With the sizzling bull market over and widespread carnage across global markets, general investors are looking for defensive plays, and high-dividend equity funds are being considered. However, can we really equate high-dividend equity funds with defensiveness? Before this question can be answered, there is more fundamental work to do: defining high-dividend equity funds.
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Is a high-dividend fund really a good defence?
Yan Ting Kum
21 September 2008
With the sizzling bull market over and widespread carnage across global markets, general investors are looking for defensive plays, and high-dividend equity funds are being considered. However, can we really equate high-dividend equity funds with defensiveness? Before this question can be answered, there is more fundamental work to do: defining high-dividend equity funds.
Typical dividend equity funds emphasise dividend yield in their stock-selection criteria. However, the priority accorded this criterion in the stock-selection process is unknown, as the process is generally opaque. In fact, arriving at a definition of high-dividend equity funds is difficult, if not impossible.
Another tricky point is that traditional blue chips usually offer high-dividend yields; hence, portfolios of large-cap value equity funds may have high weighted average dividend yields, even though they do not label themselves “high dividend”.
Investors generally recognise high-yielding stocks as defensive plays because they view dividends as stable income streams, helping them to survive even if the stock market sinks. Furthermore, investors assume that companies paying bigger dividends have healthier balance sheets, which can shield their stock prices from market downturns.
Back to the original question: do high-dividend equity funds equal defensiveness? A glance at the performance of high-dividend equity funds available for sale in Hong Kong which have track records of three years or more, shows most of them have lower-than-category-average standard deviations, implying they are generally more defensive than their peers.
But bear in mind that because their investment processes are obscure, we cannot conclude that their apparent low-risk features are a result of their stock selection.
Of course, defensiveness should not be the only focal point of our investigation. Returns matter, and although returns from dividends can be a significant contributor to an investor’s total return over a very long term, capital gains (or losses) cannot be ignored in the short term. In other words, it is pointless investing in a portfolio of high-yielding stocks if it suffers from a heavy capital loss.
So, can we equate high-dividend funds with high returns? Many scholars and investors have spent a great deal of effort studying the relationship between dividend yield and corresponding stock performance, but the results are not conclusive.
Michael O’Higgins and John Downes invented a yield-oriented strategy name, “Dogs of the Dow”, in 1991 (updated in 2000). “Dogs of the Dow” investors buy into the 10 highest-yielding stocks in the Dow Jones Industrial Average and re-balance their portfolio annually. Based on the data from 1973 to 1998, Mr O’Higgins and Mr Downes found that the “Dogs of the Dow” portfolio (with an annualised return of 17.9 per cent) hugely outperformed the overall index (with an annualised return of 13 per cent).
Elroy Dimson, Paul Marsh and Mike Staunton provided further support to this theory. Based on an analysis of cumulative return data for US equities from 1926 to 2000, they found that high-yielding stocks outperformed the index by 160 basis points annually.
But almost all research in this area focuses on the US: it is questionable whether this stock-selection criterion is as effective across the globe. For instance, a recent study by Kuwait Financial Centre showed that many Gulf companies with high-dividend payouts were underperformers in the stock market.
At the fund level, only about half of the high-dividend funds available for sale in Hong Kong outperformed their global peers this year. And besides, due to the opacity of the investment process, it is difficult to determine whether their out-performance can be attributed to high-dividend-yield stock selection.
In conclusion, picking a fund with the phrase “high dividend” in its name never guarantees higher returns or lower risks. To add value to your portfolio, a fund manager’s skill remains the most important factor.
Yan Ting Kum is a senior research analyst with Morningstar Asia Ltd
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