SocGen's Dylan Grice Unveils A Brand New Investment Strategy

dylan grice

Photo: www.investmentweek.co.uk

Loyal readers of Popular Delusions, the famous note written by SocGen’s Dylan Grice, are in for a treat this week.He has teamed up with fellow strategists Andrew Lapthorne and Georgios Oikonomou to demonstrate how to “express” the views he proffers on a regular basis in the markets.

“[W]e’ve combined our admittedly modest individual talents to reach an immodest conclusion: that we can create an investable index of equities that we think generates relatively safe income, protects capital, and (even) grows over time.”

It’s called the “Quality Income Index.”

The gist of it is just like it sounds: investing in quality companies that pay out sustainable dividends tend to generate the highest returns over the long run.

The SocGen strategists point out that dividends are the most important factor behind long run equity returns

Source: Societe Generale

Sustainable dividends are key

'The second thing we know is this: dividends are only sustained by companies economically able to sustain them ... But you know what they say about past performance. Things change. Good historic dividend payers can and do hit problems (e.g. RBS or BP to name two)...

Our research suggests that good dividend cover is not a good indicator of how safe that dividend is in the future. In fact we've found that balance sheet quality (as we define it) is the best predictor of dividend cuts ... But as it happens, not only does balance sheet quality provide a good indicator of dividend sustainability, but it is itself likely to be systematically mispriced (i.e. too cheaply).'


Source: Societe Generale

'That means both its balance sheet and its underlying business economics are robust. Note that both are necessary.'

Source: Societe Generale

These are boring businesses with boring balance sheets that are ignored and often underpriced

Grice explains why investors make the mistake of investing in overpriced high-flyer-type stocks:

'We think it's down to what psychologists call the 'possibility effect‛ in which people value potential changes differently ... managers overpay for the possibility of game-changing near-term outperformance in the same way that people overpay for game-changing possibilities embedded in lottery tickets. Effectively, managers pay to play. They like stocks that move a lot. Stocks which can shoot up by 100% or more in a short period of time. Stocks which offer the possibility of radically altering the managers' annual performance (and bonus)...Stocks which are, in other words, the opposite of the ones we want in our index.'


Source: Societe Generale

Backtested, Grice's Quality Income strategy has far outperformed other income strategies

Source: Societe Generale

But there are caveats

Finally, a caveat on future performance, especially considering the current macro environment:

We worry about the world every bit as much as the next person and we remain particularly concerned about the consequences of the yield having been squeezed out of capital markets over three decades of central banks acting for the common good. Naturally, therefore, we're concerned about the prospects for our index. Macro storms buffet all ships. But we think our index should at least give the upfront protection of a secure, high and (as it is equity and not fixed income) a degree of inflation protected yield.

Source: Societe Generale

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