It’s understandable that many investors have a strong appetite for yield because we are in a market environment where yield is scarce and likely to remain so.
Bond yields have been falling for the past 30 years. In 1995, the average index yield on an investment grade bond index was close to 8%. But today, investment grade bonds are paying little more than 1%.1
Indeed, some experts believe that with bond yields so low, the traditional portfolio split of 60% equities and 40% bonds can’t deliver for investors. This means that dividend-paying equities can now play a far more important role within portfolios in generating yield.
Certainly, the risk profile of equities is generally higher than that of bonds. But it is worth remembering that the potential for capital appreciation is greater. For income investors currently stacked with bonds, adding in dividend-paying equities provides diversification benefits and also the potential to enhance the risk and return profile of their portfolios.
The good news for dividend-seekers is that, despite the events of 2020, dividends are still abundant. In fact, the value of dividends paid out by companies in the MSCI AC World Index totaled almost US$1.1 trillion in the 12 months to end March 2021,2 so the availability of dividends has remained resilient.
In the US, for example, the total dividends paid in 2020 were virtually unchanged compared to 2019. Looking ahead, Asian (ex-Japan) dividends are expected to remain robust next year — in fact, they're likely to be more than 25% ahead of the 2018 levels.3
In Europe and the UK last year, we saw regulators impose caps or bans on dividends in the banking sector. Although this created headlines, it did not necessarily reflect the ability of banks to pay a dividend, but was rather an action based on an abundance of caution. As the global economy has moved into a recovery phase, regulators have started to relax restrictions on dividends.
We believe the post-Covid dividend environment is a positive one, characterized by steady recovery and resilience. This favorable outlook is driven by factors including the low interest-rate environment, unprecedented fiscal support benefiting households, businesses and infrastructure, and an improving fundamental backdrop as evidenced by a solid earnings outlook and a fast-recovering global economy.
The cyclical growth recovery (especially in the developed world and China) complements long-term structural growth trends such as evolving applications for new technology and decarbonization.
The development of vaccines in 2020 and rollout in 2021 boosted sentiment and the outlook for company earnings and dividends.
The quick-fire development of vaccines in 2020 and their rollout in 2021 have also boosted both sentiment and the overall outlook for earnings and dividends. In fact, dividend increases have been gaining momentum, especially in key markets such as the US.
The number of companies increasing dividends far outnumbers those that have reduced pay-outs. There has also been a pick-up in share buybacks. This points to the confidence that companies have in rewarding shareholders, and bodes well for the dividend outlook.
So, where can investors find strong dividends? Looking at the cash piles available on a sector-by-sector basis, we believe that technology, consumer sectors, communication, health care, industrials and financials are relatively well placed to generate dividends. We also aim to identify steady dividend-payers with strong fundamentals in sectors such as energy and materials. Given the current broad base of economic recovery, the companies that stand to benefit will also be diverse by sector.
In general, we believe value is likely to outperform growth during a period of inflation. We consider financials and energy to be value and we see commodities and infrastructure benefiting from inflationary pressures. Tech may underperform if inflation increases, so too could consumer staples and insurance.
While value-style investing has enjoyed a boost since the end of 2020, the MSCI ACWI Growth Index has outperformed MSCI ACWI Value Index by about 5.5%4 over the last month. Over the long term, we believe that owning companies that are exposed to structural growth may do well regardless of the value versus growth regime. A balanced portfolio of value and growth stocks can provide exposure to cyclical and structural growth forces.
Inflation is certainly a real consideration. Currently, a combination of high savings rates, pent-up demand, a double-digit increase in the money supply, plus record fiscal stimulus and the vaccine roll-out, will lead to a sharp economic recovery.
Strong demand for products will lead to higher inflation and there are few historical guideposts for this type of environment. The biggest risks to equities currently are not necessarily related to their fundamentals, but instead to the risk of interest-rate movements.
While we think that inflation will increase in the short term, we envisage a temporary increase as deflationary forces such as ageing populations and efficiency gains from technology will continue to have an effect.
Nevertheless, while closely monitoring the macro environment, as active stock pickers we should always invest based on the fundamentals of the underlying companies.
1 Source: Bloomberg, as of June 2021
2 Source: Bloomberg, as of March 2021
3 Source: Jefferies, FactSet, 2021
4 Source: Bloomberg, as of 23 June 2021
IMPORTANT INFORMATION
Diversification does not ensure a profit or protect against a loss in a declining market.
Dividends are not guaranteed and a company’s future ability to pay dividends may be limited.
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.
US-100821-154862-1