June 2, 2020
Income-focused stocks can complement portfolios during market downturns.
Record-low interest rates. Ten-year U.S. Treasury rates well under 1%. Global debt of almost $10 trillion yielding less than zero. In these challenging times for income-producing securities, many investors continue to turn to dividend stocks as one of the few remaining sources of satisfactory yields.
Among income-producing stocks, we prefer premium yielders (defined as the top 40% of high yielders in the Russell 1000® Index), which we believe offer attractive levels of income, are currently undervalued, and will outperform other income-focused investments during times of crisis.
Over more than two decades, a portfolio of premium dividend-focused equity securities has provided a more stable and secure yield relative to many other yield-focused instruments (see chart). This has been especially true during times of crisis. When the dot-com bubble burst in 2000, premium-yielding equities increased throughout the proceeding recession while many fixed-income classes fell. During the Great Recession, premium dividends again outperformed most fixed-income classes. In today’s economic turndown, those premium-yielding equities are following this same pattern.
Performance data quoted represents past performance, which does not guarantee future results.
In addition, given the current record-high spread between equities and fixed income, we believe it is prudent to remain invested in a portfolio of companies that make responsible capital-allocation decisions. Higher-yielding companies are usually financially sound with attractive cash flows, and the stocks of those firms have historically tended to have above-average returns with lower-than-average volatility than the overall market.
However, it is important to note that the highest yielders have not always been the best performers over time. A struggling company with high but unsustainable dividends can find its share prices falling and dividends cut. To avoid this dividend trap, we focus on quality dividend companies that exhibit balance-sheet strength, profitability, and earnings stability. We believe those companies can ultimately maximize return potential, minimize volatility, and provide steady cash flow, even in down markets.
We acknowledge that, like other securities, income producing equities are not immune to the impacts of the Covid-19 pandemic. Capital-return plans face many threats, including earnings downturns, bans on dividends for U.S. and European-Union companies receiving equity infusions from rescue packages, and corporate liquidity issues.
During the Great Recession, Main Street focused its ire on Wall Street executive bonuses. Today, dividend payouts and buybacks—viewed as enriching executives and shareholders and not the everyday worker—have morphed into the new villain. And dividend payouts may fluctuate frequently—especially in these extreme market conditions.
But even with this backdrop, income-producing securities continue to look attractive to us. Regardless of the political or market climate, we believe that there will always be premium yielders that will deliver better risk-adjusted returns than most fixed-income options over a full market cycle.
Pacific Life Fund Advisors manages the five Pacific Funds multi-asset funds. For more information, click here.
The Bloomberg Barclays U.S. Aggregate Bond Index is composed of investment-grade U.S. government and corporate bonds, mortgage pass-through securities, and asset-backed securities.
The Russell 1000 Index measures the performance of the 1,000 largest companies in the Russell 3000® Index, which represents approximately 92% of the total market capitalization of the Russell 3000 Index. The Russell 3000 Index measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the U.S. equity market.
Past performance does not guarantee future results. All investing involves risk, including the possible loss of the principal amount invested.
This commentary represents the views of the portfolio managers at Pacific Life Fund Advisors LLC as of 5/20/20 and are presented for informational purposes only. These views should not be construed as investment advice, an endorsement of any security, mutual fund, sector or index, or to predict performance of any investment. Any forward-looking statements are not guaranteed. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed. The opinions expressed herein are subject to change without notice as market and other conditions warrant.
Sector names in this commentary are provided by the portfolio managers and could be different if provided by a third party.
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