Saturday 20 October 2012

FTSE Dividend Yield vs Gilts - The Circle Has Turned

Swings and roundabouts
Source
The yield on UK gilts - government loan stock - sets a 'risk-free' baseline for the financial markets: 'risk-free' in the sense that default risk (the risk of losing your money) is close to zero, although inflation can always erode the capital value of fixed-interest securities (i.e. excluding inflation-linked securities).

By contrast, yield from dividends is usually seen as having a risk premium because you can quite easily lose some - or all - of your money. And pension funds, in particular, have to look at risk very seriously.

What is perhaps surprising is that this dividend risk premium is now positive and is at a generational high - with dividends now paying a premium over gilt yields last seen in the early 1950s. And bear in mind that Mr Market's memory usually only goes back a year or two!

The following graph comes from Coutts' Daily Themes:

 
 
The key message of the graph and article is that the last time the risk premium was this positive it triggered a structural move by pension funds into dividend shares.

There are differences, of course, as the article points out:
  • Firstly the absolute level of dividend yields on UK stocks in 1952 was relatively high at 6%, compared to a current yield of a little over 4% - and inflation was around 6%
  • Pension funds in 2012 continue to ‘de-risk’ by selling equities and buying ultra-low-yielding government bonds

However, they note that: "Even assuming no dividend growth over the next 10 years, the effective breakeven (forward) price of the FTSE All Share is some 22% lower than current levels compared to government bonds."

The article concludes: "The good news for private investors is that they can take advantage of this perverse asset allocation to pick up high-yielding dividend stocks with long-term potential for dividend growth at attractive prices."

Because I'm pretty sure the pension funds will soon be rediscovering the value of dividend shares - particularly those pension funds of large FTSE companies that have a huge deficit.

I feel a boom in dividend shares coming on.

I am not a financial adviser and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

8 comments:

  1. For the last three years, I've been building a portfolio of good dividend payers with good track records. It's getting harder to find them at good prices (and thus yields) so it seems that people either want bonds or blue chips.

    However, my mid cap tracker has also done well recently, so who knows where bargains remain.

    ReplyDelete
  2. Yes, been this way for a while. The other little peak to the right hand side of the graph is 2003, where it proved an excellent timing signal. No such luck this time!

    When comparing dividend yields in the 1950s and now, it's worth remembering buy backs. Like them or loathe them, they are cash that would otherwise be spent on yield, and if you add them back they dividend yield gap between then and now might not seem so big.

    ReplyDelete
  3. I'm literally just about to start building a high yield portfolio so this is an article that interests me a lot. Even though I am yet to invest (I'm waiting for confirmation that my stock account has been set up) I am seeing that most of the shares I am interested in are priced high but this is a risk I'm willing to take.

    ReplyDelete
  4. David,

    HYP is a brilliant way to go, but if you're fairly new to investing, I strongly advise you to read:

    All about Asset Allocation - Richard Ferri
    Smarter Investing - Tim Hale
    The Long and the Short of it - John Kay

    Good luck!

    Steve

    ReplyDelete
  5. >"high-yielding dividend stocks with long-term potential for dividend growth at attractive prices"

    Perhaps a bit too optimistic. While I agree that HY shares should form a significant part of an equity portfolio, their prospects for long term growth are generally limited. They are mostly large companies operating in a competitive markets with smaller and more nimble companies biting at their heels. Some will do well through various forms of acquisition and reconfiguration, but others may well go into long term decline or be run by idiots (think GEC/Marconi or Kodak).

    ReplyDelete
  6. Please do share some guidelines regarding good portfolio.

    sgx dividend stocks

    ReplyDelete
    Replies
    1. Singapore

      Just browse the site. The portfolio approach I use is quite simple. In summary: 50%/50% high-yield dividend shares/fixed-income securities. Diversify: no more that 5% of portfolio in any single security/firm; diversity sectors (mainly not too many financials). Use tax-free accounts where available.

      Delete
  7. I've ever seen, you can include some more ideas in the same theme. I'm still waiting for some interesting thoughts from your side in the next post. One thing I just want to say is that your blog is so perfect!

    ReplyDelete