Allocating to Dividend Growers to Manage VolatilityBy Ehren Stanhope
As we find ourselves in a period of uncertainty, high volatility, and threat of persistent inflation, many investors have expressed interest in strategies that offer reduced volatility and relative downside protection. A dividend growth strategy may be the answer.
Stocks with consistent and strong dividend growth tend to be higher-quality companies. These names generate steady operating income and share the surplus with equity shareholders through dividend streams that increase over time.
Additionally, these companies tend to be less volatile than the average stock, which can generate relative outperformance in down markets. The table below shows the hypothetical performance of stocks with five consecutive years of dividend growth1 from 1969 to 2021.
Notice that performance of the dividend growers nearly matches the return of the Russell 1000® Index. However, volatility is 2.4% per year lower. Said another way, the ride to achieve a similar return has fewer twists and turns.
Because dividend growers tend to be higher-quality and lower-volatility in nature, we generally expect that they will provide relative protection in down markets. The Downside Capture statistic of 60% bears this out historically. For example, in a 10% down market, this suggests dividend growers would be down around 6%. Nobody likes losing money but losing less than the market can be a powerful way to compound returns over time while clipping dividend payments.
The research above is conducted on the U.S. Large Cap market, however, we have found that the key tenets of dividend growth investing generally hold true in U.S. Small Cap and Non-U.S. markets as well. Additionally, we offer variations on the above that include ten-year dividend growers, quality and stability constraints, and return on invested capital.
Through the mid-point of the year, dividend growers have generally outperformed across three universes that we monitor – U.S. Large Cap, U.S. Small-Mid Cap, and Non-U.S. markets (including emerging).
While nobody knows when the recent bout of volatility will end, including allocations to dividend growers could be an opportunity to lower overall equity portfolio volatility while generating reliable income. This feels like a valuable recipe given today’s uncertainty for equity and bond markets.
1 5-year dividend growers based on a universe of U.S. Large Stocks and market cap weighted. Hypothetical returns are gross-of-fees.
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