No matter how many working years you have ahead of you, you had better get used to the possibility that interest rates could remain very low for decades and that you may need a new income strategy for achieving financial independence.
Michael Clarfeld, who co-manages the $6.7 billion ClearBridge Dividend Strategy Fund SOPYX, +0.69%, pointed to a trend that can help investors build income over the long term: the decision of many pipeline operators and alternative asset managers to convert from limited partnerships to corporations.
Many investors have shied away from limited partnerships because of the tax complications tied to a Schedule K-1 rather than a 1099-DIV form. Becoming a corporation makes them eligible for inclusion in benchmark indexes like the S&P 500 SPX, +0.74%, and funds and exchange-traded funds that track the index will then buy them.
In addition, pipeline operators and private-equity firms tend to be cash cows that will keep raising their dividends, making them prime candidates for this strategy of building income.
The brutal environment for investors seeking income
Why look more intently at dividends? Consider this simple math: If you save up $1 million for your retirement nest egg and invest it in securities paying interest or dividends with an average yield of 5%, you’re looking at $50,000 in annual income. But what if those old assumptions about interest rates and yields have become unrealistic?
Before the 2008-2009 financial crisis, investors had grown used to economic growth, followed by central banks raising interest rates to keep the lid on inflation, then recession, then a lowering of interest rates to spur recovery before finally a return to economic growth. But all that has changed.
The U.S. economy is still growing, but the Federal Reserve seems likely to resume cutting interest rates. The yield on 10-year U.S. Treasury notes TMUBMUSD10Y, -0.43% has declined to about 2.08% from 2.69% at the end of last year. More than $13 billion in European and Japanese government bonds have negative yields. It is conceivable that this trend of low and negative rates could continue for decades.
That means you won’t be able to rely on the traditional “safe” course of relying on bonds for interest income. You may have to build income by holding shares of companies that can continually increase their cash flow and dividend payouts for years and years. There are plenty of mutual funds and ETFs that focus on identifying companies that are most likely to increase dividends.
The opportunity from conversions from limited partnerships to corporations
Clarfeld said “equity dividend investing provides a good opportunity in this market, because you can buy quality companies with higher yields that we believe, with pretty high conviction, can grow their dividends for the conceivable future.”
“If rates go lower, you will do well in these securities. This is where you want to be,” he said.
And if high inflation were to return and interest rates then rise, “the dividend growth will be a powerful offset,” he said
In his search for solid companies that will continue raising dividends, Clarfeld is looking at both energy pipeline operators and alternative asset managers.
He named Williams Cos. WMB, -4.52%, which is already a corporation, as a pipeline operator held by the ClearBridge Dividend Strategy Fund. The current dividend yield for Williams is 5.78%, based on the closing price on July 25. Clarfeld expects the company to meet its stated advantage of raising its annual dividend “in the high single digits” annually for the foreseeable future.
Many of the largest alternative asset managers and private-equity firms, including Blackstone Group BX, +0.04%, Apollo Global Management APO, +0.25%, Carlyle Group CG, +0.16% and KKR & Co. KKR, -0.33% have announced plans to convert to corporations. Ares Management ARES, +0.89% did so last year.
Clarfeld stressed that these asset managers have a tremendous advantage over mutual-fund managers: Most of their services aren’t available to retail investors and they require multiyear commitments from most of their institutional clients. “They don’t have to worry about redemptions,” he said, which means they are not forced to invest at unattractively high prices or sell into declining markets.
They also “generate tremendous cash flow and distribute almost all of it to shareholders,” Clarfeld said.
Blackstone is the only one of the alternative asset managers mentioned above that is held by the ClearBridge Dividend Strategy Fund. Blackstone announced its conversion on April 18 before the market opened. Since the close on April 17, the shares have risen 37% through July 25. The current dividend yield for the stock is 3.86%.
Examples of income builders
These two examples show how this strategy works. Both companies have been growing income for investors over the past five years. Home Depot is one of Clarfeld’s largest holdings; he said he also owns shares in McDonald’s and called both excellent examples of the type of long-term holding he and his colleagues look for.
• If you had purchased shares of Home Depot HD, +0.63% at the market close on July 25, 2014, you would have paid $81.03 a share. The quarterly dividend at that time was 47 cents a share, so the dividend yield was 2.32%.
Fast-forward to July 25, 2019 and the closing share price was $215.55, while the quarterly dividend had increased to $1.36. The current yield for an investor who just bought the shares is 2.52%. But for those who bought five years ago, the yield on those shares would now be 6.71%. Assuming you hadn’t reinvested the dividends, your original investment would have grown by 166%.
• If you had bought McDonald’s MCD, +0.53% at the close on July 25, 2014, you would have paid $95.72 while the quarterly dividend was 81 cents a share, for a dividend yield of 3.38%. Not bad, but not spectacular either.
The shares closed at $214.44 on July 25, 2019. The quarterly dividend is now $1.16 a share. So the current yield for an investor who bought the stock on July 25, 2019 is 2.16%. But for the shares bought on July 25, 2014, the dividend yield would be 4.85%. And your investment would have more than doubled in value.
Fund holdings and performance
Here are the 10 largest holdings (out of 56) of the ClearBridge Dividend Strategy Fund as of June 30:
|Company||Ticker||Dividend yield||Total return – 2019 through July 26||% of fund|
|Microsoft Corp.||MSFT, +0.82%||1.31%||39%||4.1%|
|Blackstone Group Inc. Class A||BX, +0.04%||4.16%||71%||2.9%|
|Home Depot Inc.||HD, +0.63%||2.52%||27%||2.8%|
|Comcast Corp. Class A||CMCSA, +0.04%||1.88%||32%||2.7%|
|Merck & Co. Inc.||MRK, -0.39%||2.69%||8%||2.5%|
|American Tower Corp.||AMT, -0.40%||1.68%||31%||2.4%|
|Apple Inc.||AAPL, +0.35%||1.49%||32%||2.4%|
|United Technologies Corp.||UTX, -0.54%||2.16%||30%||2.3%|
|JPMorgan Chase & Co.||JPM, +0.44%||3.11%||21%||2.1%|
|Mastercard Inc. Class A||MA, +0.97%||0.47%||49%||2.1%|
|Sources: Legg Mason Global Asset Management, FactSet|
The ClearBridge Dividend Strategy Fund has a four-star rating (out of five) from Morningstar for its institutional shares SOPYX, +0.69%, which have annual expenses of 0.74% of assets. The fund has several share classes with varying expenses (and possibly sales charges), depending on how the shares are purchased. If you purchase shares in any mutual fund through an investment adviser, it is very important to discuss the total expenses paid, including the adviser’s fee.
ClearBridge Investments is a subsidiary of New York-based Legg Mason LM, +0.93% that manages about $150 billion.
Here’s how the institutional shares have performed against their Morningstar category and the S&P 500:
|Total return – 2019 through July 25||Average return – 3 years||Average return – 5 years||average return – 10 years|
|ClearBridge Dividend Strategy Fund – institutional shares||22.8%||13.0%||10.1%||12.8%|
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