With a sophisticated dividend strategy, the Goldman Sachs Eurozone Equity Income Fund has been scoring above average for decades. “We spend our risk budget mainly on stock selection and do not deviate much from the benchmark in terms of sector and factor exposure,” said Nicolas Simar of Goldman Sachs Asset Management in an interview.
Simar has been at the helm of the Eurozone Equity Income Fund (ISIN: LU0191250090) since its inception in 1999 and can boast a particularly fine track record over this period. In its 25-year history, the average total return after expenses is 6.69 per cent, compared to 6.14 per cent for the MSCI EMU total return index.
The main reason for the outperformance is the fundamental bottom-up stock selection, Simar said. “We are not aiming for the highest possible dividend yield, but for a sustainable dividend. Our portfolio includes companies that show structural growth in free cash flow. This allows them to increase their dividend.”
The fund aims for a dividend yield 50 to 100 basis points above that of the benchmark. “Currently, we offer a yield of 4.5 per cent, compared to 3.5 per cent for the index. If we were to construct a portfolio with a much higher dividend yield, it would either come at the expense of the quality of the companies, or it would create an undesirable sector concentration,” Simar said.
Tech stocks
He deliberately plots the fund’s performance against the broad benchmark rather than, say, a high-dividend index or MSCI value index. “We want to avoid a tilt towards certain factors or sectors and aim for a balanced portfolio. For each sector, we select the most attractive stocks with an above-average dividend yield.”
That is why the fund includes well-known tech companies like ASML and SAP in its portfolio, despite their relatively low dividend yields. “Although we have a concentrated portfolio of typically less than 40 stocks, there is good diversification,” Simar said. The portfolio’s expected dividend growth is in line with index-level growth. “We are not concerned with above-average earnings and dividend growth. The main criterion is that free cash flow more than covers the dividend.”
Highly cyclical value stocks Simar tries to avoid as much as possible. “It comes down to good timing here and that is always tricky. Our institutional clients are not waiting for an occasional strong outperformance that then ends with a sharp correction. Consistency in performance is important to us and we have succeeded in that so far.”
Extremely cheap
After years of underperformance of European equities against Wall Street, the dividend expert sees bright spots. ‘The underperformance is mainly due to weaker earnings growth, but in recent years the earnings trend in Europe has been better and the gap with US companies is narrowing. Europe is extremely cheap compared to America. While that is not enough to expect a catch-up, it does indicate that Europe is very attractive to investors.’
European companies are also much more international than American ones, according to Simar. About half of the turnover of companies in MSCI Europe is generated outside Europe. “Moreover, balance sheets in Europe are rock-solid, so dividend payments are relatively high and more and more companies are buying back their own shares. Share buybacks were previously unpopular among European companies, but this is now a better alternative than expensive acquisitions due to low valuations. Share buybacks and dividend yields already yield nearly 5 per cent at the index level.”
Laggards
The fund’s positioning has become a bit more defensive in recent months. “We are in the late phase of the current economic cycle and have reduced cyclical stocks in favour of quality stocks. Furthermore, weight of the technology sector has been reduced as valuations have risen too far in our view.”
Besides quality stocks, Simar is now looking more for laggards, such as the energy sector. “Oil and gas companies show capital discipline and offer low double-digit free cash flow yields. That allows for a dividend yield of 4 to 5 per cent and a share buyback yield of another 2 to 3 per cent. Other defensive players such as utilities and operators of toll roads and airports are also promising at the moment.”
This article was originally published on InvestmentOfficer.nl