By Philip van Doorn, MarketWatch
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 /zigman2/quotes/205930607/realtime TIBIX -1.20% 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 /zigman2/quotes/205930607/realtime TIBIX -1.20% 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 /zigman2/quotes/211347112/realtime BX:TMBMKDE-10Y -2.89% 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 /zigman2/quotes/203508018/composite MCD -0.82% . 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.
“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.
An example in that last category is Ares Capital /zigman2/quotes/204858389/composite ARCC -3.56% , 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.