Even with July’s rally, broad-based equities remain significantly down on the year. But the dividend yield factor has produced strong positive excess returns over broad traditional beta in both the US and international markets.1
In fact, the factor has produced positive excess returns in six of the past eight months.2 While returns are flat on absolute basis (0.45% in the US), the strong relative returns (+13%) have been a welcomed sight amid deep market losses. As a result, investors have poured $47 billion into dividend focused ETFs this year.3
In this post I will delve into what’s driving dividends’ strong, pervasive returns — and what to expect going forward in this complex market.
What Makes Dividend Yield the Strongest Source of Excess Returns?
Of the 123 funds we classify as dividend strategies, the average return in 2022 is -8.4%. This is 6 percentage points better than the return on the broad S&P Global BMI Index.4 And 96% of funds focused only on US equities have outperformed the S&P 500 Index (-12.4%), with an average return of -5.6%.5 And dividend yield is the strongest source of excess returns among all other factor strategies, outpacing minimum volatility, quality, and size exposures, as shown below.
Year-to-date Excess Returns: Average Factor ETF Return versus S&P 500 Index
To understand what is driving this strong performance, I grouped the 67 dividend ETFs focusing on just US equities into one portfolio (Portfolio A), equally weighted the ETFs, and rebalanced monthly.
Next, I equal weighted the top 100 stocks in that portfolio (out of 2000) to create a concentrated dividend equity exposure of the most heavily owned stocks within dividend equity ETF exposures (Portfolio B). I also rebalanced Portfolio B monthly. I then ran the performance of both portfolios versus the S&P 500 Index and parsed returns by sectors, market cap, and styles to identify the drivers.
The cumulative return series for both portfolios and the S&P 500 Index is shown below. The more concentrated dividend exposure has had the strongest performance so far this year, as it is only down -2.6%, compared to -5.7% and -13.1% for Portfolio A and the S&P 500 Index on a price return basis, respectively. These returns also came with lesser drawdowns and volatility, as the standard deviation of daily returns for Portfolio A was 18%, Portfolio B 17%, and the S&P 500 Index 24% over this time frame.
Dividend Portfolio Return Time Series versus S&P 500 Index
Is There a Sector Bias to Returns?
Drilling into the drivers of returns can help isolate if, more broadly, dividend funds are benefiting from sector biases, other style effects, or idiosyncratic stock selection. Given many of these are indexed funds, the latter would equate to how stocks enter an index (i.e., the screen).
Take a look at the return attribution of Portfolio A and Portfolio B versus the S&P 500 Index, as shown below. The Portfolio A sector and stock selection effects were equivalent. But allocation effects were a larger driver for Portfolio B. Given there are larger sector differences in Portfolio B, this is not a surprise. The largest overweight is Utilities at 11%, while the largest underweight is Tech at -16%. And there is no exposure to Real Estate.
For Portfolio A, the more expansive exposure, the sector differences are not as large – particularly on the overweight as Financials have an overweight of just 7%. Yet Portfolio A is underweight Tech by -14%.
Brinson Attribution of Dividend Portfolios versus S&P 500 Index Year-to-Date
The Brinson-attribution can over simplify return drivers, however. A factor based framework can help examine attributes like style biases. As shown below, this attribution approach shows that style biases, and not sector, are driving returns.
Industry effects are still positive, but now less pronounced. Meanwhile stock selection effects are negative, illustrating how non-dividend related styles are having a more distinct impact. For both portfolios, the “dividend” factor was one of the largest contributors, followed by value, an intuitive result given the close relationship value and dividend have (excess return correlation is 81%, historically).6
Factor Attribution of Dividend Portfolios versus S&P 500 Index Year-to-Date
Naturally, each portfolio has a negative exposure to growth, given the positive exposure to value. This anti-growth profile has been helpful, as a result of the dour performance of growth stocks as real rates have risen. The other similarity was the positive contribution from having a bias toward firms with low earnings variability (i.e., fundamental stability). Market cap differences, even though the holdings are equal weighted, did not have a material impact.
The last part of this research would be to take the more heavily concentrated top 100 Portfolio B and make it sector neutral (Portfolio C). By making the sector weights similar to the S&P 500 Index, sector biases should be reduced. The one caveat is that within the top 100 stocks in Portfolio A, there is not any Real Estate exposure. As a result of the roughly 2% weight that should be in Real Estate being redistributed elsewhere, the sector neutrality in this example is not 100% pure.
Nevertheless, as shown below, this portfolio still had positive excess returns, with style effects as the driving force — led by the same descriptors of value, dividend yield, and low earnings variability. In fact, industry effects made up only 25% of the overall excess return in Portfolio C as compared to 50% in Portfolio B. While the sector neutral portfolio (-5.9%) underperformed the non-sector neutral portfolio (-2.6%), the still strong excess returns indicate the stylistic attributes of inexpensive, high yielding, and low fundamental volatility stocks are the main drivers of dividend strategies’ outperformance.
Factor Attribution of Sector Neutral Dividend Portfolios versus S&P 500 Index Year-to-Date
Why Has Dividends’ Blend of High Quality and Value Been Beneficial?
The takeaway from the above analysis is that the strong performance of dividend exposures is a function of their close relationship with value stocks as well as stocks with more stable fundamentals. This is why we referred to dividend exposures as a blend of high quality value in our midyear outlook.
Why have value and high quality been in favor this year?
Broad-based valuations were elevated to start the year, but as growth prospects were revised lower and rates increased (changing the discount rate), richly valued stocks have fallen. Stocks with more inexpensive valuations have not witnessed the same level of re-rating, as their valuations were more constructive to start the year and “value” stocks’ excess returns have historically had a more positive relationship to rising rates.7
In terms of fundamental stability, there has been a preference for profitable firms. This makes sense because earnings sentiment (i.e., fundamental volatility) is waning, evidenced by downside revisions to 2022 and 2023 earnings-per-share estimates over the past few weeks.8 Dividend exposures are more likely to have firms with positive earnings-per-share, as it is highly unlikely that a majority of firms would continue to pay dividends if bottom line cash flows are negative. In fact, only 7% of the stocks within the top 100 portfolio have a negative earnings-per-share over the past 12 months, based on recent filing date, compared to 33% for the total US equity market.9
With heightened macro volatility stemming from changes in monetary policies and increased geopolitical conflict, exposures that lean defensive (remember both Portfolio A and Portfolio B had lower standard deviation of returns), with value biases (a factor having its best year since 2001 versus growth stocks),10 and earnings/fundamental stability may continue to prove beneficial in portfolios.
1 Based on the return of the S&P 500 High Yield Dividend Index versus the S&P 500 Index and the return on the S&P Global Dividend Aristocrats and the S&P Global BMI Index as of August 9, 2022 per Bloomberg Finance L.P. data. 2 Based on the return of the S&P 500 High Yield Dividend Index versus the S&P 500 Index as of August 9, 2022 per Bloomberg Finance L.P. data. 3 Per SPDR Americas Research as of August 9, 2022. 4 Per SPDR Americas Research as of August 9, 2022. 5 Per SPDR Americas Research as of August 9, 2022. 6 Based on the correlation of quarterly excess return of the S&P 500 Pure Value Index and the S&P 500 Index versus the S&P 500 High Dividend Index and the S&P 500 Index from 1994-2022 per Bloomberg Finance L.P. as of August 9, 2022. 7 Based on the quarterly excess return of the S&P 500 Pure Value Index and the S&P 500 Index and the movements in the US 2-year yield from 1994-2022 per Bloomberg Finance L.P. as of August 9, 2022. 8 FactSet as of August 9, 2022. 9 Per SPDR Americas Research as of August 9, 2022. 10 Based on the return of the S&P 500 Pure Value Index and S&P 500 Pure Growth Index from 1994-2022 per Bloomberg Finance L.P. as of August 9, 202213 “The Cash Burning Question”, Barclays Equity Research June7, 2022.
Brinson, Hood, and Beebower (1986) presented a breakdown of the arithmetic excess return assuming a simple two- step investment decision process in which the returns are driven by allocation or selection effects.
S&P 500 High Dividend Index
The Index is designed to measure the performance of the top 80 high dividend-yielding companies within the S&P 500 Index.
S&P 500 Index
The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.
S&P 500 Pure Growth Index
S&P Pure Growth Indices includes only those components of the parent index that exhibit strong growth characteristics, and weights them by growth score.
S&P 500 Pure Value Index
S&P Pure Value Indices includes only those components of the parent index that exhibit strong value characteristics, and weights them by growth score.
S&P Global BMI Index
Comprised of the S&P Developed BMI and S&P Emerging BMI, is a comprehensive, rules-based index measuring global stock market performance. The S&P Global BMI represents the only global index suite with a transparent, modular structure that has been fully float adjusted since its inception in 1989.
S&P Global Dividend Aristocrats Index
Designed to measure the performance of the highest dividend yielding companies within the S&P Global Broad Market Index (BMI) that have followed a policy of increasing or stable dividends for at least 10 consecutive years.
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