The SIM Global Equity Income Fund was launched in September 2012 to offer investors the opportunity to invest in a fund that strives to deliver an attractive and growing stream of annual income derived from dividends, while at the same time generating real growth in investment capital on a rolling three-year horizon, by investing in shares globally. Given the extremely low-interest rates and bond yields available in most of the world, funds like this are very popular overseas, particularly in Japan and the United Kingdom. Being locally managed by Denker Capital, this fund is the only one of its kind available to South African investors as a rand-denominated feeder fund.
It is axiomatic that the return generated by any equity investment comes from only two sources, capital appreciation (i.e. change in the share price) and income (i.e. dividends received). Because the former tends to be where most of the short-term excitement occur, it has become the feature investors and market commentators obsess about to the exclusion of the incredible long-term returns that can be achieved through the patient compounding of consistent dividend income.
The power of this compounding becomes obvious when one compares the returns generated by the MSCI World High Dividend Yield and the MSCI World indices. The high yield index comprises a subset of the highest yielding companies in the global index. In each case the difference between the total return (solid line) and price return (dotted line) is simply the additional return earned by reinvesting the dividends received. Notice how much bigger the reinvestment benefit is in respect of the higher yielding index, while on a price-only basis the performance of the two indices was far more comparable.
It is precisely this compounding effect that the SIM Global Equity Income Fund seeks to harness in a manner that differentiates it from most other equity funds. Its mandate demands an intense focus on achieving an annualised yield significantly greater than that of the overall equity market through investing in companies that are reliable dividend payers, yet trade at higher than average yields. Where the income paid out by a typical equity fund commonly accrues almost by accident, because the manager is fixated on capital appreciation only, we actively seek out companies that offer an above-average dividend yield and then ensure that we are there to collect our dividends when they are paid. By doing this we have managed to provide our investors with an average annualised yield in excess of 4% in US dollars in each of the past three years. This compares very favourably with the yields that were obtainable from other types of investments during the same period. It is important to recognise that this was not a notional yield, but actual cash money received that could be reinvested or spent.
An added attraction of targeting dividends as a source of income is the fact that successful companies tend to increase their dividends from year to year and are usually loath to reduce their dividends, even during difficult times. By selecting one’s companies carefully it is possible to construct a portfolio that will deliver a highly predictable and growing stream of income through most economic and market cycles. Those investors who patiently reinvest this income will begin to notice how the proportion of their investment value attributable to the reinvested income begins to swell as the miracle of compounding starts to work. Studies have shown how this component of the investment return comprehensively dominates price changes in the long term. The challenge for investors is that it requires patience and that, to quote Charlie Munger, is “hard”.
The good news for our investors is that our focus on dividends does not mean that the possibility of capital appreciation is excluded. Sustained changes in the share prices of companies result from changes in their earnings. Growth leads to higher prices, while stagnation or decline leads to lower prices. Gratifyingly, for us, it has been shown that companies that pay a large share of their annual earnings out as dividends tend to grow their earnings faster than most other companies in subsequent years. This counter-intuitive truth means that the potential for capital appreciation of the companies that tend to interest us is often underestimated by the rest of the market. Through careful selection we have, as a result, been able to also deliver on the fund’s second objective, namely achieving real growth in the investment capital.
We are pleased with the behaviour and performance of the fund during its first three years of existence and remain confident of our ability to continue to achieve the income and capital appreciation objectives that have been set. Should we succeed, patient investors will be handsomely rewarded.
 Robert D. Arnott and Clifford S. Asness, “Surprise! Higher dividends = Higher earnings growth.”, Financial Analysts Journal, January 2003.