Indexology^® Blog

Much has been written about dividends in academic literature. There are several theories regarding the dividend policies of companies. One theory asserts that dividends are irrelevant because an investor who wants cash flows could sell shares. Another theory suggests that a bird in the hand is worth two in the bush, meaning that investors prefer cash dividends over uncertain capital gains. There are other arguments that take into account the tax treatment, in which investors would prefer dividends to capital gains if dividends were taxed favorably. In India, dividends are non-taxable in the hands of the recipient. As mentioned in a prequel to this article, India has historically had a lower dividend yield in comparison with developed nations. Moreover, Indian large- and mid-cap companies have exhibited more stable dividend yields in comparison with small-cap companies. Let’s take a closer look at the large-cap segment of the Indian market.

From Exhibit 1, we can see that the majority of Indian companies in the S&P BSE LargeCap have paid dividends between 2005 and 2015. The S&P BSE LargeCap is designed to measure the top 70% of companies in the S&P BSE AllCap, based on the cumulative average daily total market capitalization of the included companies over a one-year period. In general, companies prefer not to reduce or omit dividends, as it is perceived negatively in the capital market. This has been noted in the past when the aggregate dividend paid by the companies in S&P BSE LargeCap has either increased or remained the same. This occurred even during the 2008 global financial crisis, although the number of non-dividend-paying companies also slightly increased during this period. More recently, during fiscal year 2015, the aggregate dividends paid have decreased in the S&P BSE LargeCap.

Exhibit 1: Dividend-Paying History of Companies in S&P BSE LargeCap

Source: S&P Dow Jones Indices LLC, Factset.  Data as of Aug. 31, 2015.  Past performance is no guarantee of future results.  Chart is provided for illustrative purposes. 

From Exhibit 2, it can be observed that the majority of the dividend-paying companies in the S&P BSE LargeCap have had a dividend payout ratio (DPR) range of 0%-40% in the 10-year period ending in 2015. More recently, the percentage of dividend-paying companies with a DPR greater than 40% has increased. Companies have negative earnings when DPR is less than 0%, and if it is greater than 100%, then companies have paid out more than they have earned in that fiscal year. In addition, we can note that there were few companies in the S&P BSE LargeCap with a DPR of either less than 0% or greater than 100%.

Exhibit 2: DPR History of Dividend-Paying Companies in the S&P BSE LargeCap 

Source: S&P Dow Jones Indices LLC, Factset.  Data as of Aug. 31, 2015.  Past performance is no guarantee of future results.  Chart is provided for illustrative purposes.

Different classes of investors have different preferences for dividend income. Some may prefer companies that have paid stable or increasing dividends over those that either do not pay dividends or have an unstable dividend payment history. However, dividend increases do attract attention in the capital markets. Together with S&P Dow Jones Indices, Asia Index Private Limited recently launched the S&P BSE Dividend Stability Index. It is designed to measure the performance of companies in the S&P BSE LargeCap that have paid ordinary dividends of 4% or more for at least seven of the past nine years, and the most recent DPR should be between 0% and 100%.

Exhibit 3 details the performance characteristics of the S&P BSE Dividend Stability Index over the 10-year period ending Sept. 16, 2015. The highest excess positive returns over the S&P BSE SENSEX were observed during the 2008 global financial crisis. This is consistent with the results we obtained earlier when we noticed that aggregate dividends paid by companies in S&P BSE LargeCap did not decrease during that period. The capital loss suffered was marginally offset by dividends. Over the same 10-year period, the S&P BSE Dividend Stability Index has provided a CAGR of 15.22%, which is 1.64% in excess of the S&P BSE SENSEX.

Exhibit 3: Performance Characteristics of the Indices 

Source: S&P Dow Jones Indices LLC, Factset.  Data as of Sept. 16, 2015.  Past performance is no guarantee of future results.  Charts are provided for illustrative purposes and reflect hypothetical historical performance.

Many strategies exist worldwide in which investors focus on dividends. With the Indian economy growing at a fast pace and the capital markets maturing, Indian investors may also seek to benefit from them.

The yield-to-worst of the S&P/BGCantor Current 10 Year U.S. Treasury Index averaged 2.26% for the month of November.  The index started the month at 2.15% and closed the month at 2.22%.  At one point on Nov. 9, 2015, the yield was as high as 2.35%, and the index ended 8 bps wider overall.

The anticipation of a Fed interest rate hike on Dec. 16, 2015, and general U.S. economic improvement had the majority of bonds in the red for the month.

The S&P 500^® Bond Index lost 0.28% for November, while it kept the YTD return in the green, at 0.25%.

Energy was the sector that lagged the most, as the S&P 500 Energy Corporate Bond Index was down 4.42% YTD.

All sector indices of the S&P 500 Bond Index underperformed, except for the S&P 500 Financials Corporate Bond Index and S&P 500 Telecommunication Services Corporate Bond Index.  These indices were positive for November but did not return much, coming in at 0.09% and 0.03%, respectively.

Outside of the S&P 500 Bond Index, the S&P Taxable Municipal Bond Select Index was the positive performer of the S&P U.S. Aggregate Bond Index, with a 0.47% gain for the month.

Exhibit 1: Performance of the S&P 500 Bond Index and S&P 500 U.S. Aggregate Bond Index

Source: S&P Dow Jones Indices LLC.  Data as of Nov. 30, 2015.  Past performance is no guarantee of future results.  Table is provided for illustrative purposes.

The Fed’s policy makers, the FOMC, meet on December 15th and 16th and are widely expected to raise the target Fed funds rate for the first time since 2006.  The odds of a 25 bp increase in the target range to 25-50 bp is about 77% based on Fed Funds futures.  There are two key economic reports still expected before the meeting: employment and inflation.

The first chart shows the monthly change in payroll employment since 2009.  The market expectation is for a 200,000 increase, in line with recent numbers and further confirmation that the weakness seen in August and September is behind us.

The second chart shows the core rate for the CPI (CPI ex-food and energy). While the FOMC looks at a similar measure, the personal consumption expenditure deflator, the CPI is more widely followed and will be released on Tuesday, December 15th as the FOMC members gather for their meeting. It is expected to show inflation remains below the Fed’s 2% desired figure.

For those who wonder why there is so much interest in the Fed and a possible turn in interest rates, the last chart of the 10 year Treasury note yield is a capsule history of the bond market since the 1960s.  We are nearing the end of what used to be called the “Great Intergalactic Bond Rally.” Once the Fed begins the shift to rising rates, it will be a different financial world.

Unfortunately for commodities, there’s no waking up from this nightmare. It’s real. Since 1970, the S&P GSCI has never seen a Nov. with as many as 21 negative commodities. After a glimmer of hope in Oct., only 3 commodities, sugar, cotton and cocoa are on track to be positive in Nov. In other words, for every one commodity that is positive, seven are negative in Nov., 2015.

Moreover, Nov. 2015 is the 5th worst Nov. on record since 1970, only behind 1997, 1998, 2008 and 2014. Year-to-date, the index is also on pace to be the 5th worst year with 1998, 2001, 2008 and 2014 losing more. Though YTD through Nov. 2014, the index was in better shape than the index is through this Nov.

While 2015 is not the worst year for any single commodity despite 2 down more than 40%, 7 down more than 30% and 13 down more than 20% (more than half in a bear market for the year), there are a number of commodities setting notably bad years. Aluminum, feeder cattle, Kansas wheat, nickel, and the industrial metals sector are all posting their worst years after 2008. Below is a table showing the rank of worst years since 1970 (for example, aluminum is having its second worst year in history and gold is having its sixth worst year in history):

Last, it is worth mentioning that 20 of the 24 commodities are in contango. Although this is the highest number since Nov. 2013, there have been 23 other months in history where 20 or more commodities have been in contango together. However, November is the worst month on average of any of the twelve months for having the most commodities in contango. It is the only month that has more than half on average (12.4) in contango, and of the 24 months in history having 20 or more commodities in contango, 7 have occurred in the month of November. Contango has had a significant cost, erasing almost an additional ten years of gains, for commodity investors rolling the first nearby most liquid contracts. Notice the spot index is only at the Feb. 2009 level, while the total return is at the Jun. 1999 level.

In the current environment of short-term volatility amid a long-term positive outlook for the Chinese economy, a focus on growing, sustainable dividends in China’s equity markets could provide the opportunity to get a slice of the region’s structural growth and potential downside protection compared with a typical growth strategy, such as an earnings growth strategy.

In recent years, with the release and implementation of a series of dividend-encouraging policies issued by Chinese authorities, the amount of dividends issued by companies listed in China’s equity markets has gradually increased.  In 2014, the size of the total dividend pool for companies in the S&P China A BMI was USD 70 billion, nearly triple the size of the dividend pool in 2009.  In terms of the number of companies, 70% of the S&P China A BMI universe paid dividends in 2014, which is much higher than the 55% reported in 2009.

From a dividend growth perspective, Chinese companies may offer much faster dividend growth than companies in many other parts of the world.  From 2009 to 2014, Chinese equities provided a dividend growth rate of 17.0% per year, driven mainly by improved earnings—far higher than equities in Pan Asia, Europe, and the U.S.

One unique feature of Chinese companies is that they tend to have more concentrated company ownership, either in the form of a founding family or a government-affiliated entity.  The implications on dividends are three fold.  First, many of China’s IPOs are due to the privatization of large stakes in SOEs and family-run businesses.  These are typically mature companies that pay dividends from the beginning of their public listings.  This explains the fast growth of dividend pools in China.

Second, dividends may provide a sign of positive corporate governance in China.  Under the conditions of high concentration of ownership and weak legal protection for small- and medium-sized shareholders in China, the distribution of dividends can be used as a way to limit large shareholders’ ability to expropriate minority shareholders’ rights or improper government intervention in the listed companies.

Third, many of the largest dividend-paying Chinese companies are SOEs with a high degree of direct or indirect government ownership.  Therefore, the Chinese government influences companies’ earnings and dividends.  Given the government support to improve dividend policies, these companies tend to return a greater share of earnings to shareholders via dividends.

The S&P China A Share Dividend Opportunities Index seeks to offer a transparent, rules-based, diversified, and tradable strategy for investors looking for exposure to China’s growth via dividends.  The index seeks to measure high-yielding A share stocks traded on the Shanghai or Shenzhen Stock Exchanges.  The index was launched on Sept. 11, 2008, showing a seven-year live track record of consistent outperformance against the benchmark, the S&P China A BMI (see Exhibit 3).  The index may be attractive to investors for its total return, income generation, and potential for downside protection.  For more information, please refer to the following research paper by clicking here.