The 'smart' route to dividends

Scott Longley

a couple of plants in a pot

The question of how you go about picking a dividend index was front and centre of the smart beta panel at the Big Call Dividends events held last week in London in association with ETF Stream.

Andrew Innes, associate director for global research and design at S&P Dow Jones Indices, said his company had two broad categories of indices. The first is the Dividend opportunities, which select by high yield. "There are some screens in there to avoid dividend traps, but essentially it is going for high yield stocks," he told the audience at Schroder's offices in London.

"The alternative approach is our dividend aristocrat range; which includes stability criteria. It looks ta dividend growth for the past 20 years, which is basically one of the only methodology points. You kind of end up with around 50 to 50 names."

"You are always trying to balance that absolute high yield with some quality metric."

He said that S&P DJI rarely looked at balance sheets and instead it was more about payout ratios and other measures that in essence would provide a "synthetic stock".

A further range comes from S&P's low volatility/high dividend selection with the idea being that you are exposed to two factors.

From the providers point of view, Amanda Rebello, head of passive distribution at DWS, said the company had recently migrated its benchmark for its dividend range to a more quality focus. She said it was a similar approach to S&P but it incorporates an additional factor of the three-year free cash-flow growth.

She said that was where the most demand came from investors.

On the vital issue of weightings, Innes said that in a factor index, for dividend strategy, it was weighted by dividend yield. "It's not too far away from equal-weighted portfolios because we don't want any stock-specific risk."

Demand side

Anthony Kruger, iShares specialist sales at BlackRock, said that there was s till demand for traditional type strategies but that "more and more we have investors looking for that quality or factor overlay, to mitigate some of the risks."

"We are looking at dividend sustainability, dividend persistency, as well as quality metrics and even one momentum metric."

Chancal Samadder, head of ETF strategy at Lyxor, said there were now two generations of product available to investors. "Over the last three or four years, you have seen a huge number of strategies come to market and the job for the issuers is to sift through all that and work out which ones will work in the long term. We don't want to shoot the lights out, we just want to be sensible."

Given the focus on quality, Samadder pointed out that the area was now becoming quite crowded but added that the major indices were "actually quite different". "The difference is how you define quality, and the outcomes can be really quite different."

Investor explanations

Innes said the explanations for investors would all be specified upfront from the methodology documents.

"In terms of investor needs, the kind of clients that will be looking for a dividend stream will also be looking for capital preservation," says Rebello. "So a quality component combined with a low volatility aspects is something we think goes hand in hand."

Kruger said that from a factor investing point of view, quality and low volatility are two separate categories that exist for similar but different regimes you are experiencing. "With rising interest rates, if you are looking for defensive characteristics from factors, quality looks like a better metric that minimum volatility."

In terms of where the money has been heading, Samadder said that currently there have been outflows from dividend income funds partly as a result of the increase in US interest rates.

Innes said that the big question was what would happen with much of the high yield dividend sector in a higher rate environment. "If clients want to stay in these high dividend/low volatility products, there are ways to minimise the effects of higher interest rates."

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