Pressure on equities drives investors to dividend funds

With their stable income and preference for defensive stocks, conservative dividend strategies can be seen as an alternative to government bonds at times of stock market uncertainty. Are they really? Yes, says fund manager Thomas Schüssler of the well-known DWS Top Dividende. But it is the equity markets that are currently driving the inflow.

“In short, the answer is that dividend strategies can always be an alternative to bonds,” he said in an interview with InvestmentOfficer’s Dutch service Fondsnieuws. Yet, he points out that, with interest rates low for years, government bonds have been unattractive. “If dividend strategies were on investors’ radar as a good alternative to bonds, they could have made the switch years ago.”

That did not happen. Dividend funds, including DWS Top Dividend, have suffered significant outflows in recent years. 

“They were out of sight for investors. Very much out of the picture. And what do you expect?” Schüssler said. “We have had positive returns in recent years, but a huge underperformance in relation to the MSCI World. If you can achieve enormous price gains through the broad market or with growth stocks in particular, what do you care about a dividend yield of 3.5 to 4 percent?”

Bluntly punished

This picture has changed over the past three months. High-performing growth stocks have fallen from their pedestal. More than half of the US growth stocks in the Russell 1000 Growth Index lost 10 percent from their peak last year. Almost a quarter of the index names lost as much as 30 percent. And this year, too, these stocks are suffering.

In the meantime, the substantial outflow from Top Dividende has come to a halt and there has even been a small inflow. Schüssler said this is not because of the continuing negative returns on government bonds. They have actually become more attractive in recent months, the valuation has improved.

The substantial declines in the equity markets are a factor. “Investors want to invest more defensively again,” he said. “They are more risk-averse now. So I attribute that small inflow in Top Dividende not so much to bonds being under pressure, but to equities being under pressure.”

Deep junk

This sentiment brings dividend stocks back into the picture as an attractive alternative to bonds, he said. “They often pay 3 percent. On the bond side, you currently have to be in ‘deep junk’, bonds with a very high credit risk, to achieve that.”

Top Dividende invests in blue chip companies. “In my fund you won’t see a bankruptcy. In addition, the rising dividend yield offers protection against inflation. Bonds do not have that feature.”

Nevertheless, beating inflation as a dividend investor used to be a lot easier. “Inflation is very high, combined with the markets being very expensive, making this a difficult time,” he said.

No chance

And, as Schüssler points out, with a bond investor tend to be further away from home. “Certainly as a bond investor in Europe, you don’t have the slightest chance of real capital preservation. Impossible. If you have a large allocation to bonds, you have the guarantee of losing purchasing power.”

The equity market, at least for now, gives investors a chance to cope with inflation, he said. “So if you look at the portfolio of bond investors from an allocation perspective, a shift of part of your bond allocation towards equities would be justified. Including dividend stocks.”

The current uncertain environment calls for broad diversification, even more than usual, he said. “Across sectors, countries, etcetera. That’s easier said than done, with an MSCI World that is 70 percent American and a lot of tech companies.” 

“And yes, you will have to take a closer look at the balance sheet and the business model before you buy a stock. The time when you ‘simply’ buy a stock and can count on a rise of tens of percent is over. No more free lunch. Inflation has put a brake on the whole market.”