How to tell an oasis from a mirage in the search for yield
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Income is the dominant driver of most asset class returns over the long run. For some asset classes, such as high-yield corporate bonds, the income received can even exceed the total return due to a portion of capital being lost to defaults.
Even for equities, reinvested dividends are typically responsible for more than half of cumulative total returns over time, and arguably this understates the importance of income to stock market investors, with buybacks providing an additional route by which cash is returned to shareholders.
Given the importance of income, the decline in yields on most asset classes since the global financial crisis, and the further fall during the Covid crisis, appears to bode ill for future return potential. Central banks have doubled down on using ever looser monetary policy to stimulate economic activity. Official interest rates have been cut to very low or negative levels in most developed countries, and balance sheets have been used to buy bonds, pushing government yields close to zero or even below in many cases.
One definition of madness is repeating the same action but expecting a different result. That hasn’t stopped policymakers from believing that looser policy will eventually generate higher growth and inflation. For this strategy to work they now believe low interest rates and quantitative easing will probably be needed for the foreseeable future.
The good news is there are still attractive yield premiums to be earned across a range of asset markets and securities. The yield pickup over government bonds offered by corporate bonds and emerging-market debt is above the median levels that have prevailed over the past 20 years. In addition, the earnings yield premium offered by global equities is also above the average seen since the global financial crisis and well above the levels that prevailed for the two decades before that.
These yield premiums exist for a reason, with many businesses and borrowers in financial distress. There has been a slew of dividend cuts, especially in sectors that were already under pressure and are now beginning to see company failures and defaults.
Dividend resilience
The answer is to be selective in what to own and what to avoid. History shows that the highest-yielding assets are often compromised and can deliver disappointing returns with significant risks. The yields they offer are essentially illusory, because their underlying assets struggle to generate sufficient cash to cover their income payments. Better ...
Even for equities, reinvested dividends are typically responsible for more than half of cumulative total returns over time, and arguably this understates the importance of income to stock market investors, with buybacks providing an additional route by which cash is returned to shareholders.
Given the importance of income, the decline in yields on most asset classes since the global financial crisis, and the further fall during the Covid crisis, appears to bode ill for future return potential. Central banks have doubled down on using ever looser monetary policy to stimulate economic activity. Official interest rates have been cut to very low or negative levels in most developed countries, and balance sheets have been used to buy bonds, pushing government yields close to zero or even below in many cases.
One definition of madness is repeating the same action but expecting a different result. That hasn’t stopped policymakers from believing that looser policy will eventually generate higher growth and inflation. For this strategy to work they now believe low interest rates and quantitative easing will probably be needed for the foreseeable future.
The good news is there are still attractive yield premiums to be earned across a range of asset markets and securities. The yield pickup over government bonds offered by corporate bonds and emerging-market debt is above the median levels that have prevailed over the past 20 years. In addition, the earnings yield premium offered by global equities is also above the average seen since the global financial crisis and well above the levels that prevailed for the two decades before that.
These yield premiums exist for a reason, with many businesses and borrowers in financial distress. There has been a slew of dividend cuts, especially in sectors that were already under pressure and are now beginning to see company failures and defaults.
Dividend resilience
The answer is to be selective in what to own and what to avoid. History shows that the highest-yielding assets are often compromised and can deliver disappointing returns with significant risks. The yields they offer are essentially illusory, because their underlying assets struggle to generate sufficient cash to cover their income payments. Better ...