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How high quality dividends could boost income generation
28 Oct 2024
In a financial landscape marked by economic challenges, geopolitical uncertainty, and policy speculation, we believe a high quality dividend strategy investing in defensive stocks could provide income seekers with valuable portfolio diversification.
- The financial backdrop remains challenging for investors.
- However, market participants are looking beyond the headlines and identifying positive signals.
- In such an environment, active managers seek to identify robust businesses that can steadily deliver healthy dividend payouts.
- Company fundamentals remain key regardless of the macroeconomic picture.
- Dividends have historically constituted a sizeable portion of stock returns and outpaced inflation.
- In tandem with solid dividends, our managers aim to enhance client income with targeted portfolio strategies, such as covered calls.
- Areas of interest currently include defensive names given their attractive valuation frameworks, non-bank institutions such as insurance firms, and Asia with its growing number of industry leaders, especially in the semiconductor space.
Financial markets currently face a combination of diverse signals that have shaped the actions of policymakers and central banks. For instance, core and services inflation remains a challenge. At the same time, unemployment in the US is rising while job creation has slowed. Into this mix, we also have diminished excess savings and a rise in consumer credit defaults. Elsewhere, geopolitical tension in the Middle East persists.
Yet despite these roadblocks, stock market valuations are improving as investors look through these challenges. Inflation, although sticky, has fallen significantly year-on-year. The US unemployment rate remains at a 50-year low, the credit-to-income ratio has declined, and people's financial health is still reasonably robust.
We have also started to see interest rate cuts, and the most recent quarterly earnings numbers show that many companies are in good shape. Meanwhile, concerns about the profit sustainability of US tech giants have seen investors broaden their horizons and embrace value names and businesses with a smaller market capitalisation.
Against this backdrop and given the difficulties investors face in predicting the economic outlook, an active approach to assessing the market from a bottom-up perspective and identifying defensive companies that will perform well in good times and bad could make a difference.
As always, the long-term driving force of the stock market remains corporate fundamentals, and in an often-complex trading environment, we believe that a dividend-focused strategy could attract investors who may feel buffeted by persistent uncertainty.
Actively managed income enhancement
Dividends are a significant contributor to the total return of the stock market. Indeed, statistics show that over 30 per cent of the cumulative rate of return on equities in the US has been driven by dividend payments. What’s more, US dividends have historically offered a robust inflation hedge1. Dividend yields tend to be more resilient to market volatility too.
By adopting an active management approach, we have demonstrated that our dividend strategies can generate more diverse and higher-quality income options. We can also strengthen dividend income by reducing a portfolio’s dependence on economically sensitive industries and focusing on sustainability leaders. Therefore, we look at well-managed, high quality firms with transparent business models and healthy balance sheets that can consistently deliver solid returns irrespective of the economic cycle.
Returns can also be enhanced with the use of portfolio management strategies like covered calls, which we feel is an attractive, suitable and sustainable method of generating a potentially elevated income level.
Emerging investment opportunities
For instance, we have recently seen investment opportunities in defensive names, given their valuation frameworks now appear more attractive following a period when they lagged growth-oriented technology or internet-related companies.
While in the financials segment, there are interesting ideas among non-bank institutions, including insurance firms that are less immune to changes in borrowing costs than banks. However, among the banks we are watching, our focus is on companies that have improved shareholder returns due to a strengthening of their capital positions.
Regionally, Asia boasts a growing number of industry leaders, especially in the semiconductor space, so we also see potential to harness these developments.
1 https://www.spglobal.com/spdji/en/research/article/a-fundamental-look-at-sp-500-dividend-aristocrats/
