In May Lyxor introduced an ETF offering exposure to the dividends paid out from the Euro Stoxx 50 index’s constituent stocks, rather than exposure to the stock prices themselves. The ETF does this by tracking an index representing a five-year “strip” of the dividend futures traded on Eurex, each of which represents the cumulative dividends to be paid out from the index’s 50 constituent companies in the relevant year.
Here’s IndexUniverse.eu’s report on the original fund and index launch, and a subsequent feature article examining the product in more detail.
Since the Euro Stoxx 50 dividends ETF was launched by Lyxor on 19 May, it has outperformed the Euro Stoxx 50 index itself by around 5%. In the chart below I’ve compared the performance of two Lyxor ETFs, one tracking the dividend index, the other the Euro Stoxx 50 net total return index. Both funds’ NAVs are rebased to 100 on 19 May.
Earlier this week James Montier of fund manager GMO released a piece of research in which he makes the same argument as Patrick Armstrong did in our June feature: that European dividend expectations look too pessimistic, and investing in them makes sense.
Montier starts by demonstrating that dividends contribute around 90% of an investor’s long-term total return from equity investing, then goes on to illustrate that European dividend expectations are already pricing in the equivalent of the US great depression (see the chart below). Since 2008 there has already been a sharp fall in dividend payouts in Europe, but the path of dividends to 2019 implied by Eurex’s futures suggests further falls, just as US dividends fell for a decade after 1930.
One can quibble about some of Montier’s assumptions: there’s no comparison of the starting level of dividends, nor of companies’ payout ratios. Both these measures could have a significant impact on subsequent distributions. And his argument that “even Japan has managed to grow its dividends by just over 2% annually during its two decades of post-bubble economic stagnation” sounds impressive at first glance, but on reflection doesn’t amount to so much if one considers that Japanese companies paid out almost nothing in dividends in 1989, whereas the Euro Stoxx 50’s starting point in 2008 was a 4-5% yield.
Also, 20% of the Euro Stoxx 50 index is in financial stocks, whose dividends are already under pressure as a result of demands for higher capital ratios. If the economic environment deteriorates further, there will be additional calls for banks to scrap payouts (although some investors, like Armstrong, argue that such an outcome is already largely priced into the dividend futures market).
Nevertheless, Montier makes some other interesting comments in support of investing in dividend futures. First, he points out, dividends offer a very effective long-term inflation hedge, so you might easily consider a product investing in them as a match for pension liabilities. Second, he adds, dividend products are one of the rare cases where you’re likely to benefit rather than suffer from index survivorship bias, since large, dividend-paying stocks are likely to get into the index, while dividend cutters get thrown out (and when investing in a “pure” dividend strategy you don’t suffer from the stock price deterioration that typically occurs as markets discount such an event). Finally, argues Montier, over time dividend swap- or futures-based products should show lower volatility than stock prices themselves (the chart of the performance of Lyxor’s two ETFs already hints at this).
Assets in Lyxor’s Euro Stoxx 50 dividends ETF are still tiny by comparison with those in the Euro Stoxx 50 ETF itself (€34 million as opposed to €4.9 billion). But the increased attention being paid to the dividends market by some of Europe’s most successful asset allocators suggests that the first figure should soon rise. Meanwhile, credible arguments that future dividend expectations are structurally depressed mean that the Euro Stoxx dividends ETF may indeed carry on outperforming the Euro Stoxx 50 ETF itself.