Current economic sentiment provides a supportive case for dividend stocks based on recent earnings guidance, analyst projections and general optimism towards a continued economic recovery. Analysts remain positive that the stabilisation of cash flows will support dividend growth globally. This extension of the recovery could see investors considering an allocation to dividend strategies.
Macroeconomic Outlook for Dividends
The change in economic sentiment at the end of 2020 laid the foundation for companies to reflect a more positive outlook in their 2021 earnings guidance. One of the most profound areas where this impact was felt was in dividend expectations. This earnings season, dividend investors heard a number of positive themes that helped shape the future estimates on forward dividends. Three major tailwinds support the ongoing case for investors to consider increasing yield factor exposure by allocating to dividend stocks:
Many companies that faced cash flow challenges as a result of the global pandemic were forced to ‘take their medicine’ by cutting or suspending dividends in 2020. These firms will be keen to renew their commitment of returning capital to shareholders through dividends. This should benefit the relative valuations of dividend stocks, which were heavily discounted and under-owned in 2020.
This environment could present an opportunity for exchange traded fund (ETF) investors to return to dividend strategies, following momentum seen in other recovery plays. But not all dividend strategies are the same, so be sure to look under the hood. For example, some dividend-orientated ETFs produce ‘quality’ and consistent income for investors by focusing, and selecting, on a long-term track record of dividend stability. While other dividend ETFs may focus primarily on high dividend payers or sector-neutral income. Pure high dividend ETFs may increase the risk of exposure to ‘dividend traps’. Sector-neutral dividend ETFs may dilute an investor’s desired diversification and run the risk of ‘closet indexing’.
Playing the Recovery in 2021
Below are two strategies to consider:
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
Risk associated with equity investing include stock values which may fluctuate in response to the activities of individual companies and general market and economic conditions.
Non-diversification risk is the risk that the Fund may invest a larger percentage of its assets in securities of a few companies than that of a diversified fund. As a result, the Fund’s performance may be disproportionally impacted by the performance of relatively few securities. For the Fund, the non-diversification risk of the underlying index is mitigated by adopting the MSCI’s 10/40 Index Methodology as described in section 2.2 where maximum holding weights are applied to individual and group of individual securities. Please refer to http://www.msci.com/ for further details on how this methodology works.
Concentration risk is the risk that assets of the Fund are highly concentrated in a sector or group of sectors. To the extent that it concentrates its assets in a single sector or group of sectors, the Fund will be subject to the risk that economic, political or specific conditions that have a negative impact on that sector or group of sectors will negatively impact the Fund to a greater extent than if the Fund’s assets were invested in a wider variety of sectors.
While the Index is constructed to have an expected dividend yield that is greater than the parent index, no assurances can be made that this will be achieved in all conditions, and in particularly over shorter periods.