Investors should rethink what it means to invest for income, Baillie Gifford’s Toby Ross argues, because sustainably and responsibly managed businesses often pay out more dividends over time.
Ross, who co-manages the £222m Baillie Gifford Responsible Global Equity Income fund, believes income investors should focus more on what income will look like over the next five to 10 years, rather than what income will be in the current year.
Investors will then find that often the type of company they are left with are the much more sustainable and responsibly managed businesses of the future.
He said: “Those sorts of companies are not just going to give you income today, but they'll also be paying dividends for you in five or 10 years’ time and they're going to be better long term investments anyway.
“We just think it might be a better way of investing.
“We're not asking ourselves what's the dividend going to be this year, we're asking where is going to be in five or 10 years’ time.”
He argued that companies on the right side of history are the same companies that give investors a truly sustainable dividend stream.
Ross highlighted one of Baillie Gifford Responsible Global Equity Income’s top-10 holdings, Novo Nordisk – a Danish pharmaceutical company focused on diabetes – as an example.
Share price performance of Novo Nordisk
Source: Google Finance
Ross said: “They've led the way in the largest supply of insulin globally, they’ve led lots of breakthroughs in treatment for diabetes and they've been a remarkably stable dividend payer.
“They’ve been growing the dividend for over 20 years and grew it again last year by 10 per cent, so it is a company that's robust and completely committed to it when things get difficult.”
What excites him about the next 10 years for Novo Nordisk is the new set of therapies the company is trialling for obesity, which could help patients achieve a 15 per cent weight loss.
“This is a company have developed something to basically target a huge unmet need, could help tens of millions of people and do it at scale,” Ross said.
“That's exactly the sort of company we love because it's got the cash flows and a really strong business that helps it be a resilient dividend payer today.
“But it's not just focusing everything on driving cash out of business now, it is also thinking about what's going to set it up to still be growing in five or 10 years’ time.”
Ross, who also co-manages the £703m Baillie Gifford Global Income Growth fund, revealed that one of the reasons Baillie Gifford Responsible Global Equity Income was launched two and a half years ago was because there was a prevailing idea that investors had to compromise returns when investing for income responsibly.
“That just didn't seem that just didn't seem right to us,” he said. “I think one of the biggest misconceptions about income investing is that the best dividends come from the worst companies.
“There has been this long-standing assumption that if you're investing for income, then you need to invest in tobacco, big oil and payday lenders.
“Actually, on a long-term time horizon those are not the right sort of companies.”
He said that this point was demonstrated to some extent last year which proved to be a year of crisis for equity income investors.
The UK equity market saw dividend income cut by 44 per cent and the global equity income market saw a roughly 12 per cent dividend income cut.
For UK equity income investors specifically, seven of the top 10 dividend payers in the country cut their dividends, which came largely from energy firms and banks.
Ross compared this to Baillie Gifford’s Responsible Global Equity Income’s dividend payers, of which nine out of 10 increased their dividends during the year. These companies included Microsoft, Taiwan Semiconductor Manufacturing Company and Pepsico.
Source: Baillie Gifford & Co.
“I think if you look behind the dividend cuts in many of these companies, you see a big sustainability challenge,” he said.
“If you take Shell or BP, why did they cut their dividends last year? Well, the oil price fell.
“But fundamentally, what was the problem? The oil price fell and these companies were paying out too much in dividends and had to pivot their portfolios towards a more sustainable energy source. They couldn't do all of those things and meet their dividend commitments, and so the dividend had to give.”
In his view, this also underscored the importance of looking globally for income. He argued that the benefit of investing for income globally is that it allows investors to diversify away from many troubled high dividend payers that are prevalent in the UK.
“If you're investing in businesses that don't have that big sustainability challenge built into them, you're much more likely to be able to keep growing your dividends over time,” he said.
During 2020, Ross pointed out that the fund’s dividend distribution actually increased by 0.4 per cent despite the global cut in dividends seen across the industry.
“That has proved the point to us that if you're investing in sustainable businesses, when the going gets tough you're still going to be able to grow your income stream,” he said. “We've been through this extreme stress test, but we think that this approach has proven itself.”
Since inception, Baillie Gifford Responsible Global Equity Income has delivered a total return of 39.51 per cent, versus 22.21 per cent from the average fund in the IA Global Equity Income sector and 35.7 per cent from the MSCI All Companies World Index.
Performance of the fund versus sector & benchmark since launch
Source: FE Analytics
The fund has ongoing charges of 0.54 per cent and currently yields 2.2 per cent.