Pursuing Current and Rising Dividend Income for Your Clients’ Long-Term Retirement Needs
Manager Q&A: Federated Strategic Value Dividend U.S. Equity
“Manager Q&A’s” delve into investment approaches used by Federated Investors strategists. This installment features Senior Portfolio Manager Daniel Peris.
As a reminder, our income-first approach is driven by a core belief that we invest as owners of companies, not traders of stocks. As owners, we take the long view, seeking high-quality companies that make a practice of sharing the profits with the company owners, regardless of market conditions. Companies in our relatively concentrated portfolio tend to be non-cyclical and well established, with substantially higher dividend yields than the broader market and a history of paying above-market dividends and regularly increasing them.
The Strategic Value Dividend proposition for clients is to invest as a businessperson, for business-like cash returns. But we do so through the stock market and can be measured in stock-market terms. For those clients whose primary interest is the stock market, the portfolio’s total return (dividend plus share price movement) has been roughly similar to that of the broader market’s (mostly share price movement) but with a much lower standard deviation or measure of volatility. In short, we seek to offer a high and rising income stream from high-quality business assets for those who want the cash. For clients who don’t need the income immediately, we seek to offer the market’s overall return but with fewer ups and downs.
Q: How can the strategy help investors reach their retirement savings goals?
One of highlights of the fund is its ability to offer a unique balance of risk and reward. The fund’s consistent strategy of long view investments allows it to perform well, even when rates rise.
While our portfolio has no business sensitivity to near-term interest rates, the stock market historically bids down so-called “bond-proxies” in a rising-rate environment. While we are far from a bond proxy—we have rising coupons and our income streams are well above those of government bonds—we have seen periodic downward movements in share prices since central banks, including the Bank of Canada, have been easing off the gas with no fundamental change in the income stream we have generated.
But over time, our strategy has held true and both dividend and stock market performance have been consistent, delivering value to long-term shareholders. The reality is that, given our longer-term approach, a rise in rates and decline in prices among some portfolio constituents can be beneficial. It helps to lift our portfolio’s gross yield, which potentially means a higher rate of return going forward as new money pays less for the same income stream than it would when prices are higher. For those reinvesting their dividends, it also means this income stream is getting reinvested at potentially more attractive prices.
Longer term, our strategy speaks for itself. No matter the level of interest rates or the outcome of a political election, the companies that we choose for our portfolio will continue to sell their soft drinks, diapers, wireless services, prescriptions, food, etc. And they will likely continue to share with company owners a big part of the profits from those transactions.
Q: With U.S. indexes at all-time highs, do valuations influence your team’s approach?
For us, P/E was a useful proxy for actual distributed profits a half century ago. Now P/E is a kabuki show, part of the Wall Street Theatre. Which E? Forward, backward, normalized, GAAP, without all the bad stuff taken out, absolute or in comparison with companies that are not our opportunity set. That is, if Google had a P/E of 2, it wouldn’t matter, because it doesn’t pay a dividend. The P/E that matters to us is the relationship of the price to the E that is actually paid to company owners, the dividend. And as we know, the true return of value to a shareholder is the dividend check.
Q: What do you consider to be the three main virtues of dividend-paying companies?
They tend to be solid and well established. The stock prices of such companies typically have been less volatile than those of non-dividend-paying companies, a characteristic reflected in our fund’s comparatively low beta relative to the market. And dividend-paying companies historically have paid a sizeable portion of their returns in cash, which in addition to providing income can help cushion a portfolio’s downside.
Q: How does your approach differ from that of an ETF or other passive strategy ?
Again, our focus is on stocks that have a history of generating and growing income and sharing that income with its owners. We home in on companies that meet that criteria to develop a high-conviction, concentrated portfolio. We are not traders or benchmark-centric. Our portfolio turnover is relatively minimal.
Passive dividend strategies, on the other hand, seek to replicate a specific part of the market as measured by a benchmark. When the market changes, their benchmark component weightings change, too, creating the potential for significant disruption and portfolio turnover. This can create wide, costly swings in portfolio holdings with the potential also to raise risk. Research shows that managers with high-conviction portfolios and high active share (which is a measure of how much a portfolio’s components vary from a benchmark) have a better chance of outperforming their index (and underperforming, too). The differences between high active share managers and closest indexers can be dramatic. In landmark research, former Yale School of Management colleagues Antti Petajisto and Martijn Cremers studied 1,124 funds over two decades and found actively managed stock portfolios with the highest active share levels outperformed their benchmarks by an average of 126 basis points after fees from 1990 through 2009. The outperformance widened to 261 basis points before fees and expenses.
Q: What is your team’s strategy in regard to hedging currency?
Frankly, we don’t do it. There are a lot of reasons. Many global companies in our portfolio already hedge currency risk, multinational companies have exposure across borders, making currency hedging murky, etc. But perhaps foremost, we have found that over time, currency fluctuations have had a basically neutral impact on performance over long measurement periods consistent with our long-term investment horizon. Sure, currency fluctuations can impact performance; it might be headwind at one period, and a tailwind in another. As far as Canada is concerned, the recent dollar weakness relative to the loonie has the U.S. on sale.
What is the outlook and positioning for the strategy over the next 6 to 12 months?
While it would appear rates are more likely to rise than fall, it doesn’t really fundamentally change what we do—build a portfolio of 25 to 45 stocks based on their dividend yield, dividend growth history and potential, and their financial condition. Interest rates change; the stock market changes. Our approach has not. We will continue to follow the cash, as we always have.