Investors may not be able to find relief in high dividend paying stocks during a period of surging inflation and rising interest rates, according to research from Dimensional Fund Advisors.
As inflation figures continue to breach decade-level highs in the UK and across most developed markets, some investors are turning to dividend-paying stocks in the hope of receiving income protection and higher returns.
However, these stocks don’t necessarily provide the inflation protection than they appear to, according to Dimensional’s research.
The study found that during periods of high inflation over the past 100 years, dividend-paying stocks have not delivered superior inflation-adjusted performance to stocks that don’t pay a dividend.
The report looked at the performance of US portfolios formed on dividend yield between 1928 to 2021 and found that the outpacing high inflation over the long term was not a unique advantage of dividend-paying stocks.
Average annual returns of dividend portfolios in high-inflation years, 1928-2021
Source: Dimensional Fund Advisors
Companies in the report were divided into two groups: payers and non-payers, based on whether they paid a dividend during the previous 12 months.
Then within the payers, high payers were defined as the 30% of firms with the highest dividend yields and the low payers were the bottom 30%.
The results showed that all four dividend portfolios had positive nominal and real average returns in high-inflation years, when inflation was on average 5.5% per year.
“The return differences between payers vs non-payers and high payers vs low payers are not reliably different from zero,” the study said. “Therefore, we don’t see strong evidence that dividend-paying stocks deliver superior inflation-adjusted performance during high inflation periods.”
Another aspect to consider, according to Dimensional, are the limitations of choosing dividend-paying stocks only especially given the fact that the percentage of companies paying dividends has declined globally.
In 1927, 68% of US companies were paying dividends, whereas only 38% of US firms paid a dividend in 2021.
Percentage of US firms paying dividends since 1927
Source: Dimensional Fund Advisors
“By focusing only on dividend-paying stocks, we will be sacrificing diversification,” Dimensional said. “In fact, changes in dividend policy are common, especially during times of higher uncertainty.
“For example, many dividend payers cut their dividends during the pandemic—in the first three quarters of 2020, dividends from each dollar invested in US markets decreased by 22% compared to the same period in 2019.”
The research also found that there was no clear pattern between the level of inflation and the difference in performance between dividend payers and non-payers.
“These results suggest that even a crystal ball on annual inflation levels or inflation changes tells us little about how dividend-paying stocks would fare,” the study said.
“As a result, chasing dividends during, or in anticipation of, high inflation periods may be unlikely to lead to better investment outcomes.”
When it comes to the periods of rising interest rates, Dimensional found that there was also no meaningful difference between the performance of dividend payers, non-payers, high payers and lower payers.
The study looked at the performance stocks between March 1934 and 2021 during periods where there were rising 3-month Treasury yields.
Average monthly returns during rising interest rates
Source: FE Analytics
“Piling into dividend stocks would not have led to superior returns in months with rising interest rates,” the study said.
It also pointed to the fact that changes in interest rates are largely unpredictable even with the Fed’s attempts to signal the market.
Even with perfect foresight on interest rate changes each month, the study found that this information couldn’t add anything meaningful to returns.
“There is no discernable relationship between interest rate movements and the relative performance of dividend payers over non-payers or high payers over low payers in the same month,” Dimensional concluded.
Although investors are right to be concerned with the potential impact of higher inflation and rising interest rates on their equity portfolios, the study asserts that there is no reason to expect dividend-paying stocks or high dividend payers to offer more protection and higher returns during these periods.
It said: “Market prices reflect the aggregate expectations of all market participants, including expectations about inflation and interest rates.
“Staying disciplined and broadly diversified, instead of chasing dividend stocks, may put investors in a better position to achieve their investment goals.”