In our monthly series featuring leading financial experts and fund managers, Mr Holger Wehner, head of product specialists equity for Europe at Allianz Global Investors, explains why a high-dividend yield strategy is suitable for choppy European equity markets.
Frankfurt-based Mr Wehner believes that companies with strong dividend yields are characterised by discipline in management.
"We buy companies that provide dividend yield, but also those which are managed for dividend. This dividend commitment... has an implication for how these companies are managed," he says.
Mr Wehner says that the discrepancy between good-performing companies and those that have been hit has become large. This situation requires even more stringent stock selection.
Allianz European Equity Dividend fund had assets under management of €3.6 billion (S$5.5 billion) as at July 31. The fund has also delivered a net annualised return of 12.65 per cent since its inception in March 2009.
EUROPE'S ECONOMY RECOVERING
Despite headwinds, indicators show that European recovery has gained breadth and resilience. Strength in domestic services outweighs some softness in manufacturing. Numbers for employment in Europe continue to develop favourably.
MR HOLGER WEHNER, head of product specialists equity for Europe at Allianz Global Investors, on how Europe is bouncing back.
Q What is the fund's strategy?
A We are contrarian investors because of our focus on dividends - we are looking for companies which have a high dividend yield. We need to make sure that the number we are looking at is a realistic assumption - there are many dividend traps in the market. You have to do your homework.
We are picky about valuation and have a minimum requirement with dividend yield. We buy only those that yield at least 25 per cent more than the market.
This means we are picking a certain type of company. This is contrarian as the high dividend yield might be because the price is depressed because of certain concerns which we don't agree with - we have done our analysis and we think it is not as bad as the marketplace thinks.
Q What was the fund strategy going into the British referendum on the European Union?
A We were one of the few European equities strategies which were overweight on the United Kingdom into the Brexit vote, so we had loads of questions beforehand.
Our argument was that the companies we owned in the UK were not linked to the UK business cycle. They are, in fact, not linked to any business cycle. They are companies which have large parts of their businesses outside the UK, so they provide an implicit hedge against currency fluctuations.
Going into the Brexit vote, the biggest position in our portfolio was British American Tobacco (BAT), which is a very good dividend stock compared with other parts of the consumer staples market. It comes at better valuation and with a higher dividend yield. Since Brexit, it was the star performer on the UK stock market. Even accounting for currency weakness, BAT has seen a positive absolute return in June while the markets were quite weak. It has played out exactly like we wanted it to. All in all, our UK exposure was a big positive contributor.
Q How are European equity markets after Brexit?
A We have seen a pronounced flight to safety in June. However, while we still have low visibility with regard to the actual impact, the initial Brexit fears appear very much overdone. Markets have quickly corrected afterwards.
Despite headwinds, indicators show that European recovery has gained breadth and resilience. Strength in domestic services outweighs some softness in manufacturing. Numbers for employment in Europe continue to develop favourably. For example, one of the countries with the strongest decreases was Spain. The absolute level of unemployment is still worrisome, but it's going in the right direction.
The European Central Bank remains supportive and there is more leeway on the fiscal side. Currency and raw material prices also remain supportive. So there are supporting factors for Europe as a whole, which is why equity markets continue to be resilient.
Q How do you judge if a company's dividend yield is sustainable?
A There are two parts to dividend analysis. The first part is what the company can pay out. This is a full-blown company analysis, done by our research analysts and sector specialists in Europe to support fund managers.
The second part is what the company is willing to pay out because it's a discretionary decision of the management. Whenever there is a change in company management, it's a potential warning signal. We need to get in touch, we need to discuss what the plans are with regard to the dividend. The new management might be in favour of other activities like takeovers, and this comes at the expense of the dividend. The risk profile of the company changes. So for us, direct contact with the management is important.
In Europe, many companies can attract investors by having these dividend features. Once you've started, it becomes quite hard to withdraw. If you cut your dividend, you are going to be punished. The management's credibility will be called into question and there will be a negative price reaction.
The true dividend company will not do this. It works the other way around - it will manage the company in a way that it can keep up the dividend. This is the disciplining effect of the dividend, which is what we are looking for.
Q How should investors navigate European markets in a post-Brexit world?
A Dividend yield is a good way to navigate these markets. Historically low interest rates, temporary surges in capital market volatility and the need for the developed world to lower its debt create a good environment for taking advantage of the benefits offered by dividend strategies, especially in times of financial repression.
In a world of overall low growth, the importance of dividends for total returns is even greater.
In our strategy, a focus on such companies has resulted in considerably improved absolute risk characteristics. High distribution levels, and the commitment to paying them consistently, tend to produce more disciplined companies that need to budget their financial resources carefully and use them efficiently, resulting in lower share price fluctuations.