Investors face some serious long-term challenges beyond the obvious macro problems of the sovereign debt crisis in the eurozone, slowing growth in China and anaemic growth in some developed countries caused by deleveraging. Yields on a number of fixed income investments have been falling in this recent environment, particularly with respect to government bonds.

This was caused on one hand by deleveraging effects, especially in the US and in Europe, and on the other hand by the ‘financial repression’. This term is used to describe several instruments that governments employ to channel funds to them and to bring down unsustainable debt levels. Instruments which are used include monetisation, regulation of capital flows and the whole financial sector and most importantly negative real returns.

Low or even negative real interest rates help to bring down the debt service burden and finally to reduce the value of government debt in real terms – therefore inflation does not need to be very high or take markets by surprise. The increase in the consumer price index (CPI) simply has to be above nominal interest rates or yields. Historically, periods of high sovereign debt levels have often been coupled with an increased likelihood of default or restructuring of public debt and with financial repression. In the so called “golden age” in the US or UK for example, only stocks were able to cope with inflation in real terms while nominal assets were not able to protect wealth.

Taking this into consideration, sovereign bonds and government bonds from safe haven countries are currently not beating inflation. Nevertheless, this doesn’t mean investors should rule out the fixed interest market altogether – bonds from peripheral Europe, some emerging market and high-yielding corporate bonds are a much better choice to beat inflation.

In a world in which returns are not only very hard to come by, but where the providers of capital are fed up with the volatility of risky assets, investors may choose to ignore equities altogether, in favour of very low yielding but relatively secure fixed income assets.

However, while even the safest equities tend to lose some money during market routs, for those with a certain degree of drawdown tolerance, we would suggest that focusing on equity income makes absolute sense in a world of systematically elevated volatility and low growth. Plus, of course, dividend yield represents the bulk of historical equity returns.

In this environment, equity income strategies with a strong focus on sustainable dividend payers could help to bridge the gap between the income requirement of many investors and the need to preserve capital, primarily in real terms.

A successful global dividend strategy should not rely on one factor alone, as this would completely neglect plenty of companies that offer good dividend yields and growth potential. Therefore a multi-factor approach consisting of dividend yield, dividend growth and payout ratio results in the best risk-return profile and offers investors a more than interesting upside-downside capture ratio. This equates to full participation in bull markets but only limited exposure to bear markets. This is fully in line with long-term empirical evidence.

Nevertheless one challenge remains – how do you convince savers to participate in an equity market that is increasingly volatile? Our suggested route is via quality income. However, two things should be stressed: firstly, compounding effects over time are the dominant source and secondly, fundamentals such as dividend yield and dividend growth become more important to the overall performance the longer the stock is held. Dividends are not just for a crisis.


Dr. Oliver Plein is head of product specialist equities at DWS Investments. The views expressed here are his own.