Ben Kirby, who helps manage the $14.6 billion Thornburg Investment Income Builder Fund, says many investors, even those looking for growth, underestimate the effect of dividends on their total returns.
“Income matters, and dividends account for more than half your total return for any major market for any full decade,” he said in an interview. (For the methodology, see the last paragraph of this article.)
Kirby tends to look outside the U.S. for stocks with attractive dividend yields because “the U.S. is the lowest-yielding market in the world. That is probably the most relevant feature of the portfolio,” he said. He named, below, several companies held by the Thornburg Investment Income Builder Fund during TIBIX, -0.32% as examples of stocks to hold for rising dividend income.
The fund’s objective is to provide a current yield exceeding that of U.S. stocks, while also achieving long-term capital growth. The fund has many share classes, with different minimum investments and levels of expenses, depending on the relationship of your broker or investment adviser with Thornburg Investment Management. The class I shares TIBIX, -0.32% have a five-star rating (out of five) from Morningstar, and have a 30-day SEC dividend yield of 3.36%.
The fund has a blended portfolio of stocks and bonds, and is now about 89% allocated in stocks, for the obvious reason that bond yields are so low. For example, German 10-year government bonds TMBMKDE-10Y, -202.53% have negative yields.
Kirby said that, depending on market events, the fund’s makeup can shift considerably. He said that during the financial crisis of 2008, “we went from 10% fixed income to 45%. Most of our peers had to cut dividends in 2008 and started growing them again in 2009. Because we had bought [heavily discounted] bonds, we were able to increase our dividend per share all the way through the crisis.”
As those bonds have matured, the fund has booked capital gains. However, it has also been forced to make new investments with lower yields.
Investors have grown used to excellent stock-market performance in the decade following the post-crisis market bottom in March 2009. But “during periods when stocks rise more slowly or go down, income becomes even more important,” Kirby said.
The income problem and ‘yield on cost’
Income-seeking investors have been suffering for decades from the continual problem of having to replace matured bonds or redeem preferred stocks with lower-yielding paper. The Federal Open Market Committee’s decision last month to stop raising short-term rates and curtail the runoff of the Federal Reserve’s balance sheet doesn’t help either, as the second action pushes long-term yields lower.
No one knows how long the current “distorted” low-rate environment caused by the pumping of trillions of dollars into developed economies by central banks will last. But maybe 10 years into it, we can accept it as the new norm.
And that means you had better be used to the idea of not simply hunting for high current yields, but instead trying to select stocks of companies that are likely to increase their dividend payouts significantly over time or investing in mutual funds that do so.
One recently cited example is McDonald’s MCD, -0.54% Here are some updated numbers: If you had purchased the company’s common shares five years ago, at the close on april 8, 2014, you would have paid $98.08 a share. At that time, the quarterly dividend was 81 cents a share, for an annualized dividend yield of 3.3%. If you wanted the income, you would not have reinvested the dividend.
Since then, McDonald’s share price has risen 94% to $189.85, as of the close on April 8, and the quarterly dividend has risen to $1.16. So the current yield (for someone who bought the shares at the close on April 8) is 2.44%, but the yield on the shares you would have purchased five years ago is 4.73%. So the income stream on your original investment would now be considered very good and your investment would nearly have doubled in value.
Not a bad investment in a company many would consider “boring.” Ultimately, your “yield on cost” will be more important than the current yield when you invest — assuming you have the patience to ignore the daily noise of the financial markets and media, and remain committed for many years.
Examples
“We have a mix of lower-yielding companies that are growing their dividends very quickly, some higher-yielding companies which by definition cannot grow their dividends quickly, and some high-yielding investments that cannot increase their dividends at all,” Kirby said.
Ares Capital
An example in that last category is Ares Capital ARCC, +0.52% a business-development company whose stock has a dividend yield of 9.17%. Business-development companies (BDCs) lend money to middle-market companies and often have loan positions inferior to bank credits. This means the loans are riskier, because in the event of bankruptcy, the BDC is further back in line to collect money.
Kirby said Ares Capital’s dividend payout has been “flat for five years,” but the yield speaks for itself. BDCs are plays on credit risk — management had better be very good at underwriting loans.
Some investors shy away from BDCs because they sometimes return investors own capital to them. Kirby said, “that may happen, but all it means is your cost basis is reduced. You pay no taxes but your gain, if any, will be higher when you sell.”
He also said that Ares has been a good business over the long term because “this team has done a good job” when making lending decisions. “If you have some leverage and your credits go bad, you can really impair your book value. There are some BDCs in the space that have had more bad loans and impaired book value over time,” he said.
The leverage allows Areas to pay a dividend higher than 9% even though the average yield in the credit portfolio is around 9% and the BDC takes a management fee, Kirby said.
Deutsche Telekom
For non-U.S. stocks, Kirby and his colleagues tend to invest locally. Shares of Deutsche Telekom DTE, -0.28% listed in Germany have a dividend yield of 4.67%. The American depositary receipts DTEGY, -0.06% have a yield of 4.73%.
Deutsche Telekom owns 65% of T-Mobile US TMUS, +0.48% which has been trying to merge with Sprint S, +1.03% for years. The companies agreed to a $26 billion all-stock combination in April 2018 and continue to wait for regulatory approval amid concerns by consumer groups, regulators and some members of Congress about the effect on pricing if the third- and fourth-largest players in the U.S. mobile market combine. Kirby expects the deal to be approved.
“We like the T-mobile asset,” Kirby said. Assuming the merger is approved, Deutsche Telekom “will be gaining subscribers and market share.”
Kirby considers T-Mobile “an important component of the value of Deutsche Telekom.”
“If you strip out the value of T-mobile U.S., then the stub, which is the German and more broadly Euroepan business, is trading at a discounted valuation in the 5 to 5.5 times EBITDA (earnings before interest, tax, depreciation and amortization),” he said.
He believes that this portion of the business is actually worth 7 times EBITDA. “When that is recognized, the stock that is trading at 15 euros will trade closer to 18 euros. Call it 20% upside plus the dividend of about 5%,” Kirby added.
Home Depot
Kirby said of Home Depot: “[It] has grown its dividend over the past five years by an annualized compounded rate of 22%. They are paying $1.35 now, and five years ago [actually, November 2014] they were paying 47 cents.”
He likes what is “essentially a duopoly” of Home Depot HD, -0.85% and Lowe’s LOW, -0.39% in an area of retail that is “at least resistant” to Amazon.com AMZN, +0.39% ” As the “better operator” in a capital-intensive industry, Kirby says Home Depot will continue to benefit from the consolidation of smaller competitors.
“They also have excellent capital allocation. They understand that they are in a relatively mature business — they are not building many new stores. So Home Depot makes investments in IT, training the sales staff and logistics,” Kirby said.
The current dividend yield for the shares is 2.67%. Kirby said a company that is “disciplined” about paying dividends and buying back shares, while also allocating capital wisely, “is exceptionally attractive.”
Top holdings
Here are the top 10 equity holdings (of 73) of the Thornburg Investment Income Builder Fund as of Feb. 28:
Company Ticker Industry Share of portfolio Dividend yield CME Group Inc. Class A CME, -0.40% Investment Banks/Brokers 3.9% 1.74% China Mobile Ltd. 0941, -0.32% Wireless Telecommunications 3.7% 4.11% Orange SA ORA, -1.21% Telecommunications 3.4% 4.72% Royal Dutch Shell PLC ADR Class A RDS.A, +1.12% Integrated Oil 3.3% 4.89% Deutsche Telekom AG DTE, -0.28% Telecommunications 2.9% 4.67% J.P. Morgan Chase & Co. JPM, +0.02% Banks 2.8% 3.03% Electricite de France SA EDF, +3.69% Electric Utilities 2.7% 2.59% Walgreens Boots Alliance Inc. WBA, +0.13% Drugstore Chains 2.6% 3.20% Total SA FP, +0.28% Integrated Oil 2.5% 5.06% Merck & Co. MRK, +0.28% Pharmaceuticals 2.3% 2.72% Sources: Thornburg Investment Management, FactSet Performance
Thornburg measures the fund’s performance against a blended benchmark — 75% MSCI World Index and 25% Bloomberg Barclays U.S. Aggregate Bond Index.
Here’s how the fund’s class I shares performed against the blended index through the end of 2018, according to the fund’s fact sheet:
Total return - 2018 Average annual return - 3 years Average annual return - 5 years Average annual return - 10 years Thornburg Investment Income Builder Fund - class I -4.39% 6.55% 3.79% 9.47% Blended index -6.42% 5.35% 4.17% 8.31%
(The claim about dividends making up more than half of total returns is based on data that runs through 2010, collated for 1870 through 1990 by Jack W. Wilson and Charles P. Jones as described in “An Analysis of the S&P 500 Index and Cowles’s Extensions: Price Indexes and Stock Returns, 1870–1999,” Journal of Business, 2002, vol. 75 no 3., with data after 1990 supplied by MSCI. Calculations for returns after 1999 were done by Thornburg Investment Management.)
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