Increased shareholder demand for dividends and short termism from company management teams will spell the end for most stocks over the medium to long term, according to Baillie Gifford’s Charles Plowden (pictured). 
Plowden, who runs the £1.6bn Monks Investment Trust, warned that companies simply aren’t reinvesting enough money for growth and will therefore be overtaken by competitors.
If businesses continue to pay out most of their earnings in dividends, he said the lifespan of companies will continue to shrink and it is therefore more important than ever to select the small handful of stocks which will grow sustainably over the long term.
“The world has gone a bit mad. Companies have forgotten what they’re there for and investors have forgotten what their role in the economic chain is,” Plowden said.
The manager’s research, which looks at the growth of capex over the last 30 years, shows that companies in 1990 were reinvesting an average of 2.5 times more back into the company than they were paying out in dividends.
Today, however, the average company is only reinvesting 0.6 times its cash flow which, according to Plowden’s data, suggests that companies are paying out two-thirds of their profits and only reinvesting one-third back into the business.
He said there are two reasons why this trend has manifested itself over the years. Firstly, the manager said there is less incentive for corporate sector CEOs focus on growing their companies.
“Company management are not incentivised to invest in the long term because they’re not there for the long term,” Plowden argued. “The average tenure is about four years as a CEO, and it’s about focusing on not having any nasty surprises in those four years because then their share options crystallise and they make money.
“Another factor is this is what shareholders are demanding. Dividends, dividends, dividends. We want share buybacks, we want cashflow.
“That’s why I think it’s accelerated in the last five years – it’s because the declining bond yields mean income-starved investors are buying shares in companies like Nestlé and telling them to increase their dividends.”
The manager gave pharma giant GlaxoSmithKline as an example of a stock which is being treated as a primary source of income by investors.
According to data from FE Analytics, 53 out of 85 – or 62 per cent – of funds in the IA UK Equity Income sector hold the company in their list of top 10 largest holdings.
GlaxoSmithKline currently yields 5.25 per cent and pays out four dividends per annum. Over the last five years, it has provided a total return of 41.17 per cent compared to the FTSE 100’s return of 53.96 per cent.
Performance of stock vs index over 5yrs
Source: FE Analytics
“Forget about R&D [research & development], investors are buying shares in Glaxo and asking it to give all its money back to them,” Plowden said.
“That’s fine for a year or two – you could probably survive that – but you can’t survive 20 years of that. Because if you’re an intellectual property-based company like Glaxo and you haven’t invested in R&D, what are you going to do for the next 30 years?
“When the patents of your existing products have run out, you don’t have a pipeline because you haven’t been investing as you’ve been told by your shareholders to pay it all out in dividends.”
He added: “I think this is a serious problem for global growth and global productivity, and we hear a lot about it here and in America. It’s the riddle about why productivity isn’t improving – it’s not improving because companies are not investing.”
As such, the manager believes it is a fallacy that shadowing an index is safer than holding actively-managed funds, which many investors deem to be higher risk than trackers.
In fact, data from FE Analytics shows that the average investment trust in the IT Global sector has a five-year annualised volatility of 8.44 per cent, compared to the FTSE World’s index’s 9.57 per cent volatility.
Over the same time frame, the average IT Global trust has a maximum drawdown (which measures the most money lost if bought and sold at the worst possible times) of 7.86 per cent compared to the index’s drawdown of 10.27 per cent.
Performance of index vs sector over 5yrs
Source: FE Analytics
“The index is not safe, it is not a guarantee of positive returns – particularly when you think that a majority of companies have slashed their investment for the future by cutting their R&D. They’re doing that at a time of accelerating technological change,” Plowden continued.
“These companies have actually been cutting their investment when they should have been increasing their investment to see off any start-ups and wannabes.”
For instance, the manager argued that within the financials sector - which accounts for almost one-quarter of the global index – none of the new initiatives or disruptive suggestions have come from banks. He said it is simply mobile money going to mobile operators such as Tencent and Alibaba-owned AliPay.
“Google, Facebook and Amazon have been wary about getting involved with consumer finance because it will bring a whole new layer of regulation, but they’ve got far more data than your bank has on your finances,” the manager said.
“The banks have been paying fines and looking in the other direction, leaving them hugely vulnerable to be completely missed out of the value chain over the next 30 years.
“As for the consumer discretionary area; I think that out of the major retailers in this country, only Zara has a plausible online offering. All of the other ones are suffering from the growth of the likes of Asos and Boohoo – the newcomers.
“The established retailers have not invested, they’ve invested too little too late in the conversion to online. That’s why Amazon is just mopping up.”
Eventually, Plowden said the composition of indices will alter significantly and become more skewed as entire sectors shrink.
“The salesmen keep next quarter’s revenue going and the companies can’t afford to let them go and, in terms of R&D, that will be on somebody else’s shoulders – that will be the next chief executive’s problem,” he explained.
“Amazon, Facebook, Google, Alibaba, Tencent, Baidu – they are the leading investors in space, autonomous vehicles, alternative energy, healthcare. You name it – if it’s a big potentially transformative technology company, they are the ones pouring hundreds of millions of dollars in.
“Meanwhile the incumbents aren’t investing at all, or at least not enough. So, what it looks like increasingly to us is that there’s going to be a very small number of companies – and those are big companies - which are leading the way.”
Since Plowden took to the helm of the four FE Crown-rated Monks Investment Trust in March 2015, it has outperformed its average peer in the IT Global sector and its FTSE World benchmark by 19.11 and 34.45 percentage points respectively with a total return of 76.43 per cent.
Performance of fund vs sector and benchmark under Plowden
Source: FE Analytics
Monks is trading on a 1 per cent premium, is 1 per cent geared and has an ongoing charge of 0.59 per cent.