The case for equity income investing continues to strengthen. Worldwide, quoted companies paid out a record $1 trillion in dividends last year, according to the Henderson Global Dividend Index, a long-term study of global dividend trends. By investing globally, investors can gain exposure to a broader range of income opportunities and benefit from significant portfolio diversification.
Broadening opportunity set
Companies increasingly recognise the benefits of attracting investors by being able to demonstrate a strong and growing dividend policy. This is well established in Europe and the US but the dividend culture is now providing increased opportunities in regions such as Asia-Pacific and selected emerging markets. This broadening universe provides an attractive diversification opportunity for equity income investors.
Long-term outperformance
Studies indicate that dividends generate a significant proportion of the total returns from equities over time. The combination of reinvested income with potential capital growth has led to long-term outperformance of higher dividend paying companies compared to the wider equity market, as shown in the chart below.
Reasons for this outperformance include:
- A focus on cashflow is required in order for dividends to be sustained; dividends are therefore a strong indicator of the underlying health of the business.
- Higher yielding shares by their nature tend to be more contrarian and out of favour thus offering revaluation opportunities.
- Maintaining a healthy dividend stream imposes a disciplined approach on a company’s management team and can improve decision making.
Risk reduction – diversification benefits
As more companies globally pay dividends, the potential to diversify increases. Some markets suffer from high dividend concentration and as a result equity income strategies focused on single countries may become overly reliant on a low number of high-yielding companies that dominate the market. A global remit also maximises the opportunities at a sector level; for example, many high yielding technology companies can be accessed through investing in the US or Asia, but not the UK.
Key considerations
- Look beyond the headline yield: High-yielding equities can be more risky than their lower-yielding counterparts, particularly after a period of strong market performance when equity price rises push yields down. The high-yielding companies that are left are often structurally-challenged businesses or companies with high payout ratios (distributing a high percentage of their earnings as dividends) that may not be sustainable. An investor simply focusing on yields, or gaining exposure through a passive product such as a high-yield index tracker fund, may end up owning a disproportionate percentage of these companies, often known as ‘value traps’. It is also worth noting that companies which cut their dividends tend to suffer poor capital performance as well. Therefore, it is essential to analyse the sustainability of a company’s ability to pay income.
- Seasonality: A global approach offers equity investors diversification benefits and the opportunity to receive income from different sources throughout the year. Most regions show some dividend seasonality. European companies typically pay out more than three fifths of their annual total during the second quarter according to data within the Henderson Global Dividend Index. This is by far the region with the most concentrated dividend period. North America shows the least seasonality of any region with many firms making quarterly payments. UK firms also spread payments more smoothly than other parts of the world, although larger final dividends tend to be paid in the spring and summer following the annual general meeting season.
- Dividend outlook: Overall, we are encouraged by the health of global companies generally, with strong balance sheets and disciplined management teams focused on generating good cashflow, which should be supportive for dividend growth in the long run.
