The importance of dividends
Dividends remain fundamental to driving total return from equity investing, despite the current monetary policy environment, according to research published by Allianz Global Investors.
Allianz Global Investors is a firm proponent of the idea that the markets are having to deal with so-called ‘financial repression’ – the situation that has arisen as a result of central banks keeping interest rates artificially low to stimulate economic growth.
This has had profound consequences for investors in certain asset classes such as fixed income. However, the manager says that compared to other asset classes investing in dividend strategies “would seem to be interesting”.
“These strategies combine the benefits of currently high dividend yields while at the same time working to protect against inflation. At least as far as European companies are concerned, the gap between dividend yields and the yields on government and corporate bonds has rarely been so wide.”
As Allianz GI’s figures note, dividends accounted for 40% of total return on equity investments in the past 40 years. In the current situation, investors are, however, right to ask about just how sustainable dividend strategies will be going forward, and whether the relatively high dividend yields seen in the market are sustainable.
The average dividend yield across European companies was 3.2% in February 2014. Investors could boost this by focusing on those companies offering higher yields, or indeed look to markets where investors have been rewarded this way also, such as New Zealand, Australia, Norway and Brazil.
By contrast, they could avoid countries such as India, Ireland, Japan and Denmark, which typically offer lower dividend yields – and in some cases significantly below the interest rate on 10-year government bonds, such as Ireland, where the data to the end of December last year points to a dividend yield of less than 2% against a government bond interest rate of over 3%.
Looking at average contribution of dividends to performance between 1970 to 2014 shows that European companies tend to offer more to investors relative to performance from share price gains, when compared to other regions such as North America, Asia or Asia Pacific ex Japan, Allianz GI’s research says.
The question is: can history be repeated? Allianz GI thinks so. “We believe that the basis for dividend payments – company profits – will continue to grow moderately in 2014.
“Overall the framework of monetary policy should continue to support global growth.”
Additionally, investors looking for dividends could benefit from factors such as the conservative distribution ratio – paid dividends/earnings per share – which for European companies sits at around 55%.
This leaves scope for a rise in the ratio, hence more return to investors. Also, many companies are sitting on vast amounts of cash. Allianz GI estimates that the net cashflow of US companies is about 14% of US GDP.
Having built up these piles of cash as part of a deleveraging process, companies can now focus on improving shareholder value.
There are of course tail risks: persistently poor economic recovery, slow recovery in earnings of certain types of companies such as banks – which themselves face refinancing challenges sparked by regulation – and use of capital to engage in M&A or other investment activities rather than returning the cash to investors.
Still, Allianz GI concludes that over the long term, dividends can add value to a portfolio, and “not just through the additional income stream from earnings distributions.”
Investors can still seek out strong dividend yields despite the equity price gains seen over the past year. Investors do need to focus on future dividend expectations, however, in order to make best use of dividend strategies as part of an overall equity portfolio, the manager concludes.