In December 2011, PIMCO introduced the PIMCO Dividend and Income Builder Strategy, a global equity-centered strategy focused on delivering an attractive yield today and the potential for both a growing income stream over time and capital appreciation. It incorporates fixed income as a supporting component. We also introduced the PIMCO Dividend Strategy, which is designed to largely reflect the equity composition of the Dividend and Income Builder Strategy for investors interested in equity-income solutions without the fixed income component.
In the following interview, portfolio manager and head of PIMCO’s dividend team Brad Kinkelaar discusses the Dividend and Income Builder Strategy’s investment process, the outlook for dividend-paying companies and how the strategy integrates PIMCO’s macro insights into portfolio construction.
Q: What is the PIMCO Dividend and Income Builder Strategy? A: The strategy invests in dividend-paying stocks around the world with a focus on providing an above-average yield today and the potential for a growing income stream over time, while also seeking capital appreciation. We believe the global opportunity set provides greater potential for dividend investors, as attractive dividend-paying companies are often found outside the U.S. and can enhance diversification more broadly than a U.S.-only portfolio, which may rely on a limited number of sectors.
Adding to our toolkit, the strategy takes fixed income and cash positions when the dividend team finds them more appealing than global equities, although at least 50% or more of the strategy should be focused on equities. Portfolio managers Daniel J. Ivascyn and Alfred Murata actively manage the fixed income positions, drawing on their global investing experience, as well as PIMCO’s deep resources and over four decades of expertise.
We have also launched the PIMCO Dividend Strategy, which like Dividend and Income Builder, seeks an above-average current yield and capital appreciation over time, but is intended for investors who want an equity-only strategy rather than an integrated solution combining equity and debt. The dividend team intends to have 75% to 100% of the Dividend Strategy in equities.
Both strategies are actively managed and – although they have benchmarks – are not benchmark-constrained. The team views these flexible strategies as appealing, core solutions for gaining global equity exposure, and potentially earning steady and growing income without taking undue risk. We want to participate on the upside, while mitigating the impact on the downside.
Q: Why consider investing in the PIMCO Dividend and Income Builder Strategy now? Why should investors be looking to dividend-paying stocks? A: PIMCO is focused on providing a comprehensive set of global solutions to our clients. Income generation is a common objective for many of them – a need that is likely going to increase as our population ages and spends more time in retirement. Thus, we do view the PIMCO Dividend and Income Builder Strategy as a core, long-term strategy, as opposed to an opportunistic investment choice. We are focused on growing income over time and on capital appreciation, which are valuable features in most market environments.
That said, there is certainly a heightened awareness for income solutions amid the current low-yield environment. In fact, we see interest rates as likely to remain low for some time amid an extended period of challenging economic growth, what PIMCO has characterized as the New Normal. Many global companies are paying dividends well above the current yield on 10-year Treasuries (as of 31 December 2012), and they also provide opportunities for rising income as corporate earnings tend to grow over time. We believe a growing dividend that helps offset the erosive effects of inflation is vital for anyone who relies on their portfolio income in retirement. Generally, very few investment options effectively address this impact.
Q: How have dividend-paying stocks performed historically? A: Dividend income has been a key component of overall equity returns over most time horizons, averaging 54% of total return from January 1930 to December 2010, according to S&P and International Strategy & Investment (ISI). But what many people may not know is that dividend-paying stocks have historically outperformed the equity market as a whole over time. (The dividend team’s analysis of historical equity market index returns is based on the S&P 90 from 1928 to 1957, and the S&P 500 from 1957 to 2010, utilizing data and methodology from Kenneth R. French and Robert Shiller.) This fact may seem counterintuitive to some, but studies have shown that companies that pay higher percentages of their earnings in dividends to shareholders have tended to grow their earnings faster than companies that have kept more of the cash. (For example, Robert D. Arnott and Clifford S. Asness, “Surprise! Higher Dividends=Higher Earnings Growth” covering companies in the S&P 500 from 1946 to 2001.) That is because capital allocation matters. Businesses that have committed to the discipline of dividend payments are typically forced to manage their cash more judiciously, including the cash they invest in expansion opportunities. As a result, the team believes they tend to be better businesses and have better return potential than companies without that discipline.
Q: How is the PIMCO Dividend and Income Builder Strategy different from others in the marketplace? A: Ultimately, we believe the strategy is distinguished by our active management in pursuing three goals: an attractive current yield, a growing income stream over time and opportunity for capital appreciation. We rarely see a strategy that attempts to provide all three. Our fundamental analysis is focused on looking for value-priced companies with the ability and willingness to pay an attractive dividend today, and potential to grow dividends per share in the future. We believe that dividend strategies that passively mimic an index may be looking in the rearview mirror, expecting companies that increased their dividend in the past may do so again in the future. That isn’t always the case. By definition, an index has “average” valuations, not the compelling valuations that the dividend team seeks to identify.
Another differentiator is our global mandate, which is enhanced by PIMCO’s global macro outlook. Although we will generally invest in some U.S.-based companies, we are unbounded by geography or benchmarks. This approach provides a wide array of opportunities for higher dividends and diversification across sectors and countries. Indeed, companies in almost every country outside the U.S. tend to have higher dividend yields than those in the U.S. The MSCI All Country World Ex-U.S. Index, as an example, as of 31 December 2012, has an average dividend yield of about 3.2%, which tops the 2.3% for the MSCI U.S. Index. Other examples using MSCI indexes include Latin America with an average yield of about 3.2%, Europe at 3.7% and Australia at 4.6%. The team continuously mines the global markets to find companies that might help us meet all three of our goals.
And finally, I would add that although I am relatively new to PIMCO, I am a veteran equity investor with 17 years of investing experience in managing portfolios of value-priced, dividend-paying companies whose dividends we believe could grow over time.
Q. How are you implementing these strategies? Could you describe your investment process? A: In addition to focusing on above-average current income, growing the dividend and participating in capital appreciation, we also believe it is imperative to emphasize fundamental analysis and compelling valuations so we don’t overpay for our investments. With these goals in mind, we feel it is critical for everyone on the team to be global analysts first, performing extensive due diligence, specifically focused on finding great ideas for this strategy.
Our analysis subjects companies to detailed upside and downside stress testing, looking at the wide range of possible and probable future outcomes. This may be different from a more typical analysis that attempts to predict a specific outcome, such as an earnings estimate at a given point in time. Ultimately, we are looking for companies that we believe have the ability to grow dividends over time over a wide range of economic scenarios. We want to purchase these companies at prices that are attractive relative to their overall risk-reward profile. The valuation metrics we use vary by company, but we tend to use traditional parameters that help us value anticipated cash generation and growth prospects.
As part of this process, we seek to understand where a company stands in its life cycle of development, and this ties into our investment and diversification processes. We seek to invest in a diversified portfolio of companies, ranging from solid blue-chip companies that have grown over time, to more cyclical companies, to companies that we think can become much bigger companies in the future – and that may be different from what some investors expect, often incorrectly thinking that dividend-paying stocks are restricted to mature businesses with little room to grow. Ultimately, we are trying to build a sound portfolio of well-positioned companies with strong prospects.
Q: How do PIMCO’s macro outlook and investment process inform the Dividend and Income Builder Strategy? A: PIMCO’s Cyclical and Secular Forums, the PIMCO macro outlook, and guidelines from the PIMCO Investment Committee are all important inputs to the strategy. For example, we use our macro outlook to guide our analysis of the possible multi-year range of operating results for companies we are considering. This analysis depends not only on a company’s internal dynamics, but on dynamics of sectors, countries and the global economy as a whole.
At PIMCO, we believe we have a well-thought-out and well-defined range of economic scenarios for all major economies and markets, on a cyclical as well as secular basis. This informs not only our understanding of how macro dynamics may affect individual companies, but which countries and sectors may be advantageous to invest in and which to avoid.
We can also benefit from the fixed income, currency and commodity expertise at PIMCO – with Dan and Alfred leading our fixed income approach. More broadly, the credit team greatly enhances our appreciation of the capital structure of companies, including which part of that structure is most opportune. We generally expect to take an equity position, but we may also decide the debt offering is a better option. And certainly, PIMCO’s global credit analysis helps us identify potential balance sheet threats for companies that may otherwise exhibit the ability and willingness to pay dividends in the future.
Q. How do you approach security selection and risk management? A: The dividend team employs a constant search and information-gathering process, including traveling the globe to find different types of companies that may be appropriate for the strategy. We typically do not rely on screening, which we believe can be a backward-looking process that may miss good opportunities. We are forward-looking, building our own stress-tested upside and downside scenarios reflecting our analysis of future opportunities. It is extremely labor intensive, but we believe, value-added. To assist us, we also engage in intelligence sharing with our network of global equity colleagues at PIMCO, as well as our extensive global fixed-income team.
Our risk management begins with a prudent approach to equity selection. We view risk management as careful, price-sensitive security selection within a diversified portfolio of fundamentally sound opportunities. To use a baseball analogy, we are not swinging for the fences. We seek to be very good singles and doubles hitters. Of course, we also hope to occasionally hit some triples and home runs, but that is not our focus. We want to build a portfolio that we feel is positioned to better weather a downturn than the general equity markets with the potential for participating in more favorable circumstances as well. To do that, we believe it is critical to always keep the downside in mind and pay reasonable prices for sound opportunities.
Q. Finally, what types of dividend trends have you been observing? A: Over the past few decades, payout ratios have been declining, especially in the U.S. Yet today many companies, particularly blue-chip companies, have very large amounts of cash on their balance sheets. Rather than pay shareholders today, many companies are hoarding that capital, likely out of a combination of fear for the future and hope that opportunities will arise for capital investment.
At some point, however, shareholders may want to demand that this cash be paid out as dividends. We believe payout ratios in the U.S. have declined precisely because shareholders have not insisted on dividends. Meanwhile, some managers seem to avoid committing to higher dividends or offering any dividend at all, choosing instead to retain as much capital as possible and occasionally announcing share buyback plans that they may or may not execute. If they do execute the buyback, it may be at the wrong time – when prices are high, or simply be used to offset option grants to management.
In our view, U.S. investors have generally been led to believe the fallacy that companies need to hold on to their earnings to grow – that they cannot pay dividends and grow simultaneously. We believe that good companies can do both, and we demand both from the companies we hold. In fact, companies all over the world pay shareholders in dividends while growing their businesses. We believe the U.S. is somewhat of an outlier in that regard, further emphasizing the need for a globally diversified portfolio. Thus, we continuously seek to identify value-priced companies around the world that are both paying attractive dividends today and focusing on growth over the long term. We believe the diversified global approach is a critical element to achieving all three goals of the PIMCO Dividend and Income Builder Strategy.
Past performance is not a guarantee or a reliable indicator of future results. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Dividends are not guaranteed and are subject to change and/or elimination. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.
The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. Since June 2007 the MSCI World Index consisted of the following 23 developed market country indices: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States. The index represents the unhedged performance of the constituent stocks, in US dollars. The Morgan Stanley Capital International All Country World Index (“MSCI ACWI”) is a market capitalization weighted index composed of over 2000 companies, and is representative of the market structure of 22 developed countries in North America, Europe, and the Pacific Rim. The index is calculated separately; without dividends, with gross dividends reinvested and estimated tax withheld, and with gross dividends reinvested, in both U.S. dollars and local currency. The S&P 500 Index is an unmanaged market index generally considered representative of the stock market as a whole. The index focuses on the Large-Cap segment of the U.S. equities market. It is not possible to invest directly in an unmanaged index.
This material contains the current opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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