Dividend Strategies As Rates Rise

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July 30, 2013 12:50pm NYSE:HDV NYSE:IDV

ratesSince interest rates began rising earlier this summer, some market watchers have been declaring the dividend trade a thing of the past. It’s no wonder, then, that many clients are asking me if it’s time to abandon dividend payers.

This is just one of the questions about dividend investing I’ve been hearing lately during my sales conversations. So, as it has been a more than a year since I last debunked misunderstandings about dividends, I’ve gathered some of these dividend-related questions, and my answers, below.

In the comments section, let me know if you have other questions about dividend investing you’d like me to answer in a future post.

Q: Amid the recent rise in bond yields, should investors flee all dividend stocks?

A: My colleague Russ Koesterich has long advocated – even before rates’ recent rise – that investors should be selective when searching for dividends.  While certain dividend-paying sectors (like global utilities) look crowded and expensive, he believes that there are still opportunities to be found in the US equity market such as mega caps and energy companies.

In addition, Russ has long suggested looking abroad for dividend income, and he still believes that there’s a strong case for investing in international dividend stocks. For instance, as he pointed out in a recent post, non-US dividend companies still offer more enticing yields than fixed income and US dividend counterparts. Plus, Russ believes that international dividend stocks are likely to pay higher yields for the foreseeable future given that he expects rates to hover where they are in the near term.

Q: Does a company’s past dividend-paying history guarantee future dividend payments?

A: Just as past performance doesn’t guarantee future results when it comes to stocks, just because a company paid generous dividends in the past doesn’t mean that it will continue doing so in the future. In fact, according to one analysis, more US firms decreased dividends  in the first quarter of this year than did during the same period last year.

This is partly why it’s so important to consider index methodology when selecting a dividend-paying ETF. As another one of my colleagues, Dominic Maister, wrote last fall,many dividend indices are based entirely on backward looking data and may merely require included companies have a long history of dividend payouts. This methodology can be problematic for a fund’s performance, however, when top holdings make drastic dividend cuts.

Some indices – like the Morningstar Dividend Yield Focus Index (benchmark for the iShares High Dividend Equity ETF (NYSEARCA:HDV), which can potentially be a good way to access Russ’ preference for US mega caps) – go a step further and also include sustainability screens in their methodologies. To be selected for the index, a company must have long-term competitive advantages likely to ensure dividend sustainability and growth.

Q: Why consider a dividend-paying stock ETF?

A: There aren’t many people with a solid reputation for selecting individual stocks. This is one reason why many investors may want to consider an ETF or other fund that seeks to replicate the performance of an index of dividend-paying companies. Such funds also may offer potentially lower volatility than a handful of individually chosen stocks and can provide diversification benefits that you’d have to buy many individual stocks to replicate. In addition, dividend focused ETFs, such as the iShares International Select Dividend ETF (NYSEARCA:IDV), can be used to access dividend payers outside the United States.

Sue Thompson, CIMA, Managing Director, is Head of the Registered Investment Advisor Group, overseeing the firm’s iShares and 529 sales efforts with registered investment advisors, family offices and asset managers. Sue is a regular contributor to The Blog. You can find more of her posts here.

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