- The Columbia Dividend Income Fund has topped 94% of competing funds in the past 15 years.
- Portfolio manager Mike Barclay shared his fund’s strategy and his secrets to success.
- Focus on dividend stocks with two specific qualities instead of prioritizing high yields, he said.
In a recent interview with Insider, Barclay shared the investing process he’s used over the nearly 12 years he’s been on the fund, and how it’s garnered him impressive returns.
How to profit from dividend investing
The philosophy behind Columbia Threadneedle Investments’ high-performing dividend fund has been in place since 2004, Barclay said. Since the start of that year, the strategy has outpaced the Russell 1000 index by about 21%, as of the end of August.
These strong returns have been a byproduct of a sound screening strategy and risk management process — not necessarily an end goal in their own right, Barclay said.
“While good performance is job No. 1, job No. 1A is making sure that the solution you deliver to your clients is consistent,” Barclay said. “Because they rely on you to deliver a certain profile. And so in terms of changes, it’s always steady as she goes.”
Similarly, while dividends are clearly central to the Columbia Dividend Income Fund, Barclay said he doesn’t simply chase stocks that issue high quarterly payments.
“Yield doesn’t always protect you,” Barclay said.
Instead, he said he looks for dividend growth that’s driven by free cash flow. In fact, the portfolio manager said he thinks about all potential investments through one prism: how much he’d have to pay for each dollar of free cash flow. That’s what determines whether a stock is attractive or not, he said.
“Before you even think about the dividend, value creation is about a company’s ability to generate free cash flow over time,” Barclay said.
To find which stocks will be a good fit in his fund, Barclay said he takes every possible candidate and divides them into five groups by free cash flow. Only names in the top two quintiles are considered for inclusion, while any companies that fall into the bottom fourth or fifth quintiles are flagged for a possible sale, Barclay said. If his team doesn’t believe an investment’s low cash flows will bounce back anytime soon, they sell.
Besides free cash flow, Barclay said he prioritizes firms with robust balance sheets as a way to manage risk. Financially healthy companies tend to be serious about growing their dividends over time, Barclay noted, and they’re also likely to be safe havens during economic downturns.
“You don’t get paid all the time for having a strong balance sheet, but when you get into the middle of a stressed environment, it is the companies with strong balance sheets that are going to typically fare the best,” Barclay said.
Barclay continued: “We know cycles come and go. We know earnings and cash flows can ebb and flow. However, it’s the balance sheet that allows a company to be able to access capital — do so in a relatively inexpensive fashion.”
Once Barclay and his colleagues analyze free cash flow and balance sheets to find the right stocks, he said they tend to hold on to them for a while. There are about 80 names in the portfolio at any given time, Barclay said, which helps keep volatility below that of the market.
Interestingly, Barclay said that his fund always has representation in all 11 S&P 500 sectors, and it doesn’t move in or out of sectors as macroeconomic headwinds shift.
“It allows you to go into the sectors — into each individual sector — and think about the risks in that sector and make it about stock selection, make it about putting the best ideas for that sector into the portfolio and mitigating the risk,” Barclay said.
Having a sector-agnostic approach helps Barclay keep his philosophy and process the same, regardless of how solid or shaky the economy looks. Keeping a long time horizon and not overreacting is key to the Columbia Dividend Income Fund crushing the competition for well over a decade, during periods of both economic expansion and downturns.
“We believe that if you do the work and you invest in high-quality companies, over time that typically works out well in the equity market,” Barclay said.