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26 Sep 2017

Income insights: How to avoid the yield trap

Yield hunters need to consider their chosen destinations carefully. On the face of it, dividend payouts look robust, but not everything is as it seems.

Income is expensive

The growth in global dividend payouts we’ve seen in recent years may look impressive, but peak dividend payouts and peak share prices are a problem. Overpaying for income is commonplace. Inevitably, dividend cuts are a real risk. After all, a high yield isn’t always a good yield – and can involve an element of corporate distress – so how can you avoid the yield trap?

Global dividend cuts, increases and non-payers

Source: SG Cross Asset Research/Equity Quant, MSCI, Factset

Constructing our dividend indices

Our quality income strategies focus on less fashionable, more mature companies that can pay – and can keep paying – a high dividend. They still represent solid, low-risk investments. Each will have been rigorously tested for the quality of its business, the strength of its balance sheet and the dividend yield it promises.

A stock needs to pay a 4% dividend for us to invest, and if this drops below 3.5% we sell it. The only exception is for our Japanese index (more of which later), which has a starting yield of around 2.5%.

Right now, it’s difficult to pick up consumer staples businesses with a high enough yield. So our global portfolio is currently weighted towards utilities, telecoms and energy. The portfolio ebbs and flows with the markets – as stocks get more expensive, we naturally move towards more defensive, less popular areas.

A selective approach

In our global portfolio, we tend to have significant, enduring exposures to countries like Canada and Australia, which have tax-friendly, well-established dividend regimes. We also favour countries where the right kinds of businesses have a firm foothold, such as the UK (pharmaceuticals) and Switzerland (consumer goods producers).

In the US, the S&P 500’s yield habitually hovers around 2%, so finding a higher yield means narrowing your search. There are plenty of high quality businesses, but their tendency to substitute dividend payments with share buybacks means we cannot identify enough good companies with high enough dividend yields to justify a higher weighting in our global portfolio. Other strategies might have more leeway. For us, Europe and Asia are better hunting grounds.  

The attraction of Europe

Continental Europe offers real diversity for dividend investors. Around a third of the global 4%+ dividend yield universe can be found in Europe, and about 30% of European stocks provide a yield of 4% or more.

All European equity sectors currently offer a dividend yield in excess of the ten-year bund. Seven now offer a yield greater than 4%, and most have a sustainable payout ratio. Real Estate, Telecoms and Utilities are paying out more than 70% of their earnings, whereas the Automobile sector is paying only one-third of its earnings despite an attractive yield of c.4%. 

Overall, the ground is fertile enough for our European strategy to yield more than 5% currently. That’s even more than our high dividend income product!

Asia: the next dividend frontier

Asia’s outperformance vs. global markets has only just begun after six years in the doldrums. In our view, there’s more to come. Earnings are recovering, valuations are reasonable and liquidity is plentiful. 

The region is also becoming much more attractive as a dividend destination. Its companies have been steadily increasing their dividends for some time, yet there’s still greater scope for dividend growth than, for example, in the UK. You also get more natural diversification – dividend payers come from across the industry spectrum, including technology.

Japan, for its part, has long been relatively uninspiring for dividend seekers, with low yields and high valuations. But corporate governance has improved and share prices have fallen, and Japan now has the best dividend cover and payout ratio in the world. We’re much more interested in Japan than we used to be, hence the imminent listing of our new SG Quality Income Japan ETF.  


Does it work?

Yields of 3.8% and 5%+ for our Global and European strategies suggest the answer is yes. Since 2013, these ETFs have respectively delivered 15% and 24% more income than the average active manager in their sector – largely because of their consistency. Just once has either ETF yielded less than the average manager in any of the last four years. They’ve also reduced risk by 15% and 6% respectively in that time.  And, they’ve done all of this for just 0.45%. Why would you pay more for less?

Consistently higher yield

Source: Lyxor & Morningstar. Average additional yield over the yield of the Morningstar universe of European high dividend yield and equity income funds (2014, 2015, 2016 and 2017 year-to-date to 31/08/2017). Average additional yield over the yield of the Morningstar universe of Global high dividend yield and equity income funds (2014, 2015, 2016 and 2017 year-to-date to 31/08/2017) Past performance is no guarantee of future returns.


Unless otherwise noted, all opinions/data sourced from SG Cross Asset & Global Quantitative Research teams. Opinions expressed are as at 21 September 2017.


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