Markets, being composed from the actions of people, share a common trait with people—they can both be unpredictable. After all, in our current environment, when many large corporations such as GM, Royal Dutch Shell and others have cut their dividends, we would expect funds that invest heavily in “dividend growers”—companies that grow their dividend over time—to perform worse. But, as a recent article in Barron’s points out, that hasn’t been the case. In fact, many of these funds have performed better than the market (defined as the S&P 500 in this case) as a whole during the crisis. Why would this be?

As with any research into a science like economics, where events play out in real life and not in a controlled laboratory, there are many possible answers. Here at Emergent, we often talk about our “cash flow investing” philosophy, which is a preference for investments that pay some kind of cash flow (interest for bonds or dividends for stocks) and our reasons behind that philosophy. Those include the ability to use cash flows to purchase at lower prices and having that cash as a “cushion” against falling prices, among others.

The fund managers and researchers spoken to in Barron’s offer some additional reasons. For one, companies that consistently grow their dividends over time (as opposed to just offering very high dividends to begin with) are often in industries that are more stable, and have cash flows coming into the company that are less volatile. In addition, many of the larger sectors in dividend growth funds—like technology, health care and financials—have been less impacted by the coronavirus shutdown than industries like hospitality and retail. Furthermore, companies that have consistently increased dividends over time tend to be larger, and so stock portfolios weighted by market-cap (meaning more of the portfolio is invested in bigger companies) are more top-heavy, and large-cap stocks (meaning bigger companies) have withstood the shutdown better than smaller ones.

Some of these attributes of dividend growers may continue to be the case in future downturns or recessions, while some may not. History may repeat itself, but not always when we think it will. The key with any strategy, whether dividend-based or not, is to understand what its pros and cons are and why you are invested in it. Portfolio managers will never be right all the time, but they should at least be able to understand their proposed strategies and follow them when they say they will.

Alex_Signature-1
Alex Urpí, CFA®

Sources:
https://www.barrons.com/articles/dividend-growth-funds-hold-their-own-in-an-era-of-payout-cuts-and-suspensions-51588257901?refsec=financial-planning

Photo:

unsplash-logoPro Church Media