Growing dividend streams + long-term capital appreciation = countermeasure against low-yielding nominal assets

CIO Insights 2Q2016

The prevailing ultra-low interest rate environment has become known in macroeconomics as “financial repression.” The term attempts to describe how deflationary tendencies and the consequent loose monetary policies in place around the world pose an ever rising challenge to private savers’ ability to get a decent return profile from public retirement programs, private pension plans and insurance savings schemes. To make matters worse still, we should not forget that people’s basic means of income such as salaries and fringe benefits are also growing harder and harder to adjust upwards. For example, average real wage growth statistics in the US and other developed economies have been decidedly flat for years now.

How is one to remedy the situation? In the case of unconstrained long-term investment programs, the asset allocation of choice between fixed income and equity should lean toward real-yield assets (e.g., equities) while deemphasizing nominal yield ones (e.g., fixed-coupon bonds).

The Fund obtains its total return from two main sources: dividends and capital appreciation from its portfolio companies. In the context of our deep value approach, within those generic categories we aim to generate performance in two ways: (1) growing dividend streams as a result of improving future free cash flows accruing to our firms and (2) appreciating equity prices as our companies’ depressed current market valuations eventually rise toward their true intrinsic worth.

First, as far as growing dividends are concerned, the Fund distinguishes itself from the strategies of most dedicated dividend funds available in the market place, whose usual objective is to maximize current dividends. Our portfolio firms, however, often struggle with current cash flow generation because of an adverse business environment, company-specific management problems or major capital spending programs that are undertaken to assure competitiveness in the future. Thus, true to our long-term investment philosophy, analytically, we prioritize future real income growth over current nominal payout. Even with this clear focus in mind, we should nevertheless mention that the current aggregate dividend yield accruing to the Fund approximates 3% per year, which is quite impressive compared to what dedicated dividend funds are currently achieving.

Second, with respect to appreciating equity prices, the fund stands in clear contrast compared to conventional equity funds such as growth, momentum or index funds, which place their emphasis on currently rising equity valuations. Evidently, as deep value investors, we take the contrarian route by investing in select equities whose current prices reflect large discounts to their true economic value because of a variety of stock market driven obstacles such as neglect, fear, complexity or misunderstanding. Again, the aim is to achieve above par long-term investment results by patiently deferring payback to the future rather than falling for the easier, short-term-minded solution of “instant gratification.”

For what it’s worth, we can assure that your portfolio managers believe in what they do: they practice what they preach by having their own savings invested in the Fund. They are willing to tolerate short-term market fluctuations in order to let the return-compounding mechanism do its work over the long horizon, which should represent the appropriate stance of any investor in the Fund.

Sincerely,