The chart illustrates peaks and troughs in dividend points, highlighting the importance of dividend risk management tools.
The figure illustrates the breakdown of S&P 500 dividend points across sectors over the past decade. At the beginning of the decade, dividend point contribution is more evenly split across the sectors relative to the end of 2008. The top three dividend weights at the beginning of the decade were financials, consumer staples, and energy, which accounted for 44.4% of the total dividend points of the S&P 500. At the end of the period, the top three dividend point contributors were financials, consumer staples, and industrials, which in total accounted for 48.5% of the total dividend points of the S&P 500.
The chart plots the relationship between the S&P 500 dividend growth and the headline CPI rate during the last 20 years. It suggests that dividend growth remained elevated during periods when inflation spiked above trend levels. To take the example of 1990-91, this is the last time the US experienced a phase of above-trend inflation and below-trend growth, or “stagflation-light”. Dividends per share rose by as much as 15% that year and closely followed the trend in inflation. In more recent years, with the commodity boom, dividend growth has persistently remained above 10%, providing decent inflation protection at a time when year on year headline CPI growth has moved above 4%. Recently, as the economic recession deepened and CPI number dropped dramatically, dividend growth has plummeted and entered the negative territory. The positive correlation with inflation may be attractive to investors – particularly those attempting to hedge longer-dated inflation-linked liabilities – where there are because low real yields on index-linked securities.
Hence, dividends may prove to a strong alternative asset to provide inflation protection. The advent of the exchange-traded futures on index dividend market seem likely to eventually rehabilitate equities as an inflation hedge, largely because dividends provide a portion of equity total returns free of the inveterate volatility caused by swings in equity valuation.
Besides using the index dividend as a sole inflation-hedging investment vehicle, the index dividend can also be used to improve the risk-return profile of a portfolio hedging against inflation. Using a future on index dividend, one can achieve a reasonable dividend exposure, providing inflation protection and diversification. As an example we build a portfolio including Commodities (S&P GSCI Index), Inflation-Linked Bonds (Barclay Capital US TIPS Index), and the S&P 500 Dividend Growth data. As shown in the figure, this portfolio exhibits less volatility and higher Sharpe ratio with respect to a portfolio that doesn’t include the S&P 500 Dividend Growth.
For those readers who are interested in the idea of investing in dividends, please refer to a paper I wrote recently on the topic of dividend investing on ssrn.com
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1425518
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