Managing volatility with shareholder yield
The stock market’s sharp pullback in October caught many by surprise and prompted investors to take a closer look at active strategies that can help mitigate volatility. Across the board, global economic and corporate fundamentals remain healthy, but increasing levels of volatility are expected on the heels of heightened trade tensions and normalizing monetary policy. During this period of uncertainty, prudent stock selection is critically important. An emphasis on quality companies with globally diversified revenue streams and a history of sustainable free cash flow growth can help investors stay the course.
For deeper insights, we spoke with Andrea Glogoff, Managing Director, Global Portfolio Management at Epoch Investment Partners (“Epoch”). Epoch manages over $43 billion in equities for an impressive roster of institutional clients.
Geopolitical Risks Take Center Stage
After six consecutive months of positive returns, the market abruptly reversed course in October. In what started as a sharp downturn in the high flying technology sector soon spread and led to a broad-based selloff within the U.S. stock market. Despite a rally late in the month, the S&P 500 finished October with a 6.84% decline—its largest monthly decline in more than seven years. Returns were even weaker overseas, and the bond market—often a safe haven during “risk-off” environments—also posted a negative return.
There were a host of factors negatively impacting investor sentiment, including the Federal Reserve voicing its commitment to additional monetary policy tightening, concerns that rising interest rates and trade tensions could crimp profit margins, uncertainties surrounding the midterm elections, and a host of geopolitical hot spots. On a global basis, more defensive areas of the market (consumer staples, telecommunication services, and utilities) proved resilient, but were not enough to offset broader weakness. According to index provider MSCI, the market capitalization of the MSCI World Index shrunk by an astounding $3.2 trillion for the month of October.
Figure 1: Relative safety of traditional, dividend-paying sectors in a turbulent market
MSCI World Index
Month of October 2018 – Total Return (%)
Source: Morningstar. Total return (%) for month of October 2018. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index.
Fundamentals and Shareholder Yield Continue to Shine
Despite near-term volatility, the outlook for equities remains favorable. Epoch seeks companies with a history of free cash flow growth across a variety of market environments and management teams who are committed to returning cash to shareholders. This includes companies with attractive levels of shareholder yield; more specifically, the ability to raise their dividend, increase share buybacks and reduce balance sheet debt. Collectively, these attributes can help identify quality firms with more durable business models.
Source: Epoch Investment Partners
Several positive catalysts are in place to support higher levels of shareholder yield over the next several years, including U.S. Tax Reform and Repatriation. According to government data, roughly $450 billion of offshore cash from multinational firms was repatriated back into the U.S. during the first half of 2018. The Federal Reserve reported that companies have chosen to return the bulk of that capital to shareholders. Also strengthening the case for a shareholder yield approach is what Epoch commonly refers to as, “Tech is the New Macro.” More specifically, Epoch’s fundamental research team has noticed a meaningful uptick in free cash flow growth across several industries benefiting from technological innovation which has fostered a capital light world with higher ROE (return-on-equity) and profit margins.
Figure 2: U.S. share buybacks expected to hit a record high
Source: Epoch Investment Partners, Goldman Sachs. Estimates as of September 30, 2018. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index.
An Active Approach to Identify Growing Companies
The current environment demonstrates the value of active portfolio management. Bottom-up, fundamental research can help identify growing companies with economically resilient business models. Epoch looks for companies that are using technological advances to help cut costs and capital expenditures which, in turn, can help bolster their cash flows. Companies with high barriers to entry may have an advantage, as they are better suited to pass along rising input costs—a key consideration if tariffs lead to higher input costs. Elsewhere, companies with recurring revenue streams could hold up relatively well. Active management can also help separate strong and sustainable business franchises from those that are more susceptible to moderating economic growth.
The information contained herein is general in nature and is provided solely for educational and informational purposes. New York Life does not provide legal, accounting, or tax advice. You should obtain advice specific to your circumstances from your own legal, accounting, and tax advisors. Dividends fluctuate and are subject to change. There is no guarantee they will continue to be paid. While dividends may cushion returns in down markets, investments are still subject to loss of principal amount invested.
Opinions expressed are current opinions as of the date appearing in this material only. The information and opinions contained herein are for general information use only. New York Life Investments does not guarantee their accuracy or completeness, nor does New York Life Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results.
All investments are subject to market risk, including possible loss of principal. There is no assurance that the investment objectives mentioned will be met. Diversification cannot assure a profit or protect against loss in a declining market.
Index performance is shown for illustrative purposes only and does not predict or depict the performance of the Funds. Indices are unmanaged, include the reinvestment of dividends, and cannot be purchased directly by investors. Past performance does not guarantee future results.
Free cash flow is the amount of cash a company is able to generate after making required investments in the existing business, such as for new machinery and to pay for supplies.
MSCI World Index is a free float‐adjusted market capitalization weighted index that is designed to measure the equity performance of 24 developed markets.
S&P 500 Index is an unmanaged index and is widely regarded as the standard for measuring large-cap U.S. stock-market performance. Index results assume the reinvestment of all capital gain and dividend distributions. An investment cannot be made directly into an index
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