Invesco Diversified Dividend Fund year-end portfolio review
The end of 2012 commemorated our team's 10-year anniversary managing Invesco
Diversified Dividend Fund. It was a strong year for the portfolio and equity markets as
companies have done an admirable job of managing their businesses through myriad
economic challenges in recent years. This is evidenced by the recovery in corporate
profits when compared to the recovery in GDP growth.
Within our discipline, several sectors offered notable opportunities in 2012. For example, our
investments produced a median dividend increase of 10%, and 76% of our holdings raised their
payouts.1 Looking forward, our portfolio is focused on defensible businesses with operating profit margin sustainability and prudent capital allocation.
In 2012, financial sector investments made the largest contributions to the fund's returns. The fundamentals of financial stocks have improved, yet valuations remain depressed given the
uncertainty in Europe and the lack of transparency around regulatory reform. We expect financial
companies to benefit from a continued recovery in loan demand and improving credit metrics. We
also anticipate that financials will grow their dividend payouts.
The utility and consumer staples sectors were two of our largest areas for new investments. Within utilities, our investments were biased toward natural gas and nuclear generation stocks, which trade at lower valuations than their more diversified electric utility peers. We added to several of our existing holdings and established two new positions in this sector.
Margins in the consumer staples sector largely remained stable or increased in 2012. The sector currently has an operating margin of 9.3%, which is below both its 10-year average of 9.5% and its peak of 13% in 2003. Valuations are in line with levels seen at this point in prior cycles, and dividend stability and growth are among consumer staples companies' priority uses of capital.
Positioning and outlook
In recent years, operating leverage has been impressive due to prudent cost management, low
wage growth, restrained capital expenditures, offshoring and low interest rate expenses. After nine consecutive quarters of positive incremental improvements, margins for S&P 500 Index companies turned negative in the fourth quarter of 2012 as the result of tepid revenue growth and fewer costcutting opportunities.
We believe negative incremental margins are more of an issue in cyclical businesses. We're also more confident in the durability of margins in more stable growth sectors of the marketplace. As we navigate 2013, we remain focused on companies that offer an attractive total return profile, emphasizing appreciation, income and preservation.