The latest stock market malaise is giving hope to an investment strategy that gets little love in a bull run. As traders seek protection against the collapse in stocks and bond yields hit new lows, strategists at Bank of America Corp and Morgan Stanley predict inflows into dividend funds, especially in payout-rich Europe.
The global debt market rallied in May even as other risk assets tumbled after the US threatened Mexico with tariffs, sending traders chasing for income elsewhere. And with the dividend yields of US and European stocks well above the sub-zero levels of 10-year German bond yields, this may just be the time for the stock tactic to shine.
Strategies focused on higher-yielding stocks have been a tough sell during the past decade’s bull market as investors chose to reward companies that put their cash into expansion and new projects over those returning money to shareholders.
Since the Federal Reserve resumed its rate hikes in December 2015, European dividend funds have lost $50bn in outflows, equivalent to about 22% of total regional stock redemptions, and have continued haemorrhaging this year, according to Bank of America.
In search of safety, traders have instead been flocking to quality stocks, which Morgan Stanley now sees as overvalued, preferring “attractive and secure” dividend yields instead. 
Equities with high payouts, which usually have a strong inverse correlation with bond yields, have been left on the sidelines this year, triggering buy calls from Wall Street’s key strategists.
Neuberger Berman’s Will Hunter used the May dip as an opportunity to load up on high-dividend stocks.
“Two key factors may make equity income funds of interest: low rates and an investor’s aversion to volatility,” said Hunter, whose Dividend Growth Fund is up 12% this year and has beaten more than 80% of peers. “Equity income may add more risk to a portfolio versus fixed income, but these stocks have historically been less volatile than the broader equity markets.” Dividend strategies were swept into the spotlight during the end-2018 market plunge as the MSCI World High Dividend Yield gauge outperformed the global benchmark for four months straight. In April, these stocks resumed their outperformance after staying on the sidelines throughout the rally.
Wells Fargo launched its $100mn Global Multi-Asset Income Fund in December of last year, at the peak of the market collapse, targeting retirees and international investors tired of low-yielding fixed income instruments.
“With rates likely lower for even longer, we see a rebound in the search for yield and envisage the appeal to be at the more conservative spectrum of the income space, given where we are in the economic cycle,” said Dan Morris, head of the multi-asset solutions team at Wells Fargo.
This year’s bond-market rally has been a mixed fortune for higher-yielding stocks, depending on how different funds slice and dice them. Bond proxies including utilities and real estate have proved to be ports in the storm whereas equities with higher payouts, but lower earnings quality have been shunned by investors.
“I don’t really agree with the idea that dividend funds should outperform when yields fall because they tend to contain stocks with lower quality earnings, but I do agree that bond proxies should outperform and they have,” said John Roe, the head of multi-asset funds at Legal & General with a combined £1tn ($1.3tn) under management.
What might help dividend funds, according to Roe, is traders searching for value shares, which often have elevated payouts because of low valuations. His team has been buying US value stocks recently after cheaper stocks have lagged growth shares this year.
Aaron Clark, a portfolio manager at Boston-based GW&K Investment Management managing $37bn, says buying high-yielding stocks poses the risk of getting stuck with “melting ice cubes” – companies that are cutting costs and using cash flows to service a dividend instead of investing in growth.
“Anyone can come up with a high dividend-yielding portfolio, the key is avoiding value traps and trying to find companies that have potential to drive the business,” he said.
Bank of America recommends focusing on the long-term horizon when it comes to the performance of income strategies, saying dividends have contributed about 40% of Europe’s total equity returns over the last 50 years. And investors are currently rewarding reliable dividend payers: the so-called dividend aristocrats in Europe that have a track record of increasing payouts are trading close to a three-year high relative to the broader market.
Stocks continued last week’s decline and bonds rallied yesterday after China retaliated with tariff hikes against the US over the weekend. The Stoxx Europe 600 was down 0.2%.
“At the end of last year, people got scared and realized that they needed protection,” said Jorik van den Bos, an Amsterdam-based portfolio manager at Kempen Capital Management. “I’ve been doing this for 20 years and what we see is that when there’s a sell-off in the market, dividend funds are sold off less.”
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