.6% and the MSCI ACWI Index 9.1%
Roberts, however, argues that this creates an attractive entry point for such stocks. He says: “Quality defensives are priced so appealingly today that we believe they will provide attractive investment outcomes more or less independently of which direction the economy takes from here. All that is required is some patience.”
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