The search for yield continues to dominate discussions among advisors, investors and asset managers more than 10 years after the global financial crisis. As the Federal Reserve continues to cut U.S. interest rates and the amount of negative yielding government debt increases globally, investors find themselves seeking income in excess of the meager levels available from savings accounts and government bonds.
This has led to previously obscure ETF categories, such as bank loans and preferred securities, gaining traction and raising significant assets over the last decade. Investors have also taken on elevated risk from more traditional asset classes to squeeze incremental income from ETFs investing in high yield corporate and municipal bonds and real estate securities.
A notable long-term trend has been that investors have increasingly turned to stocks for income. The spread between 30-Year Treasury and S&P 500 Index yields have compressed over the last decade, and in August of this year, the S&P 500 converged with 30-Year Treasury bonds to the narrowest spreads since 2008.
Spreads Compressing, Stock Yields More Compelling
December 2006 – September 2019
These dynamics have fueled the influx of investment in dividend-focused stock ETFs globally. These dividend strategies generally feature a dividend yield in excess of the broad U.S. equity market and, in many cases, in excess of many segments of the bond markets.
Growth of Global Dividend-Focused ETPs
Source: Morningstar. *2019 data through 9/30/2019.
Beware of Dividend Traps
Many dividend strategies, whether active or indexed, tend to fall into one of two camps: strategies targeting high yield stocks, or strategies that focus on companies that have a consistent history of paying dividends or increasing dividends. Both can be sound strategies, and many investors may even combine the two schools of thought to isolate high yielding companies that have grown dividend distributions over time. But, these strategies aren’t without risk. While dividend investment strategies as a whole may have featured lower volatility and in turn an attractive risk/reward profile when compared to the broad market, relying solely on historical characteristics can lead to unintended risks—namely, dividend traps.
Focusing on high yielding stocks can lead investors to areas of the market that have been under recent duress (as stock prices fall, yield generally rises) or to companies for which the market requires an attractive yield as compensation for ownership. Many high yielding stocks are high yielding for a reason. Similarly, relying solely on a company’s history of dividend payments can lead to situations like 2008 and 2009, when many companies with a decades-long track record of paying distributions were forced to suspend shareholder payments.
Approach Dividend Investing from a Position of Strength: A Durable Dividends Strategy
Fair Value: A decade’s worth of steady investor flow to dividend paying stocks paired with U.S. equity markets reaching all-time highs make valuation considerations particularly important. Morningstar’s 100-person equity research team assigns a fair value estimate to each company it covers by projecting cash flows well into the future. Think of fair value as a company’s current worth based on its future earnings potential. This approach may allow for greater upside potential while maintaining an attractive dividend yield.
Finding Yield at a Better Value
Data as of 9/30/2019
Source: Morningstar. Premium/discount to fair value represents index constituent market prices relative to Morningstar’s equity analyst-assigned fair value estimate. Fair value and dividend yield figures displayed as a weighted average of the index constituents. Index performance is not representative of fund performance. For fund performance current to the most recent month end, visit vaneck.com. For illustrative purposes only. Past performance is no guarantee of future results.
Financial Health: Focusing on yields and valuation alone may not be enough. Also important is a company’s ability to maintain or grow dividend payments. The Dividend Valuation Index relies on a predictive measurement of financial health, distance to default. This contrasts with the backward-looking approach of tracking a company’s historical trends with the hope that those trends persist. Distance to default reflects a firm’s likelihood of bankruptcy and has historically been an effective predictor of dividend cuts. Selecting companies with the lowest probability of default helps reduce the probability of future dividend cuts.
Higher Distance to Default Scores Resulted in Fewer Dividend Cuts
May 2005 – May 2018
Source: Morningstar. U.S. companies in the Morningstar Global Markets Index were assigned to quartiles at the beginning of the period based on the likelihood of default using Morningstar’s Distance to Default scoring system. Those companies with the highest likelihood of default ("Very Low" Distance to Default scores) had the highest occurrence of subsequent dividend cuts. The inverse is also true. For illustrative purposes only. Past performance is no guarantee of future results.
By considering a company’s future, Morningstar’s analysis helps to assess dividend durability and attractive allocation opportunities among high yielding stocks. DURA offers investors access to this approach to investing in stocks with durable dividends as the search for yield continues.
This content is published in the United States for residents of specified countries. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this content. Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.
S&P 500® Index: consists of 500 widely held common stocks covering the leading industries of the U.S. economy.
The S&P 500 Dividend Aristocrats Index is a list of companies in the S&P 500 with a track record of increasing dividends for at least 25 consecutive years. It tracks the performance of well-known, mainly large-cap, blue-chip companies
The Morningstar® US Dividend Valuation IndexSM was created and is maintained by Morningstar, Inc. Morningstar, Inc. does not sponsor, endorse, issue, sell, or promote the VanEck Vectors Morningstar Durable Dividend ETF and bears no liability with respect to the ETF or any security. Morningstar® is a registered trademark of Morningstar, Inc. Morningstar US Dividend Valuation Index are service marks of Morningstar, Inc.
The information herein represents the opinion of the author(s), but not necessarily those of VanEck, and these opinions may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.
Any indices listed are unmanaged indices and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in a fund. An index's performance is not illustrative of a fund's performance. Indices are not securities in which investments can be made.
An investment in the Fund may be subject to risks which include, among others, investing in the consumer staples, energy, health care, and utilities sectors, small and medium-capitalization companies, equity securities, dividend paying securities, market, operational, high portfolio turnover, index tracking authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount risk and liquidity of fund shares, non-diversified, and concentration risks, which may make these investments volatile in price or difficult to trade.
Fund shares are not individually redeemable and will be issued and redeemed at their net asset value (NAV) only through certain authorized broker-dealers in large, specified blocks of shares called "creation units" and otherwise can be bought and sold only through exchange trading. Shares may trade at a premium or discount to their NAV in the secondary market. You will incur brokerage expenses when trading fund shares in the secondary market. Past performance is no guarantee of future results.
Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus for VanEck Funds and VanEck Vectors ETFs, which contains this and other information, call 800.826.2333 or visit vaneck.com. Please read the it carefully before investing.
Van Eck Securities Corporation, Distributor 666 Third Avenue New York, NY 10017 800.826.2333
Web Access Notice: VanEck is committed to ensuring accessibility of its website for investors and potential investors, including those with disabilities. If you have difficulty accessing any feature or functionality on the VanEck website, please feel free to call us at 800.826.2333 or email us at firstname.lastname@example.org for assistance.
This website is published in the United States for residents of specified countries. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this website. Nothing on this website should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.
Investing involves risk, including possible loss of principal. An investor should carefully consider investment objectives, risks, charges and expenses carefully before investing. This and other information can be found in the appropriate regulatory documents made available for a specified country as designated in this website.
Van Eck Securities Corporation, Distributor 666 Third Avenue New York, NY 10017800.826.2333