Fund Spotlight: seeking sustainable income from dividend-growth stocks

For income investors, there are distinct approaches to generating dividends. One is to target already high-yielding dividend shares, while another focuses on dividend growers – companies with lower yields initially, but that have the potential to increase dividends over time.

The Baillie Gifford Responsible Global Equity Income fund embraces the latter. Its management is less fixated on today’s yield, believing instead that prioritising dividend growth delivers more income in the long run, as such companies boast strong growth projections and the capacity to sustainably increase profits. In contrast, high-yielding shares often represent mature companies in a post-growth phase, making their long-term high yields potentially unsustainable.

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While sustainable funds in recent years have seen rising levels of demand, options for investors in certain sectors are sparse, including Global Equity Income. The fund stands out as one of just a handful (seven) of the wider global equity income universe that are managed to a sustainable mandate.

The investment objective is to grow both income and capital over rolling five-year periods, while delivering a yield higher than the MSCI All Country World Index (ACWI). The current yield of the fund is 2% compared with 1.92% for its benchmark.  The £1.5 billion strategy focuses on large sustainable stocks that offer resilient dividend payouts and are managed responsibly with environmental and social impact in mind.

The team employs in-depth, bottom-up stock picking to identify companies that have really strong growth opportunities to increase sales and profits for at least the next 10 years, as well as robust competitive advantages and elevated cash generation to ensure profit can be passed on to shareholders.

In addition, the fund adopts a sensible sustainability-focused mandate rooted in Baillie Gifford’s Impact, Ambition, Trust (IAT) framework. This framework guides the team in evaluating sustainability risks and opportunities, prioritising value-driven and forward-looking assessments over backward-looking metrics.

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Leveraging the IAT framework, the team gains a holistic view of a company’s environmental and social impact, the long-term ambitions of management, and their commitment to implementing these activities. This approach has facilitated the fund's objective of identifying innovative and resilient businesses, resulting in a portfolio of high-calibre holdings.

The fund’s long-term nature, with an average holding period of eight years, supports its robust engagement strategy, which focuses on building meaningful relationships with investee companies. The team believes this provides an edge when engaging on complex sustainability issues and enables the fund to capitalise on future outcomes.

James Dow has successfully led the strategy since 2018, joined by Ross Mathison in 2022. The co-managers are supported by four analysts and a sustainability specialist, who has the right of veto over any stock decision.

What does the fund invest in?

The portfolio comprises 56 holdings, with 38% of the assets in the top 10 names, focusing on large-cap companies with market capitalisations over $10 billion.

The fund’s focus on income results in a preference for high-quality stocks, characterised by consistent profitability, solid balance sheets, and the ability to sustainably grow dividends over the long term. These stocks constitute approximately 75% of the portfolio. The remaining 25% includes more opportunistic companies with stronger short-term growth prospects, albeit with uncertain dividend sustainability over the long term.

While the fund has no country or sector restrictions, it limits individual stock exposure to 5% for diversification reasons. Geographically, 41% of the portfolio is allocated to North America (-14% versus MSCI ACWI). France (9%) and Switzerland (8%) represent the subsequent largest country exposures. Sector-wise, the fund displays significant overweights in industrials (+22%) and technology (+16%) versus the benchmark, with no holdings in the energy and utilities sectors.

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The largest holding is Novo Nordisk A/S ADR (NYSE:NVO) (5%), the diabetes drug manufacturer that became Europe’s largest company in 2023. The team perceives it as offering a resilient dividend and robust growth prospects, attributed to its competitive advantage in manufacturing complex drugs and supplying the unmet demand for those living with such conditions.

How has the fund performed?

Despite recent growth-style challenges, the Baillie Gifford Responsible Global Equity Income fund has demonstrated strong performance since inception, delivering a 69.1% return over five years, outperforming the benchmark and peers by +5.6% and +27.6%, respectively. Success is in part attributed to effective stock selection driven by thorough implementation of the strategy.

Like most sustainable strategies, the fund had a tough first half of 2022, in an environment of rapid inflation and rising interest rates, lagging mainstream peers due to significant overweights to technology and industrials. Mainstream income-focused peers benefited from strong performance in typical dividend-paying stocks, such as oil and tobacco, ordinarily excluded from sustainable funds. However, the fund rebounded in 2023, doubling the return of mainstream peers delivering 15.2%. Performance benefited from substantial positions in Novo Nordisk, Watsco Inc Class A (NYSE:WSO) and Microsoft Corp (NASDAQ:MSFT).

Source: Morningstar Total Return (GBP) to 30/04/2024. Past performance is not a guide to future performance.

Why do we recommend this fund?

The Baillie Gifford Responsible Global Equity Income fund has effectively implemented the unique strategy since 2018. Despite some persistent biases, compared to peers, the fund has consistently outperformed the benchmark in absolute terms since inception.

The focus on both capital and yield growth, a rarity versus sustainable peers, makes it an attractive option for boosting the spending power of capital over the long term. This can be pertinent in high inflation and interest rate environments, where a combination of capital and yield growth can generate returns that surpass inflation.

While the yield of 2% may fall on the lower end of the yield spectrum, this achieves the team’s objective of beating the benchmark’s 1.7% yield and is roughly aligned with peers. With a very competitive ongoing annual charge of 0.53%, one of the lowest among peers, this fund stands out as a core global equity income option on ii’s ACE40 list.

Please find the latest factsheet here.