Dividend Growth Investing: Like a Bridge Over Troubled Water
As the world turns, investors often question the appropriateness of their portfolio allocations relative to the ever-changing economic conditions around them. However, here at Harbor we believe that we can help you attain investing confidence in a variety of global market environments. One such way, in our view, is with a core allocation to a dividend growth product which seeks to provide both steady income and growth potential in one offering.
In the graph below, we can see that this combination of stable income and capability to achieve upside potential can lead to what we believe are attractive returns in a range of macroeconomic conditions. Historically, dividend growth strategies have performed well during a variety of phases of the market cycle with the only exception being the initial rebound phase, which can often be characterized by lower quality leadership.
Past performance is no guarantee of future results. For illustrative purposes only. Universe is largest 1,000 market cap companies ex Financials and Real Estate. Includes companies that are in the top 20% relative to sector for both dividend growth (LTM) and free cash flow yield. Dividend Growth & Free Cash Flow Yield on a sector neutral basis. Market cycle returns have been annualized. Returns time periods are 1990-03/31/2023.
Sources: Wolfe Research Portfolio Strategy; Company filings; Bloomberg; Standard & Poor’s; FactSet.
In our view, the steady performance characteristics of this type of strategy may make it attractive for a core allocation in portfolios. That said, this phase of the market cycle in particular has historically immediately preceded the most fruitful stage of returns for this investment style.
A Distinct Opportunity for Active
Notably, the recent pandemic created a rare opportunity for active investors in dividend growth strategies. Out of nearly 1,400 U.S.-listed, dividend-paying firms, over 300 firms either cut or omitted dividends entirely in the second quarter of 2020. That said, the majority of those 300 firms resumed paying a dividend in the quarters that followed, according to Standard and Poor’s.
Source: The Impact of the COVID Pandemic on Dividends, Kevin Krieger Ph.D, Nathan Mauck Ph.D, Stephen Pruitt, Ph.D; National Institute of Health. For Illustrative purposes only. This information should not be considered as a recommendation to purchase or sell a particular security.
Subsequently, we believe that these 300 firms no longer qualify for inclusion in passive dividend strategies that require a multi-year streak of uninterrupted dividend growth (often five to 10 years), even though the pauses or reductions were prompted by extenuating circumstances.
For example, the Morningstar U.S. Dividend Growth Index requires a minimum of five years of uninterrupted annual dividend growth to be considered for inclusion in the index. However, as a result of the pandemic, the average number of securities held withing the index shrank by more than 10% by the end of the pandemic.
Given these exclusions, we believe that an active approach affords an edge in current conditions, as backward-looking, rules-based dividend strategies may be excluding what we perceive to be solid dividend growth opportunities that are facing long-term repercussions from a short-term phenomenon. This pool of companies offer the prospect for alpha, which is effectively inaccessible to passive investors from our point of view.
The views expressed herein may not be reflective of current opinions, are subject to change without prior notice, and should not be considered investment advice or a recommendation to purchase or sell a particular security.
Investing entails risk and there can be no assurance that any investment will achieve profits or avoid incurring losses. There is no guarantee any company or investing strategy will pay dividends.
All investments involve risk including the possible loss of principal. Stock prices can fall because of weakness in the broad market, a particular industry, or specific holdings. At times, a growth investing style may be out of favor with investors which could cause growth securities to underperform value or other equity securities.
The Morningstar U.S. Dividend Growth Index tracks U.S.-based securities with a history of uninterrupted dividend growth. The index is a subset of the Morningstar US Market Index, a broad market index representing 97% of U.S. equity market capitalization. This Index does not incorporate Environmental, Social, or Governance (ESG) criteria.
Alpha is used in finance as a measure of performance, indicating when a strategy, trader, or portfolio manager has managed to beat the market return or other benchmark over some period.
Index listed is unmanaged and does not reflect fees and expenses and is not available for direct investment.