We’ve talked about why diversification matters across asset classes that you think could be risky, but aren’t dividend-paying firms supposed to provide a more consistent, “safer” way to generate income?
Equity income investing seeks to solve the following client needs with a single allocation:
- Long-term capital growth through broad exposure to the U.S. equity market.
- Return enhancement by purchasing undervalued firms with attractive dividend yields, with the added protection from dividend payers’ expected defensive characteristics.
- Income that can be withdrawn or reinvested, with taxable investors further benefiting from the naturally tax-efficient qualified dividend income.
While these are primary considerations for most investors, the various approaches to dividend income investing aren’t all created equal.
Traditional Dividend Income Approaches
Traditional dividend income approaches start by finding companies with specific characteristics, such as years of dividend growth or a narrow range of fundamentals . Typically this dramatically winnows down the investable universe, with many surviving dividend payers clustered in a handful of sectors. After this selection process, the remaining stocks are weighted proportionally to concentrate the dividend income strategy into the most promising positions. The result: a portfolio with significant, and frequently unintended, bets.
A Different Take on Dividends
We take a different approach because we believe that diversification matters and can be created by equally weighting both economic sectors and securities. This means broadly defining the most durable set of eligible dividend payers—those with elevated dividend yields and lower price volatility compared to peers—and equally allocating within each sector. This helps to broaden the opportunity set while mitigating the risks associated with an individual company’s payout policy. Instead of reaching for only the highest yielding securities, this approach can balance a stock’s yield prospects with risk levels relative to peers.
Active tax management can also make a difference. High levels of position concentration typically exhibit elevated turnover. As a result, taxable investors suffer from traditional dividend income approaches due to elevated turnover. This can lead to gain realization and non-qualified dividend generation. In contrast, we seek to defer gains while actively harvesting losses for taxable accounts. The result: mitigating tax drag while preserving potential after-tax outperformance.
By diversifying across both exposures and sources of dividend income, long-term investors can be rewarded with consistent excess returns, an attractive income stream and tax management.
A Better Way to Measure Success in Equity Income
In recent years, equity income strategies have seen increased interest from a broad range of investors. The goals of equity income strategies are relatively simple: provide high levels of income over the long term while growing the underlying value of the portfolio.
Potential Parametric Solution:
Alex Paulsen – Director of Investment Strategy
Mr. Paulsen is responsible for all aspects of the dividend equity and closed-end fund strategies. Prior to joining Parametric in 2012, Alex worked at BlackRock Alternative Advisors, the Funds of Hedge Funds unit of BlackRock, executing hedge fund investment reviews as well as ongoing risk management efforts for long/short equity and equity-related hedge fund strategies. He earned a M.S. in the Management and Regulation of Risk from the London School of Economics and Political Science as well as a B.S. in Economics from the University of Washington.