Volatility has increased in equity markets over recent weeks, and 2018 as a whole has been a far bumpier ride than 2017. Our proprietary analysis shows a worldwide deterioration in market sentiment and the risk environment over the last 12 months, as well as between September 2018 and October 2018. Preying on investors’ minds are fears lest the US-China trade war spiral out of control, and worries about the international effect of the US Federal Reserve’s relentless raising of interest rates, which has squeezed liquidity, strengthened the US dollar, and made conditions tougher for emerging markets.
At times of stock market volatility, investors often turn to the relative stability of dividends. Despite current macro worries, company fundamentals are generally strong. Many companies have very healthy levels of cash, and have been using it to pay higher dividends to investors. Over time, dividend payments tend to be less volatile than companies’ share prices. The graph below shows the MSCI World Index (left hand axis) against the dividends per share of that index. Although the graph shows a steep decline in dividends during the 2008 recession – an extreme event by historical standards – in general dividends show steady and relatively serene growth.
Dividend’s greater steadiness, compared with share prices, may be due to company directors’ conservatism. Company directors may be reluctant immediately to cut dividends when profits fall. Similarly, when net profits rise, they feel a duty to share them with shareholders but are often cautious and refrain from upping dividends quickly in case the higher earnings prove temporary. In effect, company directors may be exercising a smoothing effect on dividends.
Some sectors have higher dividend yields than others, often because they contain mature, low-growth but highly stable companies. Examples are common in the telecoms and utilities sectors. Higher growth companies, by contrast, may find more benefit in reinvesting their profits to seek more growth: for example, information technology companies have the lowest dividend yield in the graph below.
Dividends are only one part of the picture for the investor, however, and there is no guarantee that the highest yielding companies are always those with the highest total returns. Indeed, over the last twelve months, as the graph above shows, the best performing MSCI World sector was the lowest yielding, information technology – and this, despite the sharp selloff in tech stocks over recent weeks. The highest yielding sectors, telecoms and utilities, have a negative price return over 12 months.
Traditional equity income funds that allocate disproportionately to sectors with higher dividend yields may contain hidden risks for investors, by exposing them to sector concentration risk. That is why, in the income funds managed by the global equities desk at Merian Global Investors, we favour a balanced approach, that seeks to extract income from all sectors of the market, but that remains flexible in the light of changes to the market environment.