Income Options from Across the Pond

Dividends across the region look far healthier today than they did in 2020
Companies are still being careful to reinstate dividends only when earnings have recovered
Inflation will be an important consideration for income investors in the region

From Canadian mining companies at the top, to Brazilian government bonds at the bottom, the Americas offer a smorgasbord of income options. As economies recover, which are the areas of greatest opportunity in the region?

Dividends across the region look far healthier today than they did in 2020, even if it wasn’t hit as hard as Europe and the UK. Fran Radano, manager of The North American Income Trust, says that the majority of sectors have recovered: “Last year, most commonly we saw a suspension of share repurchases and continuation of dividends. In our trust, we only had one cut, it was 14% and they’ve subsequently raised it twice. But dividend growth has resumed across the region.”

He says weakness was confined to consumer-facing companies or companies with weaker balance sheets and excessively high payout ratios. Even here, with the exception of some travel and leisure companies, dividends have returned.

Martin Connaghan, manager on the Murray International Trust, says that in most cases, dividends have been reinstated in response to higher earnings: “Companies are still being careful to reinstate dividends only when earnings have recovered. The exception is those companies in real sweet spots, such as those in mining, which are paying special dividends because demand and pricing looks good.” This may help explain the strength of Canadian equity markets, which are heavily weighted in mining companies.

In bonds, it is a mixed picture. Viktor Szabo, manager on the Aberdeen Latin American Income Fund, says there has been considerable volatility in the region’s government bond sector. The Brazilian 10 year bond yield, for example, has moved from 7% at the start of the year to over 12%. He adds: “There has been a huge inflationary shock as a result of base effect and supply side factors. There are bottlenecks in the supply chain and Brazilian rate hike expectations have shot up aggressively. Political noise in areas such as Peru and Chile have also contributed to rising bond yields.”

Inflation

The direction of inflation will exert influence on all types of income in the region. It is at historic highs in both the US, where it has been above 5% since May, Canada, where it hit 4.4% in September and across Latin America.

Viktor says inflation remains a significant risk for fixed income markets and has reduced duration (i.e. the sensitivity of a bond’s price to changes in interest rates) and moved into inflation-linked bond markets (which are now well-developed in Brazil, Chile, Columbia and Uruguay) in response to higher inflation figures. However, he believes that inflation is probably at its peak.

“It is quite clear that if inflation numbers are rising month after month, investors will start to price in rate hikes. Our expectation is that inflation is mostly like to peak around now, avoiding a big shock. Inflation is likely to come down and that will pare back rate expectations. It is very hard to agree with the current market pricing, which is suggesting a 10% interest rate for Brazil in a year’s time. This would be really bad for the economy and we don’t see it happening.”

Fran believes inflation may be more persistent in the US than is currently expected by the market. He adds: “We look at inflation two ways. Some transitory effects are supply chain-related and should resolve, but with loose fiscal and monetary policy, inflationary pressures could be sustained for some time. Wages are structurally higher.” To deal with this, he is focusing on those companies with pricing power, such as Railroad Union Pacific and Texas Instruments.

On Murray International, Martin and the team have incorporated companies that can benefit from inflation such as real assets and commodities. This is, in effect, a hedge for higher input costs in other areas of the portfolio. He believes companies with pricing power and differentiated brands also offer some defence against inflation. In the portfolio, they hold Lithium producer Sociedad Quimica Y Minera De Chile and Brazilian mining group Vale, for example, along with Taiwan Semiconductor and Samsung Electronics.

Valuations

There is still good value to be found in income assets across the Americas. In common with the rest of the world, dividend paying companies continue to be out of favour and therefore offer scope for a re-rating as dividends resume. Even though the start of the year saw value strategies recover, which included many income stocks, growth has still outpaced value for the year to date. However, Fran believes that markets may eventually start to adjust their view given that income stocks were “extreme laggards” last year.

Fran says he has a mix of defensives and growth in the North American Income portfolio: “We have a well-diversified portfolio and not a lot of big sector bets. We have exited areas such as telecoms, which we see as slower growth, bond proxy-type stocks. We have reduced utilities but have relatively high consumer staples and healthcare positions. On the margin, we are a bit more defensive. Our top 15 names make up over half the portfolio, a reflection that the portfolio is starting to concentrate in key names.”

For Latin American fixed income, yields remain high. Viktor says he will look to add back duration once inflation peaks. “Latin American fixed income will be very attractive proposition, but we have a little time to wait.”

Risks remain. The reversal of US monetary policy will affect the whole region, as will the potential for a policy mistake by leaving monetary policy too loose for too long. Higher taxes may dampen consumer spending, while the Covid virus continues to loom in the background. However, income assets across the region look well priced, with stable income and earnings.

Companies selected for illustrative purposes only to demonstrate abrdns’ investment management style and not as an indication of performance.

Important information

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The value of investments and the income from them can fall and investors may get back less than the amount invested.
Past performance is not a guide to future results.
Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
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Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
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