So-called ‘bond proxy’ stocks are offering up a number of value opportunities after two years of underperformance, although not all sectors look attractive, according to Fidelity International’s Daniel Roberts.
Sectors such as pharmaceuticals, consumer staples, utilities, telecoms and real estate surged in popularity following the global financial crisis as central banks cut rates to near-zero.
The strong yields from companies with steady cash flows attracted investors forced up the risk scale as yields on bonds fell away, driving their share prices higher.
Performance of indices over 10yrs in US dollar
Source: FE Analytics
More recently, however, those sectors have started to underperform after bond yields troughed in 2016 and since began to rise, with the yield on the 10-year US Treasury notably having risen above 3 per cent – traditionally signalling a reversal from equities to bonds – and staying there.
“What we saw happened in the 18 months after yields troughing in 2016 was a blanket underperformance of what people think of bond proxies,” said Roberts, manager of the £883m Fidelity Global Dividend fund.
Roberts’ fund is described as a “no-brainer for cautious investors searching for a global source of dividends” by FE Invest analysts, who highlighted the manager’s willingness to take sector bets.
“Roberts also does not hesitate to take strong sector bets, which paid off over time,” they noted. “As a result the manager can’t be described as a pure stockpicker, although his stockpicking skills have added to performance over time.”
As such – and perhaps unsurprisingly – the manager has taken to adding more exposure to the bond proxy sectors that he believes are currently undervalued: pharmaceuticals and consumer staples.
The pharmaceuticals sector makes up a significant allocation in the portfolio of around 15-16 per cent, said Roberts, who highlighted a number of factors that had driven valuations down.
The manager noted very aggressive assumptions in the market over the impact of biosimilars – copies of existing licensed drugs– and a more cautious outlook on pipeline success.
As a result, said Roberts, the sector has de-rated to more inexpensive valuations despite very strong balance sheets.
“The asymmetry of returns that a value investor looks for is evident in that sector, so we are well-represented there,” he said.
Another area he has been adding to is the consumer staples sector, which is substantial sector weighting – making up 14.4 per cent of the portfolio – although he is more cautious because of leverage issues.
“We think there are opportunities within that space, we favour some categories such as spirits, household and personal care,” he explained.
Another positive is the sector’s exposure to emerging markets, which are becoming an increasingly important audience for consumer staples companies.
Performance of indices in US dollar over 2yrs
Source: FE Analytics
“It’s not fashionable at the moment, but I think there is a tactical opportunity here,” said Roberts. “This is a good opportunity for stocks that haven’t performed well on the back of that emerging market exposure.”
Utilities is another area of opportunity – and currently makes up 6.6 per cent of the fund – although here too Roberts said income investors should be careful, although for different reasons.
“They can offer index-linked returns, they are regulated businesses,” he said. “You just have to be careful because not only are they highly leveraged, they also come with political risk.”
Indeed, the Fidelity Global Dividend manager highlighted the example of the left-wing leader of the UK Labour party Jeremy Corbyn, who has previously spoken of his support for nationalising certain industries if his party were to be returned to government. Although, Roberts noted that political risk is prevalent throughout the global utilities sector.
However, not all bond proxy sectors are attractive, the fund manager added.
The telecommunications sector, he said, faced both regulatory risk and intense competition, leading to a lack of pricing power. Roberts also highlighted high levels of leverage as further challenges for companies in the sector.
“In real estate we’ve got very little exposure,” he said. “Their net asset value-based valuations are more beholden to interest rate moves and they are largely unattractive.”
As such, communications services represent just 4.8 per cent of the portfolio, while just 0.5 per cent of holdings derive from the real estate sector.
Despite being more defensively-positioned, the manager does have exposure to cyclical sectors such as financials and – unusually for an income investor, given a focus on growth – information technology. Yet, Roberts said he remains aware of potential challenges for the economic outlook.
Top holdings in Fidelity Global Dividend’s portfolio include US consumer staples firm Procter & Gamble at 4.1 per cent, UK alcoholic drinks manufacturer Diageo, US Bancorp, oil giant Royal Dutch Shell and Dutch firm Wolters Kluwer.
Roberts – who draws from a universe of 2,500 stocks – said the portfolio will look different from the benchmark, given his bottom-up approach, high conviction views and low turnover.
The manager also aims to “strike the right balance” between the yield and the quality of the dividend, which should result in a steady progression in yield.
The fund also has a capital preservation element, with Roberts focusing in on risk from a potential loss perspective rather than focusing on tracking error or volatility.
“We ask ourselves a question: ‘What is the potential for losing money on an investment’,” he explained. “Einstein called compounding the ‘eighth wonder of the world’, but when you’re thinking about compounding you’ve got to realise that compounding returns and compounding losses are not equal.”
Performance of fund vs sector & benchmark under manager
Source: FE Analytics
Since Roberts joined the fund in January 2012 it has delivered a 133.22 per cent total return compared with a 117.61 per cent gain for the MSCI AC World Index and an 89.62 per cent return for the average IA Global Equity Income fund.
Fidelity Global Dividend has a 2.67 per cent yield and a 0.93 per cent ongoing charges figure (OCF).