Falling yields across the developed market world have posed greater hurdles for investors with yield and income targets. As the spread between bond yields and equity dividend-yields diverge, these investors move up the risk spectrum to meet their targets. As such, we observe that changes in US 10Y yields drive asset flows into high dividend-yield equities (top-right chart).

High dividend-yield investing typically adds the most value over the index through employing high turnover to capture mean-reversion in price changes – occurring just after crashes. Consequently the drawdown profile of this strategy (represented by VYM, Vanguard’s US High Dividend Yield ETF) is unhelpfully similar to that of the S&P 500. In this environment we prefer to represent equity exposure with companies that have sustainable growth in dividends and are less susceptible to trade shocks, naturally leading us to defensive sectors. The SPDR Dividend ETF, SDY, captures this idea fairly well with its selection criteria based on companies with 25+ years of dividend growth. However, we note the sharp underperformance of SDY in the eye of the GFC, which can be partially explained by its weighting scheme based on dividend yield. Screening for consistent dividend growth and adding a filter for free-cash-flow growth and equally-weighting the names leads to more reliable outperformance in times of stress.

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Source: Bloomberg, Macrobond, Variant Perception