Investors who blindly opt for the highest-yielding stocks are guaranteeing themselves inferior returns over the long-term, according to research by the managers of the BlackRock Global Income fund.

The second and third deciles of the highest dividend-paying stocks outperform the first decile on a risk-adjusted basis, the research shows, while also providing better long-term performance.

The report supports a recent FE Trustnet study that showed the top-yielding funds underperform their more modest rivals, even when dividends are reinvested. 

Stuart Reeve, co-manager of the BlackRock Global Income fund, said: "Many dividend investors, including dividend-themed funds, focus their search on locating the highest-yielding stocks in the market."

"The global market yield is currently around 3 per cent and the logic is often that a stock which generates a higher dividend yield, say 6 per cent, will deliver a greater return." 

"Actually, the relationship is not that simple. History shows us that an equity’s risk-adjusted return begins to fall when the dividend yield reaches a certain point."  

"By analysing long-term data, we found that the second and third deciles of yielding stocks produced the best risk-adjusted returns, whereas moving to the top decile – the top 10 per cent of highest-yielding stocks – resulted in a significant reduction in returns." 

One of the key reasons for this is that many companies that offer a high dividend are distressed, meaning they often fail to pay the full amount they promised. 

"Once dividend yields pass a certain point, say around 6 per cent, we should expect to see a marked change in the dividend delivered. Beyond this point, the probability of the company actually paying the stated dividend declines," Reeve added. 

"In fact, less than half of the stocks yielding more than 10 per cent actually pay the full dividend. Therefore, investors need to be wary of these situations, where potential yield is not the same as realised yield." 

Data from FE Analytics shows that BlackRock Global Income has outperformed its IMA Global Equity Income sector and MSCI World benchmark since launch in May last year. 

Performance of fund vs sector and benchmark since launch



Source: FE Analytics

The fund has returned 6.59 per cent, which puts it in the top quartile of its sector over that period, while the index has lost 0.64 per cent. 

The portfolio is currently yielding 3.14 per cent, a figure that puts it in the lower quartile of the IMA Global Equity Income sector.

Reeve says picking stocks with the potential to grow their dividends in the future is key.

"While an attractive yield is an important component of total return, we believe dividend growth — a company’s ability to consistently raise its dividends — is even more powerful over the long-term, through the compounding of growth on growth." 

"A good example of a stock which produces this powerful combination of dividend yield and dividend growth is British American Tobacco. Not only is this company yielding roughly 4 per cent, but it has been able to grow that dividend by about 17 per cent annually for the last 5 years." 

"Investors should be open to the returns offered by companies which, on paper, have a low yield. For instance, the Finnish elevator and escalator firm Kone, which installs and maintains the technology in many UK buildings, offers a current yield of under 3 per cent."  

"However, it has grown that dividend by almost 23 per cent annually for the last five years. At that rate, the income received by an investor would have doubled in just over three years."