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January 28, 2016 at 07:00 PM
Dividend Paying Stocks and Interest Rate Risk
Yield-hungry investors have increasingly gravitated to the almost irresistible pull of high dividend paying stocks for income. But chasing those high yields can come with unintended exposure to interest rate risk that could hurt performance. Is there a better place to look for that income?
Dividend growth strategies focus on stocks that consistently grow their dividends over time instead of those that just pay high dividends. These strategies offer a potentially all-weather dividend solution capable of performing well regardless of the direction of interest rates.
Looking Abroad for Increased Income and Reduced Rate Exposure
If you’re looking for dividend income, a prudent path to higher yields may lie outside of the United States. Stocks in Europe and in international developed markets often have higher yields than those in the United States. That means it’s possible to pursue the advantages of a dividend growth strategy and relatively high dividend yields, as reflected by the MSCI Dividend Masters indexes shown below. Plus, international dividend growth stocks come without the added U.S. interest rate sensitivity of high dividend paying domestic stocks, such as those included in the Dow Jones US Select Dividend Index.
Boosted Income Potential Abroad
(International Dividend Growth vs. U.S. High Dividend Payer Indexes)
(Source: Bloomberg as of December 31, 2015. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.)
A Greater Diversity of Holdings Is Key
Stocks in the utilities sector represent a key source of interest rate risk in U.S.-based high dividend investing strategies. For example, a high dividend yielding index like the Dow Jones U.S. Select Dividend Index has a whopping 34% of its weight in the utilities sector. International dividend growth indexes, however, such as the MSCI EAFE Dividend Masters Index and the MSCI Europe Dividend Masters Index, have modest 9% and 6% respective weightings to utilities. Because their yields are generally less reliant on rate sensitive sectors, these strategies carry significantly less interest rate risk.
