In this note, we will look into the drivers which enable high dividend funds to build a portfolio presenting these characteristics with their attractive valuation features, and in a second step we will attempt to argue that a rebalancing (at least for those investors massively overweight in “growth stocks”) in favour of a high dividend/value style might make a lot of sense at this point.
First of all, while many commentators talk about expensive equity markets (e.g. the European market valuation multiple is currently slightly above the long term average), a more nuanced and interesting underlying reality tends to remain hidden. As a matter of fact, since the 2008 financial crisis, a huge polarisation trend has been taking place between the valuation (and performance) of stocks exhibiting “growth” characteristics and those offering “value” characteristics.
In mechanical terms, multiples paid for stocks capable of delivering structurally higher growth will move up as the cost of capital comes down (or the bond proxy part of equity market negatively correlated with risk free interest rates). On the other hand, more mature companies (for the sake of simplification, the “value” end of the market), offering a lower growth outlook and adapting their capital allocation policy accordingly (e.g. returning cash to shareholders through dividends rather than investing for growth), do not benefit from this “growth repricing” trend. Furthermore, this segment also tends to be more exposed to phenomena of technological disruption (e.g. physical real estate shopping centre suffering from structural retail decline due to the emergence of e-commerce).
What’s more, this high dividend universe is currently biased towards cyclicals and is therefore often positively correlated with inflation and/or interest rates (with Financials being the most obvious example).
In the light of the macro developments of the last few years (weak global growth, weak inflation and interest rates constantly revised downward), it is thus not surprising to observe a strong valuation expansion of the growth style versus the value style (see graph 2). This has resulted in a high dividend universe concentrating on a more limited number of sectors/themes than usual, as the rise in valuation of the defensive growth segment has led to a less attractive expected dividend yield for that segment.
