The case for applying a dividend strategy to investing today

With so much focus on the “magnificent seven” technology stocks, passive funds, ETFs and private markets, some investors may be forgetting the fundamental case for dividend investing.

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Stocks that regularly pay shareholders a portion of their earnings provide investors with upside exposure to bull equities and downside protection against volatility and inflation, according to a panel of portfolio managers at this week’s Morningstar conference in Chicago moderated by Todd Trubey, a senior analyst of equity strategies with Morningstar’s manager research unit.

Noting that Morningstar articles about dividends get “monster hits” from readers, Trubey asked the managers, “How do we have this area where some people are wondering if it’s gone, but others still really, really love it?”

During the course of the discussion, the panelists answered that a combination of trends have made the traditional equity income strategy seem less interesting to some investors. Those circumstances include the bull performance among S&P 500 companies and tech firms, in particular, for the better part of more than 15 years, a long-term trend toward falling or zero dividend yields and the rise of stock buybacks. But the giant fund companies represented on the panel aren’t dropping out of dividend investing.

“Cycles come and go,” said Mike Barclay, the lead portfolio manager of the Columbia Dividend Income Strategy at the Ameriprise-owned asset management firm Columbia Threadneedle Investments. “They’re not dead, and they’re still an important part of an asset allocation, from the feedback that we get from our clients.”

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Understanding the potential dividend opportunity

In times of high inflation or volatility, the vehicles act “like shock absorbers in a car,” according to Ramona Persaud, a portfolio manager with Fidelity Investments who is co-manager of several dividend funds and primary manager of many equity income funds offered by the firm. “You can get a smoother ride. … That can be really protective against volatility, especially if other parts of your allocation are meant to come with volatility.”

With outperformance of benchmarks on either side of an economic cycle, dividend investing pays “through-the-cycle returns,” said Andrew Brandon, a managing director with JPMorgan Chase’s JPMorgan Asset Management, where he is a portfolio manager for the JPMorgan Equity Income and the JPMorgan U.S. Value Funds within the firm’s U.S. Equity Group.

“This has been a powerful cycle, and it’s probably not done yet,” Brandon said. “The real challenge and what I want to be judged on is, can I perform through the cycle?”

Trubey pointed out that utility stocks have historically loomed large as a sector for dividend investors, although that has been shifting over time as the power needs of artificial intelligence data centers tie them back into a broader tech exposure. So he asked the managers which sectors may be similarly pulling back among dividend investors or moving in the opposite direction with greater emphasis in their strategies.

For Barclay, consumer-staple companies are getting less attractive, since “brand loyalty is not what it once was” in areas like, say, the potato chip aisle in the grocery store. On the other hand, Persaud sees opportunities in international equities, especially in stock for companies based in countries in which pension-fund investments in stocks have led to a greater “balance between growth and income” than in U.S. equities. And Brandon pointed to health care as an overlooked area among many investors, citing United Healthcare, CVS, AbbVie and Abbot as standouts for the sector.

“It’s completely fallen out of favor,” Brandon said. “These are good businesses that are still growing nicely.”

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Quants go home

Nevertheless, each of the panelists agreed that dividend investing requires a careful approach that goes beyond simply quantifying the yield. Trubey asked how they can tell whether a company’s dividend payment could rise over time or if the firm was simply “throwing a bone” to investors with it.

“It starts with the fundamentals, and we start with the balance sheet No. 1,” said Barclay. “It’s where the cash flow is going that’s going to determine the quality of the dividend.”

Persaud agreed, citing how so-called quant strategies in dividends had “loaded up” in the financial sector ahead of the Great Financial Crisis.

“Fundamental research, especially in the dividend space, can add incrementally more value,” she said. “In dividend-oriented strategies, fundamental, sort of, more analog types of research can make a difference.”