The safe way to 12 per cent a year

For example, everyone says that having shares with a great income means sacrificing capital growth. But is that really true?

Earlier this year, Dylan Grice, Andrew Lapthorne and Georgios Oikonomou, strategists, Sociétée Générale, argued otherwise.

“But we think there is another way… which we call the Quality Income(QI) [which] provides bond-like characteristic (income and capital safety) with equity-like characteristics (capital growth).”

Inspired by studies in behavioural finance, the SG team showed that shares with higher dividend yields often can deliver market-beating returns.

Their QI index has produced net total returns of 12.2 per cent a year since 1989. Its performance has been even better still since the turn of the millennium. Whilst equities in the developed world have delivered some of the worst returns in history during that period, the Quality Income Index has almost tripled!

Surely this enhanced performance must come at a cost of more risk? Oddly enough, it doesn’t, though. The QI index is actually less volatile than equities as a whole. This by design, according to its creators:

“Remember that the primary focus of the index is not actually the generation of returns per se, but the safety of the capital invested.”

And when we take a closer look, there are very sound reasons for why this strategy should work.

Rather than just looking for the highest dividend yields, the QII seeks out good quality companies with a sustainable yield and a “robust underlying business”.

The ‘quality’ of anything is subjective, of course. SG’s strategists think a company’s balance sheet is the best indicator. The balance sheet gives important clues about how much debt a business is carrying, as well as other measures of health.

Robust finances mean a company is obviously less at risk of suffering from financial distress or from cutting its dividend pay out.

Inspired by Societe Generale’s approach, we’ve constructed our own Quality Income portfolio. Our portfolio will be published next Friday in the magazine and on our website (although you'll need to be a subscriber to read it online).