Perhaps contrary to expectations, attractive dividend paying companies are present in all markets, across all industries and capitalisations. Still, many investors seem to approach income investing with a more narrow focus, perhaps believing that attractive dividend payout only resides in a handful of sectors. Sectors with more exposure to ‘old economy’ names (e.g. telecoms, energy, finance, utilities, etc.) do indeed typically offer higher median dividend payout ratios and yields. However, our research shows that while these sectors may present higher median dividend payout ratios, income opportunities in other segments appear abundant for those willing to cast a wide net. Importantly, we believe this breadth of opportunity emphasises the point that investors need not sacrifice their commitment to environmental, social and governance (ESG) principles and standards to achieve attractive equity income. There are very attractive dividend payouts among companies that also boast attractive ESG profiles.
Income investing with less ‘c’
Given the fact that two of the most polluting sectors (energy and utilities) do typically exhibit higher median dividend payouts, many yield hungry investors may ask, is it possible to achieve a high level of income without taking on significant carbon risk? Rosenberg recently ran a study on equity income investing and ESG outcomes looking at payout ratios and carbon intensity as at 30 June 2017. Our proprietary analysis of a cross section of 2,700 developed and emerging markets stocks for which carbon intensity data, ESG scores and valid dividend information was available found that the higher dividend payout parts of the equity market were, in fact, not unduly dominated by the biggest polluters.
While the top payout basket of stocks did contain its share of very high carbon footprint names, it was clearly the case that there were many lower-carbon options to choose from within the highest income-paying part of the market. This result suggests that investors, therefore, don’t necessarily need to compromise on the ‘E’ component of their ESG goals when choosing a dividend focused investment strategy.
In fact, a simple test of removing the highest carbon intensity stocks from our analysis showed that there was virtually no impact on the average dividend payout ratio, implying that there is no evidence that a low carbon orientation would hinder an equity income strategy. On the contrary, our findings suggest that there are ample opportunities for high yield investing without having to invest in the largest polluting companies.
Good governance and income investing
In the second part of the same study, we analysed the relationship between governance principles and dividend policy for approximately 4,100 developed and emerging markets companies for which both ESG data and valid income data was available. Our first finding was that companies that pay dividends typically have better governance profiles than their non-paying peers. The advantage wasn’t extreme, but it was statistically significant. We believe this to be a simple but important observation as it suggests that dividend-seeking investors may already be putting themselves on the right side of good governance practices.In our sample, dividend-paying companies’ more attractive governance scores appeared to be driven by better transparency and management incentive profiles, and most dramatically, stronger shareholder rights as compared to non-paying companies. It seems intuitive that a greater degree of protection for shareholders resulted in higher dividend payout, so this result worked to confirm a very basic, prior belief.
Limiting our scope to dividend payers only, and further limiting observations to the companies that pay out less than their annual earnings, the findings of our proprietary research showed that the stocks with higher payouts also exhibited more attractive governance profiles. This result can be interpreted to mean that good governance is generally supportive of income investing when it comes to investing in the global equities universe.
These observations come from the analysis of a cross section of global equity data (as at 30 June 2017), which provided solid evidence that stronger governance, specifically as it relates to board structure, shareholder rights and management incentives, can be associated with higher dividend payout ratios regardless of sector. This is also generally consistent with our thinking that dividend payments can be seen as a possible means of alleviating agency friction within a firm.
Still, while the key conclusion from our in-house analysis is that good governance appears to work to support an income-oriented investment approach, it’s also important to note that the stocks at greatest risk of dividend cut or cancellation – a key risk of equity income investing – exhibited a governance profile that was actually slightly superior to peers. Therefore while good governance can certainly be a key attribute of higher dividend paying stocks, other metrics must also be taken into account to ensure a more complete understanding of the risks related to potential dividend payout cuts. Or in other words, investors should not rely on good governance alone to address the very real risk of dividend cut or cancellation.
No need to compromise on the ESG profile of your investments
In conclusion, our analyses suggest that in pursuit of investing for high income within the equities market, investors do not need to abandon their ESG goals. In fact, ESG factors such as good governance indicators have shown a positive correlation to higher dividend paying companies. Furthermore, when it comes to environmentally conscious investing, the good news is that the parts of the equity market with the highest carbon footprints did not appear to be the only places to find high dividend income. We believe that adding ESG criteria to an investment universe and approach should not hinder the objective of finding higher income through high dividend paying global equities stocks.
These are all key considerations for income investors to keep in mind today, particularly as the direction of travel regarding ESG and its growing importance seems very clear globally. ESG information can help point investors to both threats and opportunities – some of which may take years to play out, but will work to shape our economy nonetheless. Companies that are dividend payers will see their businesses (hence their willingness and ability to pay dividends) shaped by these trends. We therefore believe that income strategies that can take advantage of all relevant company information – including ESG — have the greatest likelihood of success. And those already committed to ESG investing should not see their income opportunities dampened.
Kathryn McDonald is Head of Sustainable Investing at AXA IM Rosenberg Equities.