Is there still a case for a dividend strategy?

Equity markets have eked out new all-time highs once more, and despite a brief post-independence day wobble stock markets finished the week on a positive note.

As I recently noted, flows of new money into the markets during 2021 are on course to eclipse those seen in previous years, and even previous decades as well.

Though not all of that new money is finding its way into equities.

Bonds are back in fashion too.

Can it really only be three months since the yield on US 10-year treasury bonds touched 1.77% on fears about rampant inflation?

Yes, it can, however those worries about inflation have now been replaced with fresh concerns about the continued pace of economic growth, and whether the recovery can be sustained.

Concerned about the risk to growth, investors have been putting money back into the fixed income markets.

US 10-year yields recently touched as low as 1.20%, bond yields fall, as bond prices rise, of course.

And Bank of America’s regular round-up of fund flows, for the week of July 10th, showed the third-largest ever flows into investment grade or high-quality corporate bonds with $11.20 billion being allocated to the asset class.

That formed part of a total inflow into bonds of $18.40 billion, which itself was the largest move into the sector over the last five months.

Interestingly, this happened as money flowed out of banking and financial stocks, the materials and smaller companies sectors, all of which had performed well over the first half of 2021, suggesting that investors and money managers were happy to bank some profits and look to put at least some of that money into risk-averse assets such as bonds.

Now, people tend to buy bonds for two reasons:

Firstly in order to offset higher risks in the equity portion of their portfolio and secondly to secure a fixed income or rate of return.

Though with interest rates at or near zero the income that you can earn from holding high-quality bonds is rather limited.

The Bank of America Flow show report highlighted that the average yield on the 10-year bonds of the G10 economies is just 0.30% and with US bond yields dipping again that figure could fall further.

However, if you are looking for income and security you can potentially still find that within equity markets. In an age that's been dominated by growth companies, it's easy to forget what an important role dividends have played in generating stock market returns over the longer term.

After all, very few growth companies pay dividends...

Because very few of them actually make bottom line profits from which to pay the dividends.

JP Morgan Asset Management reminded us about the role of dividends in a short note entitled principles for successful long-term investing. The firm contrasted the performance of two investment strategies for $10,000, over the 50 years between 1970 and the end of December 2020.

One strategy captured just the capital growth of the index, that is the rise and fall of share prices ignoring dividends, whilst the other captured those dividends, alongside price movements, and reinvested the dividends back into the index.

And though both portfolios grew healthily over the lifetime of the investments, the strategy that captured and reinvested dividends outperformed the capital growth only strategy by a factor of more than 4.0.

Of course, 50 years is a very long time horizon and one that's perhaps far too deep for many investors to contemplate. So can a retail trader benefit from a dividend related strategy over a shorter time frame?

The answer to that is likely to be yes... if they are selective.

We say that because dividends, unlike interest payments on bonds, are discretionary. They are a reward to shareholders for their support and investment, but they are not an entitlement.

One way to deploy a dividend investment strategy is to look for companies that have a long-standing track record of dividend payments and dividend growth.

There is a group of stocks in the market made up of large-cap blue-chip equities with a track record of at least 25 years of continuous dividend payments and dividend growth.

These stocks are known as the dividend aristocrats; there are just over 60 such stocks within the S&P 500 index drawn from half a dozen sectors. And as is so often the case these days the market has done a lot of the hard work involved in tracking and monitoring these stocks for us.

For example, the ProShares S&P 500 Dividend Aristocrats ETF (Ticker NOBL) is specifically designed to track and replicate the performance of this group of stocks.

Over the last year, the performance of the dividend aristocrats compares very favourably with that of the S&P 100 and S&P 500 indices with the ETF returning +32.6%, and the S&P indices returning +35.2% and +36.6% respectively.

Markets are cyclical in nature and when they change we need to be able to change our investment strategy to reflect, and take advantage, of those changes.

The ability to allocate to pre-built strategies such as this is a very powerful tool in the modern trader’s arsenal and it's one that shouldn’t be overlooked.