Dividends On Offer

According to analysts from Société Générale, investors can perform a much-needed sanity check by refocusing their attention on dividends. For a long-term investor, dividends constitute the major part of real (inflation-adjusted) returns, write Charles de Boissezon and Shiraz Latiri in an April 2010 research note.

In the chart below, which breaks down the 40-year real returns from seven major equity markets into dividend starting yield (red component), dividend growth (grey component) and equity multiple or valuation change (pink component), it can be seen that dividends represent the lion’s share of an investor’s final outcome in six of the seven markets (Japan being the exception).

For the Euro Stoxx 50 index, which was launched in 1991, just under half an investor’s total returns since inception have come from dividends (with the remainder coming from price appreciation; that is, an expansion in companies’ valuation multiples).

Dividends have the added benefit of exhibiting lower volatility than both share prices and company earnings, write de Boissezon and Latiri, as well as providing an alternative inflation hedge to commodities and inflation-linked bonds.

However, they assert, equity investors still focus too much on the possibility of share price appreciation and too little on the actual cash flow from equities, despite the fact that, as Société Générale’s quantitative strategist, Andrew Laptorne, puts it, “investing on the basis that you will sell at a higher valuation is not as easy as you think.”

Although the majority of equity ETFs are probably marketed to investors in precisely this way – as a means to make capital gains – a recent fund listing approaches equity investing very differently by offering pure dividend exposure. With the launch of Lyxor’s Euro Stoxx 50 dividends ETF, investors now have access to an area of the market that has typically been the preserve of specialist investors such as hedge funds and bank trading desks.

The fund gives investors exposure to the payouts from the largest 50 eurozone companies by investing in a “strip” of dividend futures. The Stoxx index tracked by the ETF replicates an equally weighted investment in five futures contracts with successive annual maturities, based upon the Euro Stoxx dividend futures contracts traded on the Eurex exchange. As the near-term contract expires in December each year, the index rolls 20% of its exposure into the new five-year future. Lyxor estimates the cost of this roll (based on current futures market bid-offer spreads) at around 15 basis points per annum.

Each Eurex dividend futures contract’s price represents the cumulative gross payout during the relevant calendar year from the Euro Stoxx 50 index’s component companies (expressed as dividend “points” on the underlying index value, meaning that the cumulative points score for any year can be divided by the Euro Stoxx 50 price index to give an overall market dividend yield).

Euro Stoxx 50 Dividend Futures Delivery
Month

Price

Open interest
(adjusted)

Dec 10

111.10

113,049

Dec 11

98.10

118,658

Dec 12

93.50

138,161

Dec 13

91.00

79,834

Dec 14

92.50

45,227

Dec 15

93.40

41,581

Dec 16

96.00

20,120

Dec 17

97.00

15,123

Dec 18

98.80

25,711

Dec 19

99.00

11,012

The above table lists the 21 June 2010 Eurex Euro Stoxx dividend futures contract levels. Perhaps surprisingly, given the equity markets’ recovery since March last year and an apparent return to investor optimism, the pricing of the futures contracts discounts a gloomy outlook for dividend payouts. In particular, gross Euro Stoxx 50 dividends are priced as falling from a cumulative total of 111 this year to 91 in three years’ time, before a partial recovery to 99 by the end of the decade.

However, this view of the dividend outlook doesn’t tell the whole story. Bank and brokerage analysts’ forecasts for the same companies’ payouts are much higher – a puzzling anomaly.

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