Income investing in Europe: how our business cycle approach works

James Sym

James Sym

Fund Manager, European Equities

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  • The business cycle highlights the need to diversify investments
  • Income opportunities exist throughout the business cycle
  • Time to favour cyclicals

Divide(nd) and conquer

We take a business cycle approach to investing.

In practice, what this means is that we divide stocks into seven style groupings according to their correlation with the business cycle.

The style groupings range from areas of the market with a positive correlation to the cycle1 (Commodity Cyclicals, Consumer Cyclicals, Industrial Cyclicals) through to Growth and Financials, and then the negatively correlated areas which are Growth Defensives and Value Defensives.

Each of these areas of the market will perform differently according to which phase of the business cycle we are in, the four phases being recovery, expansion, slowdown and recession.

We seek to allocate our capital so that it has the appropriate weighting to each grouping as we move through the cycle.

As income investors, there is a second aspect to our approach.

We also divide the stockmarket into four different dividend style groupings. These are:

  • Cyclical yield
  • Stable yield
  • High yield
  • Growth yield.

These dividend style groupings allow us to see how the fund is positioned in terms of where we are getting the income from.

Fundamental research determines the individual stocks that we invest in and it is the performance of these specific stocks that drives our returns.

The business cycle and yield groupings offer a framework that helps us decide which areas of the market we should be considering in each phase of the cycle.

Yield opportunities throughout the cycle

One common misconception about income investors is that we automatically invest most of our capital in the companies that offer the highest dividend yields.

That certainly isn’t the case for us. We aim to deliver returns across the cycle and we invest in firms that can offer both capital growth and income.

At the start of the business cycle - that is, in the recovery phase - we would predominately invest in stocks that fall into our cyclical yield dividend style grouping.

These are firms with high sensitivity to the economic cycle, growing their profits and share prices - and by extension their dividends – as the macroeconomic backdrop improves.

They may pay low or even no dividends at the point when we invest in them, but we make our investment with the expectation that the dividend payments are likely to grow over time.

As the cycle moves through to the expansion phase we would continue to invest in these firms but also move into growth stocks, which usually perform well as the economic recovery gains greater traction.

When the cycle peaks and moves into the slowdown phase, we would reduce exposure to cyclical yield stocks as these will suffer from a weaker economic backdrop.

We will likely continue to hold some growth stocks but would also add exposure to stable yield stocks, which are less affected by changes in the economic environment.

Finally, as the cycle moves into recession, we would turn to high yield as well as stable yield stocks.


These kinds of firms – food groups or pharmaceuticals are examples – are generally what we would term defensives in that they are negatively correlated to the economic cycle.

Many such firms offer little in the way of capital appreciation. However, in a recessionary environment our focus is less on growing our capital than on protecting what we already have.

As a result, these firms that offer high dividend yields, and resilient share prices, are typically where we would allocate most of our portfolio at the end of the cycle.

Opportunities in cyclicals

While each business cycle broadly follows the same pattern, there are always some differences.

One feature of the current cycle is the sheer length of time it has taken for Europe to emerge from crisis (the Lehman crisis followed by the eurozone crisis).

What this means is that profits are currently at extremely depressed levels, but have high potential for recovery and therefore high potential for dividends to rise as well.

With the macroeconomic backdrop starting to improve in Europe, we take the view that now is the time to favour cyclical, economically-sensitive stocks.

These kinds of firms are generally trading on relatively cheap valuations and can have substantial scope for profit improvements.

As an example, we currently like Spanish broadcaster Atresmedia. It has a low dividend today because its profits are depressed following years of weak economic activity in Spain.

However, as the Spanish economy recovers, advertisers will increase their spending and investors in Atresmedia should see its share price rise, its profits grow, and its dividend increase.

Sectors and securities mentioned are for illustrative purposes only and not to be viewed as a recommendation to buy or sell.

1. Positive correlation means these groups move in the same direction as the cycle. Negative correlation means they move in the opposite direction.