Leaning on Equity Income Strategies as an Inflation and Volatility Hedge

Leo Wealth

by Christos Charalambous

Dividends have contributed 41% towards the S&P 500’s total return for 1930-2020. Thus, sustainable dividend income is a key factor for total return expectations. Moreover, as inflation is currently the number one concern for households, we believe equity income strategies can play a significant role in mitigating this headwind to households’ purchasing power. This is especially relevant for lower-income households. According to the Federal Reserve’s survey of Consumer Finances, 40% of the American public has less than $1000 in savings.

Demand for global dividend income funds has continued to improve, with $12.3bn of net inflows in Q4 2021 and $43bn total injections for 2021. With G7 sovereign bond yields rising, total returns will become, in our view more, reliant on a blend of capital gains and dividends. We expect companies with high free cash flow, high dividend coverage, and a sustainable dividend growth rate to outperform. In addition, defensive income-generating equities can also help reduce portfolio risk, as investors tend to pay a premium for companies with lower earnings volatility and other defensive attributes such as low financial leverage. We also believe that a company’s steadily increasing dividend per share also serves as a strong signal by corporate management teams regarding the company’s fundamental outlook and cash-generating ability. Historically, dividend growers have outperformed companies with flat dividend policies, dividend non-payers, and dividend cutters.

Aging demographics and rising life expectancy constitute an important secular demand pillar for income-generating equities. In the U.S., there are currently 76 million baby boomers (those born between 1946 and 1964) with a median age of 65. By 2030, this group will have a median age of 75 and will have largely left the labor force. As retirees seek to reduce the risk profile on their investments in later life, we expect defensive high-yielding equities to be in strong demand, particularly if a slower GDP growth backdrop keeps fixed income yields in check.

The traditional view is that an aging society is disinflationary, with investors primarily focused on demand consequences with slower population growth, and the idea that older people tend to spend less than younger people. However, we believe investors should consider the supply side of the inflation/deflation debate, i.e. when does a rising dependency ratio put upward pressure on wages and inflation expectations. If long-term inflation settles at a higher-than-expected level, this dynamic will keep income equities in strong demand.

In general, we see both tactical and secular demand for equity income equities, particularly as a hedge against inflation and market volatility episodes. Our investment team currently offers two equity income portfolios (U.S. Equity Incomeand Global Equity Income) focusing on defensive large-cap equities. The portfolios feature low sensitivity to broad global equity indices, and their low volatility profile enables strong downside protection. For the global portfolio, non-US equities account for 60% of the portfolio.

This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. 

Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.

Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

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