Embracing Einstein’s eighth wonder
In pursuing their individual remits, I am sometimes asked why our portfolios remain invested across the various asset classes – particularly when cautious of markets, and the portfolios are underweight equities relative to corresponding benchmarks. Why not maintain higher cash balances? Other related questions refer to the portfolios’ higher yields relative to benchmarks. The answer is multi-layered, but a key factor is one which is often underestimated by investors – the magic of compounding. This was allegedly described by Einstein as the eighth wonder of world. It is perhaps more relevant than ever given the current geo-political and economic challenges, and volatile markets.
Wonder in action
Compounding is the regular reinvesting of dividends to the original sum invested with the effect of creating higher total returns (capital gains/losses, plus income) over time. The policy of reinvesting dividends to buy more shares which themselves pay dividends, and then reinvesting those and so on, significantly increases portfolio returns. Finding and re-investing dividends is a key determinant of growing wealth over time and is less problematic than short-term trades in the hope of enhancing capital gains. To fully harvest these dividends, investors need to stay invested – another reason why time in the market is better than market timing.
The extent in the difference in total returns is worth highlighting. The legendary investor Jeremy Siegel highlighted in his book The Future for Investors (Crown Business, 2005) that over the previous 130 years, 97% of the total returns from stocks came from re-invested dividends. He suggested $1,000 invested in 1871 would have been worth $243,386 by 2003, but the figure rises to nearly $8 million had dividends been reinvested. A shorter time frame is perhaps more helpful! Research suggests $10,000 invested into an S&P 500 index fund in 1960 would be worth just over $1.0 million by 2025 by capital growth alone, but this would have increased to over $6.4 million had dividends been reinvested – over six times higher.
For compounding to work its magic, time and a good rate of return are required. The earlier an investor can start investing, the greater the compounding effect. By its nature, the magic works best towards the end of a decent period, when funds have accumulated. It is also important that a portfolio’s asset allocation and risk profile are adjusted as an investment journey progresses towards its financial objective. However, in general, an investor should if able start early, avoid being buffeted by market noise and remain invested, keep investment costs low, and refrain from spending their portfolio dividends – so not to interrupt the magic of compounding. They will then usually be surprised at how well they’ve done.
Investors may also be surprised at how well the investment style of their equity holdings has performed. If right that stagflation is now upon us, history suggests low growth combined with higher and more volatile inflation usually favours value stocks. These tend to be populated by the well-managed and financially sound income stocks which are increasingly being sought by fund managers. After the Alice in Wonderland world of Quantitative Easing (QE) and artificially low interest rates distorted both reality and asset prices, which in turn favoured growth stocks, value has once again regained its crown. Dividends are back in fashion and for good reason – in an unpredictable world, they should also offer some solace.
Dividends in action
Henderson High Income (HHI) focuses mainly on larger UK companies to generate a high and growing level of income, although the manager has latitude to invest across the market cap spectrum, and currently has c.10% of its assets invested overseas. Since David Smith took over more than ten years ago, the company has enjoyed a good track record over most time frames relative to its benchmark (80% FTSE All-Share Index/20% ICE BofA Sterling Non-Gilts Index). The progressive dividend policy is supported by meaningful revenue reserves – the dividend equating to a yield of 6.0% at time of writing. The company’s bond exposure assists with some of the portfolios’ objectives by complementing existing bond exposure.
Murray International Trust (MYI) seeks income from an international portfolio of mostly blue-chip equities, while also looking to grow capital and dividends in excess of inflation. The portfolio’s composition has broadly a one-third split between North America, Europe including the UK, and the Asia Pacific and Latin America – which fits well with our view as to the relative merits of the markets involved relative to benchmarks. Recently announced results show a total return of 6% against 1% for the FTSE All-World index. Asia in particular assists with the company’s income remit, with the company’s dividend equating to a yield of 3.6%.
CQS New City High Yield (NCYF) seeks a high level of income by focusing on fixed-interest securities at the upper end of the yield curve, which should be more resilient should we be right about inflation, while supplementing this with a modest exposure to mostly high-yielding equities and convertibles. These latter investments assist in maintaining the company’s track record of modestly increasing dividends over time, with help from its not insignificant revenue reserves. The long-serving and respected manager, Ian ‘Franco’ Francis, has an excellent record of stewardship with total return performance being among the best in its peer group. Meanwhile, the 4.5p dividend equates to a yield of 9.1%.
Foresight Environmental Infrastructure (FGEN) seeks a sustainable, progressive dividend alongside long-term capital preservation courtesy of a highly diversified portfolio of environmental infrastructure assets which are aligned with decarbonisation and resource efficiency. Around 70% of the portfolio is in renewable generation, with the balance in complementary infrastructure, making it one of the most diversified vehicles in its peer group. The strategy focuses on long-term, stable, and often inflation-linked cash flows, and currently supports a high, well-covered dividend – despite sector-wide valuation pressure and a wide discount.
Indeed, strong dividend cover of around 1.2x, low gearing and a comparatively high and therefore conservative discount rate suggest financial resilience. A key differentiator is the company’s trio of ‘growth assets’ – a UK controlled-environment glasshouse, the CNG biomethane refuelling network, and a Norwegian land-based aquaculture facility. These are ramping up operations and are targeted for disposal in due course to crystallise capital growth and recycle proceeds into new opportunities across the energy transition space -without the need for additional fundraising. Meanwhile, the dividend equates to a yield of 11%.
CQS Natural Resources Growth & Income (CYN) has an excellent track record of generating capital growth and income predominantly from a portfolio of smaller mining and energy companies. Meanwhile, the company is top of its peer group under the stewardship of its respected and long-serving managers, Keith Watson and Robert Crayfourd. Profits have recently been taken in precious metals (while remaining their largest exposure) in favour of increased weightings in oil and gas – the rebalancing being well-timed, having taken place before the US attack on Iran. We also favour the company because the enhanced dividend policy pays 8% of NAV via quarterly distributions of 2% of the preceding quarter-end NAV.
The managers have recently resigned from Manulife CQS Investment Management and are now serving their three-month notice period with no expected disruption to investment process or operations. They have also resigned from its sister funds – Golden Prospect Precious Metals (GPM) and Geiger Counter Ltd (GCL), both being portfolio holdings. Given these managers excellent and consistent performance and stewardship of shareholders’ funds over many years, we will be voting to follow the managers in each case to their new management company – if, and when, we are given the opportunity to do so. Good fund managers deserve support.
Biopharma Credit Investments (BPCR) specialises in lending to the life sciences industry with investments secured by rights and cashflows from the sales of approved products and not early-stage or pre-approval products. This mitigates risk. The company has performed well over time. Because of its more defensive nature (i.e. debt, not equity), the company assists those portfolios seeking diversification. In addition, it generates a high income, and this is often supplemented by royalty investments which help to fund special dividends in addition to the regular dividend of 7c. A recent dividend announcement brings the total for the year to 9.95 cents, which represents a yield of 10.5% at current exchange rates.
Finally, Schroder Real Estate Investment Trust (SREI) seeks an attractive level of income and capital growth from a diversified portfolio of good quality UK commercial property assets mostly outside the south-east. The company is overweight the higher growth multi-let industrial and retail warehouse sectors, which we continue to favour. Importantly, the company’s debt has a maturity profile of around eight years at an average interest cost of 3.5%, with the majority of this either fixed or hedged against movements in interest rates. As such, the company delivers a sustainable and growing level of income which currently equates to a yield of 7.2%.
Disclaimer: The information contained in this article does not constitute investment advice or a personal recommendation and it is not an invitation or inducement to engage in investment activity. You should seek independent financial advice as to the suitability of any investment decision. Past performance is not a guide to future performance. The value of investment company shares, and the income from them, can fall as well as rise. You may not get back the full amount invested and, in some cases, nothing at all.
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