Funds Europe hosted BlackRock and MSCI in a webinar where we discussed how dividend investing can be managed through volatile markets.
Income can be hard to find right now, including in Europe, and high- dividend strategies can help investors who are seeking income. However, volatile markets create navigational challenges in the equity income sector.
In our November webinar, Athina Georgopoulou, Emea smart beta strategist at BlackRock’s iShares, and Jean-Maurice Ladure, head of equity solutions research at MSCI, discussed with Funds Europe’s contributing editor, Fiona Rintoul, how quality dividends can help investors to steer a course through these choppy waters.
Georgopoulou highlighted the role dividends play in stock market performance, with about half of the MSCI World index’s total return over the past 30 years coming from reinvested dividends. In the current low-yield environment, dividends now also represent a greater proportion of income than bonds in a typical 60:40 allocation. However, with investor sentiment becoming more negative, it is dividend strategies’ defensive characteristics that constitute their principal attraction.
“Historically, they have offered lower volatility and reduced downside risk,” Georgopoulou said, presenting data that showed excess performance from dividend strategies in a range of defensive scenarios.
Ladure went on to consider high yield as an investment factor alongside others, such as low volatility, quality, momentum, size and value; identifying both systematic risk and behavioural finance as rationales for the premium. He explained that the high yield factor has similarities with the value factor but that there are important differences between the two. “Embedded in the dividend yield is the defensive aspect of this strategy, and you can really see this during periods of market volatility when value tends to underperform the market and dividend tends to outperform,” he said.
Ladure spoke about how a common standard methodology can work over the long run at the global, regional but also country level. “We apply the same approach to emerging markets and individual countries, and I’m glad to say that we see factor premia in emerging markets and at the country level in France, Germany, Canada and even Japan,” he said.
Their defensive quality lies behind the rising popularity of dividend strategies. Georgopoulou presented statistics that showed dividend ETFs had had net inflows in 2019 of US$4.2 billion. As Europe faces a murky economic outlook, European flows have been more pronounced than those in the US.
“Building a defensive profile there makes sense,” Georgopoulou said.
However, building an effective defensive portfolio with dividend stocks is not simply a question of investing in a traditional portfolio of high yield stocks. This may be intuitive – and what most income investors are currently doing – but investors should recognise that these strategies may come with unintended biases.
“It’s about understanding what you’re getting,” Georgopoulou said. “There is a trade-off between yield and stability, and some strategies may sacrifice stability for higher yield.”
Distilling over 20 years of simulations on the MSCI World index, Ladure then began to show what investors are getting with simple yield selection. Targeting companies with a yield 1.3 times greater than the index average led to an overall outperformance, but with a slight increase in risk and negative exposure to the quality and momentum factors on average. Georgopoulou augmented these insights with data from an individual company, which illustrated the common yield traps of broken technicals and weak fundamentals. These can trip strategies up when they simply go after higher- yielding stocks.
“Without a solid examination of a company’s fundamentals and the drivers of the dividend yield, the strategies can be subject to increased risk of yield traps,” she said, noting that “having a quality bias is paramount”.
Ladure went on to examine the payout ratio part of the “dividend yield = book to price × ROE × payout ratio” equation, highlighting a third dividend trap: unsustainable and unstable dividend payouts. An audience poll showed that 60% of viewers thought this was the deadliest of the three dividend traps.
Ladure then explained how investors can potentially avoid these yield traps. He showed the impact of MSCI’s yield trap screening, which filters out companies whose dividend is unsustainable or unstable, those with broken technicals and those that are low-quality.
Applying all these screens since the end of 1998 – together with the 1.3 times high-yield screen Ladure showed at the beginning of the webinar – would have produced on average a selection of 308 stocks from the 1,623 in the MSCI World index and added 1.7% of return per annum while reducing risk by an average of 1.3%, with the low- quality screen having the most impact. In particular, screened high-dividend yield would have had a much better relative performance than a simple yield selection during the global financial crisis, as the approach is more defensive, with a beta of 0.9 over the 21-year period of backtest.
In practice, investors are using quality index products to replace underperforming income managers. Georgopoulou provided an illustration of a portfolio containing 70% underperforming income managers and 30% broad equity managers where 35% of the underperforming income managers were replaced with quality index products. This produced a marginal increase in performance and a pick-up in dividends. A second illustration where 35% of income managers with the worst quality characteristics were replaced with quality dividends produced enhanced quality characteristics.
In a world of low interest rates and great macroeconomic uncertainty, dividends are an attractive allocation. But as Georgopoulou and Ladure’s analysis showed, it’s important to understand the biases you are exposed to and the trade-off between stability and yield.
Answering a question from the audience about sector biases in payers with increased quality characteristics, Georgopoulou pointed to a more pronounced tilt towards defensives such as staples, utilities and healthcare. “We don’t think it’s optimal to apply sector neutrality, as the objective is income above all else,” she said.
Concluding the webinar, Ladure underlined the attractive properties of high-dividend strategies. In a challenging environment, they offer income and defensiveness, as well as access to long- term factor premia.
“It’s also very nice to mix high dividend yield with other factors,” he said.
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