During the electoral campaign, Donald Trump described an America that was in decline. He was right, if he was talking about dividends.
The dividends paid by US equities increased by only 4.1% last year from the levels of 2015, according to analysis published in late February by Henderson, the UK asset manager merging with Janus. That is on an underlying basis, so excludes the effects of special dividends; including such one-offs, the growth rate was even lower at 1.5%, as event-driven distributions from the likes of Kraft Heinz in 2015 were not repeated.
That contrasts with double-digit underlying dividend hikes in both 2015 and 2014, and represents a steady slowdown in payouts through the year. Dividends expanded at a rate of 6.9% in the first quarter, but this fell to just 2.1% for the fourth quarter, the slowest underlying growth rate since Henderson began recording these statistics in 2010.
The firm acknowledged that this deceleration followed ‘lackluster profit growth and a greater emphasis on preserving cash flow to ease balance-sheet pressures’ in 2016. Bank of America Merrill Lynch Global Research has estimated that the S&P 500’s earnings climbed by only 1% for the year, on sales growth of 2%.
‘A lower but more sustainable [dividend] growth rate is nothing to fear, but we would be disappointed if the modest 2.1% underlying fourth-quarter rate were the new normal for US dividends and did not exceed US inflation more convincingly,’ Henderson commented.
Although stagnant dividend growth poses a strategic challenge for equity-income investors, there are several more tactical questions highlighted by Henderson’s research.
One is the concentration of dividend payers: just three companies – Exxon Mobil, Apple, and AT&T – accounted for one of every nine dollars distributed in the US last year. Another is drug makers: pharma was the single largest-paying sector in 2016 and boosted its dividends by 8.2% during the year. But does that adequately compensate investors for the regulatory risk now Trump too has come out against high prices? And then there is the oil sector, where dividends were slashed by 15.9% in 2016 for a second consecutive year of cuts, but where share prices have soared for an exceptional total return.
Yet, where there are investment problems, there are also smart beta solutions.
From achievers to dogs
The largest by a wide margin is Vanguard Dividend Appreciation ETF, $28 billion in size and available with an expense ratio of 0.09%. It tracks ‘dividend achievers,’ stocks with a record of upping their dividends year over year, but does not hold any of those three highest payers in its top 10 positions. It is also underweight healthcare relative to the S&P 500.
An alternative approach is taken by Alps Sector Dividend Dogs ETF, which owns and equally weights the five highest-yielding stocks in each of the 10 S&P 500 sectors. That minimizes sector and security biases, but its emphasis on yield rather than dividend growth or absolute payouts entails a value tilt.
Another animal-themed option is the Pacer Global Cash Cows Dividend ETF. This fund, which launched only a year ago in February 2016, filters for the 300 developed-market stocks with the highest trailing 12-month free cash flow yield and then screens them for the 100 with the highest trailing 12-month dividend yields. This throws up names such as AT&T and Nestlé. The process inevitably gives the portfolio a quality slant, meaning it has underperformed the wider market as value has been in vogue.
The Pacer methodology also excludes financial companies, other than real estate investment trusts, from its index – not something that would be expected of another product unveiled last year, the Fidelity Dividend ETF for Rising Rates.
As well as targeting stocks with high and increasing dividends, Fidelity’s ETF buys companies that have demonstrated a positive correlation of returns to rising 10-year US Treasury yields. Intuitively, that would suggest the portfolio would be underweight utilities and telecoms and overweight financials – and it is, but only marginally. Should the Federal Reserve deliver the rate hikes expected later this year, it will be interesting to see how the strategy performs.
A different breed of cash cows are chased by the Oppenheimer Ultra Dividend Revenue ETF, which assesses first for yield and then weights the 60 highest yielders by revenue. The switch from free cash flow to sales takes the portfolio in a very different direction from both the Pacer and Fidelity funds: its largest exposure is to utilities, with telecoms and energy also featuring prominently.
So even if dividends are in decline, the answer for investors may well lie in innovation – and plenty of ETF providers are offering it.