Gordon Scott, CFA
January 25, 2018
Oftentimes, when investors think about dividends, they do so within the context of the traditional equity income fund. These funds typically invest in well-established, blue chip companies that can be relied on to make consistent dividend payments. While these funds can generate a reliable income, they rarely invest in high-growth companies. And recently, we’ve seen traditional dividend managers underperform the Russell 1000 (the broadest and most inclusive large cap index) as dividend stocks have fallen out of favor. In fact, according to Morningstar, 98% of equity income focused funds underperformed the benchmark Russell 1000 year to date as of September 30, 2017.
A dividend growth investing strategy, however, focuses on creating a diversified portfolio of companies that not only pay out dividends, but increase their dividends over time. Our proprietary Equity Income Strategy, with a focus on total return, invests in high-quality securities that exhibit dividend growth at a rate greater than the market. A look at S&P 500 returns over time shows that the annualized total return for dividend growth stocks from January 1972 to December 2016 was 9.9%, compared to 7.4% for stocks with steady dividends and 2.4% for shares that didn’t pay dividends. Our strategy has outperformed both the Russell 1000 and large blend peers since its inception in 2003, and year to date through September 2017 had returned 15.14% (net-of-fees) compared to 14.17% for the Russell 1000.
Dividend growth stocks also offer another compelling benefit in that they have demonstrated lower volatility over time as well as outperformance. Looking at the standard deviation in total returns for S&P 500 shares over the January 1972 to December 2016 period, dividend growth stocks demonstrated a standard deviation of 16% compared to 18% for steady dividend payers and 24% for stocks that paid no dividends.
Our investment team has developed a meticulous process to identify the most attractive names for the Equity Income portfolio. Our portfolio managers and analysts employ bottom-up, fundamental research to build a high-conviction portfolio of around 40 companies. We emphasize above-average revenue, cash flow and earnings growth, all of which fuel growth in dividend payouts.
As part of the stock selection process, we seek to identify quality businesses that enjoy significant competitive advantages, high incremental margins and significant pricing power in their markets, as well as the benefit of high barriers to entry to help them maintain their strong positions. We emphasize a growth rate that exceeds the market growth rate, as well as access to businesses operating in growing markets. Proven, high quality growth is essential, as is a robust balance sheet.
In addition to common stocks, our mandate includes Real Estate Investment Trusts (REITs) and Master Limited Partnerships (MLPs). We seek to carefully manage risk in the portfolio, and do so by continuously monitoring position size, sector weightings, cash exposure, and exposure to ADRs, MLPs and REITs and holding these components within specified parameters.
As of November 30, 2017, the Equity Income Strategy outperformed the Russell 1000 on a number of factors, including revenue growth (7% vs 4% for the index), EPS growth (11% vs 7%), dividend yield (2.7% vs 1.7%), and return on equity (23% vs 14%).
Our Equity Income Strategy, with its objective of an attractive risk adjusted total return and a dividend yield in excess of the broader market, could be an effective strategy for clients interested in both growth and income.
Please speak to your CIBC Atlantic Trust wealth advisor to learn more about dividend growth investing and our Equity Income Strategy.
Gordon Scott is an equities portfolio manager for CIBC Atlantic Trust Private Wealth Management with 24 years of industry experience. Before joining Team Geneva Advisors, which became part of CIBC Atlantic Trust in 2017, Gordon spent nine years at Rail-Splitter Capital Management, most recently as a principal overseeing the firm’s investments in services, industrials and financials.
N.A. - Information is not statistically meaningful due to an insufficient number of portfolios in the composite for the entire year.
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