Ian Cowie says some of the Continent’s best companies are offering mouthwatering dividend yields these days
Pity the poor estate agents. Now there’s a phrase you don’t see very often. Barely had they begun to market Spanish villas and French gîtes as bargains because of the weak euro, than the pound began its precipitous decline.
Sterling-denominated investors may be tempted to keep their cash close to home until exchange-rate fluctuations become much less exciting. In the case of continental real estate, that would seem wise — especially when the Economist calculates that house prices in Spain remain 60 per cent higher than they should be relative to long-term average rental yields. For comparison, on the same basis, British housing appears only 25 per cent overpriced.
Unfortunately, just because things look bad now does not mean they could not be a good deal worse sometime soon. While the Greek debt drama has yet to bring the curtain down on the euro, money-market fears about a hung parliament have caused the sharpest falls in sterling for more than a year. There might be worse to come if the general election really does produce an inconclusive result.
So, counter-intuitive though it may seem, this might not be a bad time to consider some diversification away from the pound. No, this is not going to turn into another emerging markets story. The time to buy into that was more than a year ago — as I pointed out at the time, here and elsewhere. By the end of 2009, the bull argument for the tiger economies had become so wearily familiar that their setbacks this year came as no surprise.
But continental Europe may offer overlooked opportunities today. Better still, this sector is so deeply unfashionable that large blue-chips offer mouthwatering yields. Yes, that’s right. Continental Europe has discovered the joy of dividends. Formerly the preserve of Anglo-Saxon corporate culture, rising numbers of large European companies are making a practice of rewarding shareholders now, rather than relying solely on dreams of capital gains in future.
Take, for example, the Dow Jones Euro Stoxx 50 Index, which tracks blue-chips across the eurozone. Gareth Evans, an equity income strategist at Deutsche Bank, pointed out recently: ‘Despite the strong rally in equities, 54 per cent of the market capitalisation of the Stoxx 50 is on a dividend yield of more than 4 per cent. In this period of record supply of fixed income, and with government credit quality weakening, one could argue that secure, high dividend yields are a decent risk-reward proposition against bonds.’
Deutsche tipped Telefónica of Spain, the French oil major Total and the German chemicals group BASF, along with more familiar giants of the eurozone such as Royal Dutch Shell, Vodafone and BP. Evans argued: ‘The sustainability of dividends across the telecom, oil, utilities and pharmaceutical sectors is critical and in all cases we are confident that the threats are minimal. Large-cap yield has failed to participate in the rally because it is mostly regarded as a defensive strategy.’
After all the go-go excitement of 2009, investors who know that no market moves in a straight line forever might like the sound of defensive stocks paying high yields. But only the more hands-on individual investor is likely to wish to buy and sell individual shares on overseas stock exchanges, with all the hassle that can involve. Pooled funds — such as unit and investment trusts or open-ended investment companies (OEICs) and exchange traded funds (ETFs) — can minimise paperwork.
Oliver Russ, the Oxford classicist who runs Ignis Argonaut European Income, points out that this unit trust is still delivering a high dividend yield of 6 per cent, on top of capital growth that gave a total return of 31 per cent for the year to March. He claims there are advantages to hunting yield where few others tread. For example, there are more than 100 unit trusts in the UK equity income sector but only 11 European equity income funds. That is largely a function of the relatively recent conversion of our continental cousins to progressive dividend policies. Marketing of these funds may also have been held back by traditional British prejudices about working practices, excessive state interference and bureaucracy within the European Union.
So, while every week brings the launch of another emerging markets fund, new European funds remain few and far between. The scarcity of income-seeking funds on the Continent is certainly not caused by a lack of choice of high-yielding shares. Nearly 300 European stocks pay more than 3.5 per cent compared to fewer than 75 in Britain, according to Oliver Russ.
That has led to a concentration of holdings which may to some extent negate the fundamental aim of pooled funds; to diminish risk by diversification. For example, more than half the dividends paid by the constituent stocks of the FTSE All Share are derived from just ten shares — and nearly a quarter come from the two oil giants, BP and Shell.
Russ holds neither of these stalwarts for income-seekers in his European fund; nor does he have any exposure to other high-yielders, such as Vodafone, GlaxoSmith-Kline, British American Tobacco or National Grid. Instead, he backs Total, Telefónica and France Telecom among other major continentals.
Similar diversification away from the core holdings of so many UK funds can be obtained at Scottish Widows Investment Partnership’s European Income fund. This OEIC delivered total returns of 42 per cent during the year to March and yields 4.2 per cent. Manager Steven Maxwell benefited from the sharp recovery in financial shares, led by the fund’s largest single holding, Santander, the Spanish banking group that swallowed Abbey and the branch network of Bradford & Bingley. Alternatively, Jupiter European Income, a unit trust managed by Malcolm Millar, has more than a sixth of its money invested in healthcare stocks and delivered returns of just over 30 per cent with a yield of 3.3 per cent.
Contrarian investors who consider European equity income funds can take comfort from the fact that the great mass of investors and fund promoters are running after capital growth at any price in emerging markets. But while the ability to diminish risk by diversifying the shares you rely upon for income is clearly substantial, any claims made by fund managers or investment advisers about where exchange rates are heading should be viewed with caution. As has also often been said about dabbling in commodities, the traditional City advice to anyone tempted to speculate on currencies is to lie down in a darkened room and wait for the feeling to go away.
Ian Cowie is head of personal finance at Telegraph Media Group.