Richard Marwood: dividends are back on the menu as earnings recover

Transcript

Merryn Somerset Webb: Hello, and welcome to the MoneyWeek Magazine Podcast. I am Merryn Somerset Webb, editor-in-chief of the magazine, and with me today I have Richard Marwood, who is a senior fund manager at Royal London Asset Management and the manager of the Royal London UK Dividend Growth Fund and the Equity Income Fund.

Now, I know this is going to be particularly interesting to all of those of you who have been horrified by the fall of annual dividends over the last year and are desperate to know when you're going to start getting your money again. So Richard, welcome. Thank you so much for joining us.

Richard Marwood: Thank you for having me here Merryn.

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Merryn: I wonder if we could just start perhaps, if you could tell us a little bit about the two funds that you run, what the difference is between them, because they sound kind of similar?

Richard: Well, they are similar in that they're both focused on dividend-paying stocks. The slight difference in them is that the Dividend Growth Fund doesn't have to yield more than the equity market does overall. And it plays in the peer group against all other growth funds. But the income is still a very important part of the strategy. And it's not that we're investing in very, very low yielding or nil-yielding stocks, it is still focused around dividends, they just don't have to be particularly high.

The main Income Fund is a classic equity income fund where you're putting together a portfolio that will yield more than the market overall.

Merryn: OK, so the Equity Income Fund, is that mainly aimed at retirees? Who are the investors? Institutional investors or individual retail investors trying to deal with their pension freedoms? Who's in these funds?

Richard: It's a real mixture, to be honest, we've got institutions, we've got some, a lot of charity clients, council clients. We've got individuals, it's a very wide range. It's suitable for lots of different types of people.

Merryn: OK, brilliant. Well, let's talk then about what has happened over the last year because obviously, your funds will have been hit very hard from March onwards last year, when companies started to slash their dividends.

Richard: Oh, yes. It was a very, very tough year last year for income funds. For UK equity in general, it wasn't an easy year, but it was particularly difficult for the equity income space, because a lot of the higher paying dividend companies were particularly badly hit.

But the UK market found itself in a particularly problematic place, I think, last year, because the shape of our market make it very susceptible to Covid hits; we've got large amounts of consumer and leisure types of stocks, things that are reliant on physical activity, like the oil companies, that make a large part of our market. And so it wasn't the place to be.

Also, then there was the issue that we didn't know exactly what was going to happen with Brexit. And that put off a lot of overseas investors. And the icing on the cake was that the UK market was probably seen as particularly unsuitable for the theme of ESG because we've got a lot of mining companies, and because we've got a lot of oil companies.

So there are lots of reasons for people not to want to allocate towards UK equities. And that got reflected in valuations. If people aren't keen on an asset class, it does tend to go down because you'll get more sellers than buyers.

Merryn: Yes. So, basically, we have a market that is geared towards the world on the move, not a world that's stuck at home, whereas the US has a market that is much more geared to people being stuck at home, in a nutshell, right?

Richard: Yes, they've got a the much bigger tech weighting as well, and tech came to the fore last year as people were doing things remotely rather than physically.

Merryn: And Brexit: that's finally been resolved, or I'm sure lots people will think it hasn't been resolved, but it's been resolved as much as possible. Do you think that foreign investors have now forgotten all about it, in that before it was resolved, when you asked foreign investors what it was about Brexit that made them nervous, they weren't really entirely sure. They just wanted it resolved, out of the way, something that was no longer sitting around in their strategy papers as being scary. Have they just forgotten about it now? Does it matter anymore?

Richard: I think they've probably moved on, actually. The main thing that most investors hate is uncertainty, and no one really knew exactly how Brexit was going to play out. And lots of people were talking about really quite scary scenarios of lots of goods stuck at borders, big shortages of goods in the UK. And while there have been quite a lot of teething problems, it hasn't been the disaster that some people maybe feared it would be. At least now it feels like a known quantity.

Merryn: Now, you say people feared – I think lots of people were longing for it to be a disaster. Lots of disappointed people. But it's a bit like Covid. It really tells us something about corporate capitalism, doesn't it? I've been absolutely amazed.

We've had Brexit and various issues and problems and-non problems around that. We've had the shutdown of the global economy. But for us here in the UK there's been almost no obvious dislocation. You know what happened for about three days in March last year? Some shops ran short of loo paper. But apart from that, the companies of the world have somehow managed to keep the global economy going such that we haven't really been short of anything or noticed any particular change. I think it's rather amazing.

Richard: Definitely. If we think about the job that the supermarkets did last year, they did an absolutely remarkable job in dealing with a huge surge of demand, clearly, because everyone was buying all their stuff from the supermarkets rather than going out to cafes and restaurants. And we dealt with that well and good.

Merryn: Yes. And the way that the the restaurants shifted to delivering meals to you directly, and the way that logistics companies ramped up their supply, etc. I really think that everyone should look at the last year and go, "wow, capitalism, so great". That's not what they're doing, but I think they might be making a mistake.

Anyway. Onwards. So what can we expect now? We're looking around us in the UK, we're seeing these all the restrictions finally being lifted and weird stuff about – there was a newspaper headline yesterday about our new freedoms, as opposed to our actual freedoms being returned. But that's not for this podcast.

But here we are moving into an environment where we're getting back to our old lives where there is a huge amount of cash in people's bank accounts, the saving rate has gone absolutely berserk – nearly 30% at its peak – so people have a lot of spare cash. The sun's out, well it is an Edinburgh where I am anyway, and everyone's about to get out and about again.

Are you a believer in the idea that – I know the UK did not have a Roaring 20s in the last century, that was the US – but are we about to have our own Roaring 20s here in the UK?

Richard: Well, there certainly is an awful lot of pent up demand. And, as you say, there's both the demand and, in many cases, the ability to pay for it. Because people – if they have managed to keep their jobs in the last year – haven't been spending very much and they have saved a great deal. So yes, all the evidence that we're seeing is, as the restrictions start to ease, people are very, very, very prepared to go out and spend, be it on going out to eat, or going back to the shops

There seems to be something of a housing boom going on, and people who aren't moving house are also spending more on their houses, because they spend more time at home, they're doing them up and making them as nice as possible. So there is a lot of spending going on.

Probably the the area that we haven't really got to the bottom of yet is what's going to happen with travel and people going on holiday because that might take a little bit longer to recover, because it's still not absolutely clear that that's going to be straightforward and back to things as they were.

But yes, things are normalising and that's what we're seeing. And when we look at a lot of the corporate results, they've generally been quite reassuring, it has to be said.

Merryn: Yes. On travel, though, isn't it – well, for me personally, I would very much love to go to Greece for a couple of years – a couple of years? A couple of weeks, I was going to say! Or forever! – we’ve just been through another Scottish election; everyone wants to go to Greece, or somewhere.

But in a way, isn't it slightly better for the UK economy if travel abroad stays difficult? And in fact, that we do all holiday here, we use up every cottage, every hotel room, every restaurant reservation and bring our own hospitality industry back up to speed? Isn't that maybe slightly better for the economy? If not for perhaps our mental health.

Richard: Well it would certainly keep a lot more money in the economy. The question then would be the ability to deal with it. Because firstly, it would probably be a little bit more demand than the leisure system is normally used to dealing with. In the last year, we've seen a little bit of destruction of supply, because unfortunately some people will have gone out of business. And if you've then got an awful lot of demand to cope with it, it might be tricky.

Which does lead me on to thinking that there may be an element of inflationary pressure. Because if you haven't been able to go out and eat in a restaurant for the last year, if you go out now and all of a sudden a main course has gone up by a couple of pounds, chances are you won't really mind paying it. And you might find that if you're in a village that used to have three or four pubs, it's now only got two or three, so it's a bit more of a consolidated market and they've got a bit more pricing power. So I think that's one risk that we've got to keep a close eye on.

Merryn: Yes, interesting. Finally, next week in Scotland, you'll be able to go out to dinner, sit inside and have a drink, which is exciting, because you can't rely on being able to sit outside here. And when my husband rang to try and make a reservation at somewhere we wanted to go earlier in the week, we were told that the actual reservation itself cost £20.

Richard: Really? And that wasn't a minimum spend? That was just to get the slot?

Merryn: It wasn't clear; he did it online and it wasn't clear whether the money would be set against our gin and tonics or not. We'll find out; I'll report back.

Do you think that inflation will just be a flash in the pan? Or do you think there's something more long-term going on? We've heard a lot about the difficulties in supply chains. And we've seen sharp rises in a lot of commodity prices. And also, of course, there is the shortage of chips.

So there are a lot of things happening in the supply chain that suggest that there is much higher inflation than a lot of people are prepared to accept coming. But is that just a blip? Or is it a more long-term dynamic, a swapping round of the last 30, 40 years of low interest rates and deflationary pressure?

Richard: It's tricky to know. But there certainly is an awful lot of inflationary pressure. There is that supply and demand thing that we've talked about already, as you say. Commodity prices have been very strong, and we may be looking at a world that is going to be slightly less global. So people might look for maybe shorter supply chains, rather than necessarily just the cheapest supply chain.

There's been a lot of money pumped into the system, and I think the thing that might be different this time round to the great financial crisis would be that last time when money was created by governments, a lot of it just went and sat on bank balance sheets and didn't necessarily go anywhere. But this time, a lot of the stimulus has been direct to individuals and direct to companies – it's furlough, it's various kinds of support. So it's, it's actually gone, and it's out there in the economy.

So there are reasons to think that inflation could pick up. The only thing that really hasn't come through yet is wage inflation, but I think if we get to a stage where there is significant wage inflation, then inflation almost becomes a self fulfilling prophecy, it becomes a reinforcing loop. And the thing that we don't know yet, just to come back to what we were saying about Brexit, is labour availability. Is the labour market tighter in a post Brexit world as we get fewer people coming across from the continent?

Merryn: And also there may be a shift in what people are prepared to do, or not prepared to do. Getting people back into offices may involve paying them more to do so; may involve bonuses; may involve all sorts of different things.

And we're certainly seeing in the US, aren't we, where unemployment benefits have been unbelievably generous – or surprisingly generous, should I say – over the last year or so this dynamic of people saying, “I don't really want to go back to back to work full time for the amount that I was paid before”, and the price has gone up. So that may well feed into wage inflation across the board.

Richard: Particularly because, as we mentioned earlier, if you've been employed in the last year, and you've been working from home, it hasn't cost you very much to go to work. So actually to be in an equivalent position when you go back to the office, you probably do need to be paid a little bit more.

Merryn: You need to be topped up a bit. Yes. Oh, interesting.

OK, so let's go back to dividends. When can my long suffering readers expect the cash to start pouring into their pockets properly again? When will we see dividends back up in the UK at the levels that they were, say, in February last year?

Richard: Well, to get back to that level may well take a little while. At its worst last year, we probably saw dividend cuts down around 45%. But that was at the worst. And what we've seen since then is many companies starting to resume dividends again.

So if we think about why companies cut last year, some of the sectors were told that they weren't to pay dividends. If you look at a bank, or some of the insurance companies, they were told by the regulator, just please don't pay dividends, because we want you to keep the capital as a safety buffer.

Some companies were just being prudent; they didn't really know how things were going to play out, so they thought they'd just hold back the money. And a lot of them have actually come back later in 2020 and early 2021 and started paying them and some people have even actually paid catch-up dividends as well.

And then there was a sort of third camp. There were some businesses that were genuinely fighting for survival. So if you were a business that was reliant on leisure or tourism or travel, you were trying to absolutely minimise your cash burn. And you're probably still in that mode. Those are the businesses that haven't come back to paying dividends yet.

So when we look in our portfolio – we own something like WH Smith, which as you can imagine, is reliant on people going through train stations or going through airports. They're still in a mode where they don't want to be letting in too much cash leave the business until the business fully recovers. So it's a business that we like, but they're not back on the dividend list yet, but many other things have already returned.

Merryn: You're confident holding WH Smith? Presumably it's quite cheap?

Richard: Well, yes, it's recovered a long way actually. One of the things that makes us a bit more confident there is that a lot of their business is in the US now. And if you look at the amount of traffic that's going through US airports, because so much of it is domestic, that's recovered quite a long way already. So there's plenty of reasons for optimism there.

Merryn: Right, let's have a look valuations across the board then. We've been writing at MoneyWeek for about a year now telling everybody the UK is cheap, the UK is cheap. It's cheap, you should buy the UK. Obviously, that would have been a mistake in March last year, but it's come good now. Is the UK as a whole still cheap relative to global markets?

Richard: Certainly it is relative to other markets. Now, I think one really strong proof point on that is how many bids you've seen come through into the UK market. A lot of investors may have been allocating away from the UK in 2020. But towards the back end of the year, we started to see lots of corporates stepping into the market.

So in our own portfolio, we had McCarthy and Stone, the retirement house builder, that got bought by private equity. Signature Aviation was acquired by private equity as well. And we've also seen other bids elsewhere, mostly from private equity. So you can see St. Modwen being bid for this week; John Laing's had a bid approach; Agrecco has had a bid approach.

There's a lot of money out there in the private equity world. And it's looking at some of these quoted equity valuations and thinking, well, actually, there's an opportunity here, and they're stepping in to try and take advantage of that.

Merryn: Does that worry you? One of the things that we've written about a lot over the last decade or so is this shrinking of the listed market, and this idea that as the markets shrink – or the markets that everybody has access to shrink – you get undesirable effects. Like, perhaps, it's one of the drivers behind rising wealth inequality, if all of the growth is happening off market; and perhaps it's one of the drivers of people feeling a little iffy about capitalism, because the companies that they know the names of they can't actually buy publicly.

And then there was a study about a decade ago, showing that as the number of listed companies in any one country falls, so the government, driven by voters, becomes less pro-business.

Richard: it certainly does, because to an extent, it doesn't tend to be the worst businesses that get acquired, it's often the best businesses that are doing interesting things or have got an interesting market position or an interesting technology. If it's your best businesses that have been bought by other people, then that is a worry.

I think also, there's an element of concern around. At least when a business is in the public market, it is very visible, it has to adhere to quite high governance standards. A lot of its activities are very visible to shareholders and to the public. But once things move off market, clearly that visibility reduces and in a time when we're all very keen on governance and scrutinising what companies are up to, it is harder if they're not quoted.

Merryn: Yes, well, that actually brings me to something I wanted to talk to you about, which is that if you look at some of the stocks in your portfolio, so Shell and BAT and Rio Tinto and all this kind of thing, a lot of the ESG advocates will say, well, that is not a suitable portfolio. It's not an ESG portfolio. Basically, it's an anti ESG portfolio.

But I suspect that one of the things you might say is, do you want these companies listed where we can watch them? Where they're forced to have ESG strategies of some kind or another? And what they do is transparent? Or do you want them off market because we've let them get so cheap that private equity picks them up? Is that the way you would look at it?

Richard: That's certainly one of the angles that we look at it. There is that visibility, there is the ability to engage with these companies and influence what they do. And ultimately, when you look at something like Royal Dutch [Shell], or you look at Rio Tinto, they do things that make the economy function the way that it does; we still need them to be around.

I know, there are lots of question marks about oil. The world might be falling out of love with oil, but it's not falling out of love with energy. There are more people in the world all the time consuming more and more energy, and it's got to come from somewhere. And you need someone to help develop the infrastructure to achieve that. I think we need to encourage these companies to invest in those areas and help us develop the energy transition.

Merryn: Apart from everything else, we still need the oil, right? We need the oil, and this idea that we can suddenly go oil free in the matter of a decade is nonsensical. We're going to need fossil fuels for decades and decades to come. So why would we not want to support the companies that produce it?

Richard: Well, you're quite right. The last barrel of oil is going to be burned decades and decades into the future. And there's an awful lot of infrastructure to be built up before that can happen. You do need these kind of companies to be encouraged to do it.

And in doing that, step forward someone like Rio Tinto, because if we're going to have lots of electric cars, we're going to have better electricity networks, we're going to need a lot of copper. And that's got to be dug out and refined by somebody. So these people are actually going to enable the energy transition, much as they may not be seen as the sort of classic ESG companies.

Merryn: I suppose another another point to make on some on the miners in particular is that they have quite big moats around them now, effectively, because when they opened some of their big mines a decade ago, two decades ago, it was an awful lot easier to get going on a new mine than it is now.

I'm guessing here – this is not my area – but I assume if you find somewhere you want to open a new mine of some kind, it's a multi decade business to get all the permissions and work with the local governments, work with communities, etc. It's a rather more complicated business than it might have been the old days, when you just dug a hole and got going.

Richard: Well, it's always been quite complicated. But certainly if you look at Rio Tinto's latest project, where they're building a massive copper mine in Mongolia, that's been fraught with difficulties, both political but also just technical. It's an enormous project to build one of these things. And it's often not as straightforward as you might hope.

So supply is not a quick thing to put on it, if we suddenly decided that we need an awful lot more copper. Even if we went and started today to try and expand that supply, chances are you're not going to see anything coming out of a smelter for five to ten years.

Merryn: Interesting. Now, let's talk briefly then about the commodity bull market, which has been on the go for a while. Is it on again? Are we on flash in the pan? Or are we into an environment where you think that the demand for commodities, and so this bull market, will continue for some time? I'm guessing you're going to say it's going to keep going for some time based on what you just said about energy infrastructure? But what do you think?

Richard: Well, I think that is the case. I can see why there is genuine secular demand for a lot of these commodities. And in recent years, there has been quite a restraint of supply in the mining sector. So if you've got more demand and you've got less supply, that does tend to fuel prices. So yes, I think there's, it's got some legs in it this year.

Merryn: OK, so we can still go out and buy the miners and feel confident.

Richard: Yes, we're keeping them in the portfolio. And I think they'll carry on generating the cash flows and taking advantage of these high prices.

Merryn: OK. What's your favourite stock in your portfolio? Fund managers always tell me they don't have favourites, but I don't believe them.

Richard: It's like having children: you need multiple children so there's always one behaving well. So portfolios are a bit like that.

I suppose, if you look through our largest holdings in the Income Fund, there's some fairly unusual businesses in there that take advantage of different things. One of our largest holdings is IG Group, the people that do the financial spread betting, they've benefited enormously from the volatility of the markets. People are interested in markets and they're wanting to trade those. So they've attracted a lot more customers, those customers are trading more and they made a lot of money out of it. So very pleased with that one.

Merryn: Can you use them to spread bet on cryptocurrencies? Not planning on doing that, by the way readers, I am absolutely not planning on spread betting on cryptocurrency prices.

Maybe.

Richard: I suspect you probably can, I would have to check that, I certainly wouldn't be allowed to do it myself.

Merryn: OK, I'm just a bit over-excited this morning by the story we were discussing earlier about the managing director of Goldman Sachs in London being able to retire because he's made such a fortune trading cryptocurrencies, and I'm thinking, “really missing a trick here, fiddling around with trying to make 3% to 4% a year from miners and oil companies”. We are totally missing a trick, right?

Richard: Well, the one thing I do wonder with all these cryptocurrencies is if it is an indication of how much money is being pumped into the system. The money has to go somewhere, be it into the price of art or the price of nice apartments in Chelsea or into football clubs or whatever. It has to go somewhere and maybe that excess liquidity is spilling out into the crypto world now, which is driving prices.

Merryn: Yes, I'm sorry, I interrupted you. Back to IG. It's done very well, after people being home and having lots of money.

Richard: Yes, we've pretty much covered that one. Much more prosaically, another company that we've got an income from that’s done really well for us is Dunelm. As people have stayed at home and they've decided that we'll have another cushion on the sofa, or they want to order a little bit more furniture or some new bedding. They've done really, really well. And that's despite having not been allowed to open their physical stores in the second lockdown. They've done very well online, and that seems to be a trend that they're keeping going with

Merryn: Interesting, I haven't bought any new furniture during lockdown. I've attempted to buy garden furniture... but back to our conversation about supply, demand, and inflation, everything's always out of stock. It's extremely irritating.

Richard: Well, you raise a very, very good point there. This really has tested supply chains. And as you say, it probably means that we're struggling to cope with demand. And if there's a lot of demand, then prices tend to go up.

Merryn: Yes. So maybe I should take back what I said earlier about the only consequences of Covid being a temporary shortage of loo paper. In fact, I can't buy any garden chairs. And that matters, too!

Richard: If you want a shed you'll have to wait three months.

Merryn: But I would get it in the end. And that's the key point.

Now, one stock that you have in your portfolio – I'm not sure if you have it in both – is AstraZeneca. And of course we all love AstraZenca now; I'm having my next jab next week, very exciting. But there's a massive pay row there at the moment. Do you want to tell us about that and how you feel about this?

Richard: Well, yes, there is a lot of controversy about how much the CEO is being paid. It's something that we're still watching quite closely. We haven't decided yet exactly what we think. But I think it'd be hard to say anything other than the CEO has done a very good job.

If we think back maybe ten years ago, AstraZeneca was under tremendous pressure; people thought that they were running out of patent life in their drugs, they needed some new products. And, actually, roll the clock forward ten years and they've developed an absolutely amazing portfolio of oncology drugs, showing very good growth. They've got good market shares in China, the business has really been rehabilitated. They've done a great job in terms of getting the vaccines to market as well. So it's hard to say that they haven't done a good job. It's just a matter of calibrating what is the right level of payment for that success that we've seen.

But it's interesting when you look at the Astra share price, we do own it in both the dividend growth fund and the income fund. But the shares – pretty much from the day that they announced that they've developed the vaccine – have been under quite a lot of pressure, because prior to that they were seen as a safe haven in a locked-down world. And when they actually developed the vaccine and it meant that the the economy may normalise again, all of a sudden people lost interest in that security and were much more interested in the the kinds of businesses that would benefit from the the economy normalising and reopening. So their success meant that their share price went a little bit soggy.

Merryn: So now they look reasonably cheap, under the circumstances.

Richard: Well, they're still performing as a business extremely well. And I think that does come down to one thing that's always very important to remember, when you're investing.

A business exists in two ways, really. It exists as a share price and what investors think of it. But it also exists as a real business and how well it's trading, and the two don't always marry up. So sometimes the best opportunities for an investor is when you've got a business that's operating well, and the market's less interested in it, that's when you get the best bargains.

Merryn: And back to pay briefly, do you normally vote on this kind of thing?

Richard: We are very active at Royal London, and we vote on every holding that we've got. And we engage with companies and speak to them. And we take the angle of stewardship and engagement very seriously, indeed.

Merryn: OK, so there is an ESG angle for those looking for an ESG angle on your fund. At least you're using your shareholder democracy properly.

Richard: Yes, well, I think it is a very important thing to do. Yes.

Merryn: All right. Sorry, I've been talking to you for ages and I apologise. But one last thing I wanted to ask you about.

We talked earlier about M&A, and about how that is a problem because it removes companies from public view or from the public listings, and that comes with various connotations. But one of the things that people are talking about at the moment is a new wave of IPOs in the UK and how that's exciting. I read something the other day that referred to it as a tech boom, which might be over-egging it.

But I wondered if, if you ever participate in IPOs in the UK, if you see anything coming up that you might be interested in?

Richard: We certainly look at everything that's coming. But as you say, a lot of the things that have come very recently have been more of a tech type nature. They tend to be at quite high valuations. They don't tend to be the kinds of businesses that are paying dividends. So it hasn't really been the kinds of things that are going to find their way into my portfolio.

But yes, there are a lot of businesses coming in, there will probably carry on being a lot of listings while the market's prepared to take them and while the market is prepared to put quite high valuation on these things. Then, while the demand is there, the supply will come.

Merryn: Yes. And hopefully they will mature into the kind of dividend paying businesses that can make it into your portfolio.

Richard: I'm sure some well and others may fall by the wayside. But that's the nature of the IPO market, isn't it? You have to watch these things for a while and see which are going to be the durable businesses.

Merryn: Yes, yes. OK, I know I said last question, but last last question. Some of these IPOs are coming through with this idea that it's OK to have a dual structure for shareholders so that a founder can come to market and have more power per share than an ordinary shareholder: one share, two votes, as opposed to one share one vote.

Some people would say that that's OK, because at least it means that people are more comfortable bringing their companies to market if they know that they might have more power over how it’s run over a three- or five-year period. And other people say this just isn't OK. It's not what the public market is about. I wonder if you feel that it's OK, if it at least expands our market? What do you think?

Richard: Personally, I have a bit of a problem with it. And I think the clue is in the name: equity, everyone's treated the same. And if you have these structures, then it's not equal, not not all shareholders are treated in the same way. If people want to retain the power over the company, then maybe they need to keep a larger stake rather than selling such a big chunk of the company.

Merryn: Yes, that is a good way to look at it. Wonderful. OK, that really was the last question. Unless you have anything that I haven't asked about that you really want to tell us.

Richard: Well, there's always lots to talk about with the market as well. I think we've covered quite a lot of topics.

Merryn: Richard, thank you so much. I really enjoyed talking to you. And I hope that you will join us again during the coming Roaring 20s.

Richard: Thank you. It's been a pleasure.

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