Fund Highlight: Guinness Atkinson Inflation Managed Dividend Fund (GAINX)
Most mutual funds set pretty broad goals, like capital appreciation or a high level of dividend income. Newly minted Guinness Atkinson Inflation Managed Dividend Fund (GAINX), however, has taken a more direct approach—the fund’s objective is to “…seek a moderate level of current income and consistent dividend growth at a rate that exceeds inflation.”
That’s a lot more specific, and a lot harder, than it sounds. It’s one thing to buy dividend-paying stocks that have a history of increasing their disbursements, it’s an entirely different animal to include fund-level dividend growth as part of the mandate. So, dividends at the company level take on a whole new area of importance with this fund.
Interestingly, though, dividends aren’t the first thing co-managers Dr. Ian Mortimer and Mathew Page look at. In fact, dividends don’t even show up as an issue until pretty late in the selection process. Although this may seem odd at first, it isn’t when you think about what the fund is trying to achieve—a moderate level of current income and consistent dividend growth. A company’s ability to increase its dividend is more important in the magnitude of the dividend.
First up in the selection process is what the managers call the “10 over 10” methodology. In truth, “10 over 10” is marketing spin that simplifies a pretty complex process. From a big picture perspective, the first step in screening a total universe of about 14,000 companies is to select only those that have achieved a cash flow return on investment (CFROI) of over 10% every year for 10 years.
Individual investors can’t calculate CFROI because a team of accountants at Credit Suisse calculate this number and constantly update the figures. Mortimer and Page stress the complexity of this metric by highlighting the fact that Credit Suisse has a team of hundreds dedicated to maintaining the database used for this portion of the fund’s investment process. The managers use this measure because they believe it allows them to compare companies across countries, stripping out the impact of such complicating factors as different accounting practices.
Putting that into plain English, the first step is to pick out companies that have a history of earning consistently high returns on capital. In any given year, a 10% CFROI places a company in the top quartile of the database. By requiring that a company must achieve a CFROI above 10% every discrete year puts the bar even higher. This helps to weed out cyclical companies and those that have had just one or two really good years and brings the potential list of candidates for the fund down to about 400.
The choice of 10% and 10 years sounds good for a marketing pitch, but the managers stress that they put a great deal of time and effort into testing and retesting their data to come up with those two figures. Whether coincidence or not, research backed up the fact that this combination would give them useful results without being overly stringent—the basic tradeoff when constructing any data screen. Moreover, this same research showed that the top performers identified by the screen tended to continue to outperform.
With a smaller universe, about 400 or so companies, Mortimer and Page weed out smaller companies (less than $1 billion in market cap) and those with heavy debt loads. The reasons are pretty logical, excessive debt makes it harder to maintain performance through difficult periods and smaller companies are prone to more volatility of performance and share price movement. This drops the potential universe down to about 300 companies.
Now, the managers use Guinness Atkinson’s Four Criteria Process, another fun marketing term. This is a systematic approach to rank the final stock candidates on value, quality, investor sentiment, and price momentum. Each of these components has measures associated with it that are unique to the fund company’s approach. The end result is a list from highest ranked to lowest ranked; this fact is more important than minutia of the process.
This list is used to generate ideas. Clearly, companies at the top of the heap are potential purchase candidates. Those at the bottom are less attractive. The bottom of the list also helps inform sell decisions, as a low ranking clearly indicates that there may be better investment options available. And, now that there is a list of ideas, the managers look at dividends.
With the extent of the process before dividends being considered, it’s almost easy to forget how important they are to the fund’s objective. The managers were very clear that dividends only come in after all of the other processes because they don’t want to find a dividend paying company and try to convince themselves that it is a good investment opportunity. They want to find good investment opportunities first, and then decide whether or not those companies can provide the dividend and dividend growth they are seeking.
On the dividend front, it is important to note that Mortimer and Page are not running a high dividend fund. They are seeking investments with solid dividends that have a high likelihood of increasing their disbursements over time. So a compelling dividend payment history (regular increases) is a more important factor than dividend level (a high yield). That said, at present a dividend yield of about 2% dividend yield is the lower range of what the managers will normally consider. Of course, market action affects this level, as does the individual companies being considered—a “great” company with a bright future selling at a low valuation probably wouldn’t be excluded from consideration just because its dividend was below 2%.
After all of this, the managers are looking for a fairly concentrated list of 30 to 40 companies to purchase. They chose to have a concentrated portfolio for multiple reasons, including the mathematically based fact that the benefits of portfolio diversification tend to become less significant after a certain number of stocks are purchased. On a more functional level, the managers also wanted to ensure that they knew the companies in the portfolio in great detail rather than just having a cursory knowledge of hundreds of companies.
One other factor about the fund is interesting—the managers roughly equal weight the portfolio. There is no hard and fast rule about equal weighting; however if a holding increases in value enough that it is becomes overweighted, it will be trimmed with the proceeds placed in positions that are underweighted. In this way, the managers are forced to take profits from winners and invest in stocks that presumably have a lower valuation. Using this approach also limits the downside risk of any one holding, since no one position will account for a disproportionate amount of the fund’s assets. Moreover, each security will be able to contribute roughly equally to overall performance, so there can’t be a reliance on a small number of holdings to boost returns. The managers expect that true change in the portfolio will be on the order of 20% to 30% per year.
The fund is brand new, so there isn’t a lot history to go on. That said, while the fund was three years in getting to the shores of the United States, a similar product has been available, and managed by the same duo, The United Kingdom for over a year. So there is some experience behind the approach. Additionally, the fund’s expense ratio is around 68 basis points, which is quite a bit lower than average for equity funds.
The target is for a portfolio yield in the 3% to 4% range, which means that, after expenses, investors are likely to see a dividend closer to 3% from the fund. Although there can be no guarantee, the goal is for dividend growth of between 5% and 10% over the longer term. This is the part that will be hardest to achieve. However, if they reliably select companies that are top performers with solidly growing dividends, the goal seems attainable.
Investors interested in growth of income, rather than a high level of income, may find this fund appealing. As a new fund, it is something of a leap of faith, but with holding like Total SA (TOT), Aflac Inc. (AFL), Microsoft (MSFT - Free Microsoft Stock Report), VF Corp (VFC), Kraft Foods Inc (KFT - Free Kraft Stock Report), Procter & Gamble (PG - Free Procter & Gamble Stock Report), Johnson & Johnson (JNJ - Free Johnson & Johnson Stock Report), Wal-Mart Stores (WMT - Free Wal-Mart Stock Report), PepsiCo Inc (PEP), and Coca-Cola (KO - Free Coca-Cola Stock Report), the fund certainly has a solid foundation from which to grow.
The fund’s minimum investment is $10,000, with subsequent minimum investments set at $1,000. While the no-load structure of the fund should be appealing to smaller investors, a relatively steep initial investment and the large subsequent investment requirement would likely make this fund more desirable for an investor with a lump sum to invest. The objective of the fund, meanwhile, would likely appeal to an investor near or in retirement looking to generate a growing income stream, so the investment minimums may not be a big issue. If you can afford the entry price, like the objective, and believe that the relatively untested investment approach will yield solid results, this new fund is definitely worth a closer look.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.