Which dividend strategy works best? Fairvalue investigated this question by examining the 13 most important dividend indices. This article highlights the two most promising concepts. Exchange-traded index funds (ETF) that map a dividend strategy are very popular with investors in 2019.
MSCI’s dividend strategy
The selection process used by MSCI to compile its high-dividend yield indices is complex. The starting point is always the respective parent index from which companies with an above-average dividend yield are selected. Thus, for example, the MSCI World High Dividend Yield Index only contains companies that are also included in the broad-market MSCI World Index
So-called Reits are excluded from MSCI’s dividend strategy. Due to legal requirements, these real estate companies have to distribute almost all of their profits as dividends to the shareholders. The dividend yields of these groups are therefore particularly high across the board. According to MSCI, this in turn would lead to an overweighting of Reits in the high-dividend-yield indices.
Even corporations that do not pay dividends or pay out distributions from their assets because they are making losses are not candidates for MSCI’s dividend strategy. It canceled the dividend for 2019 and 2020 because of the costly restructuring of the bank. In addition, the 5 percent of shares that distribute the highest proportion of their profits are excluded. According to MSCI observations, a very high payout ratio is often associated with falling profits. The index provider sees this as an indication of future dividend cuts. The 5 percent of shares that posted the highest price losses in the previous year are also not included.
Five years of positive dividend growth
Another basic requirement for inclusion in an MSCI High Dividend Yield Index is positive dividend growth over the past five years. In addition, the companies must pass a quality test in which MSCI examines and evaluates fundamental key figures. Only companies that pass this test are eligible for the dividend strategy. From the population of the parent index restricted according to these criteria, the companies then qualify for the respective high-dividend-yield index, whose dividend yield is at least 30 percent above the average of the parent index.
The dividend shares ultimately selected are weighted according to the market value of their theoretically tradable shares (market capitalization in free float). However, the weight of an individual company may not exceed 5 percent.
S&P’s dividend aristocrat concept
The shares for the S&P Global Dividend Aristrocrats Index are selected by the provider S&P from the S&P Global Broad Market Index, which, unlike the MSCI World, also contains companies from the emerging markets . Companies that want to be shortlisted for the 100 companies in the index must have a history of increasing or at least constant dividends over the past 10 years.
- The market value ( market capitalization in free float) must be at least one billion US dollars.
- Companies that write losses are excluded.
- The dividend yield must not be higher than 10 percent. With this rule, S&P wants to remove companies from the list of candidates that are suspected of not being able to maintain their distributions in the long term, as well as stocks whose prices have fallen sharply.
Diversification rules for the dividend aristocrat strategy
Of the companies that meet these basic requirements, the 100 with the highest dividend yield make it into the index. However, there are some restrictions that should ensure sufficient diversification :
- The number of corporations from one country may not exceed 20 and their index weight may not exceed 25 percent.
- The number of stocks from a sector, such as the financial sector, is limited to a maximum of 35 stocks. Their index weight must not exceed the 25 percent mark either.
- S&P weights the companies based on the dividend yield. The higher this figure, the greater the weight in the index, which is limited to a maximum of 3 percent.
Once a year, the S&P Global Dividend Aristrocrats Index is compiled on the basis of an updated investment universe. The index weighting is adjusted every six months. S&P monitors the development of dividend payments on a monthly basis. If a group cuts the dividend, it will be removed from the index in the following month. This also applies to companies that lower their distributions and as a result slide to last place in the index in terms of dividend yield.