An income strategy has its benefits in uncertain times

 
Kathleen Brooks
THERE seems to be no end to the uncertainty surrounding the outlook for the global economy. Bonds tend to be the first port-of-call in uncertain times. However with prices at multi-year highs investors are right to be nervous about entering into a long position from here.

So what should investors do? UBS analysts claim that they have found the next big valuation gap in the market: European dividend yields, currently at 4.2 per cent, which is a 25-year high relative to the 10-year real euro bond yield.

Equities tend to be considered more volatile than bonds. However, this is not the case for dividend growth. UBS has conducted research looking back to 1968, which examines earnings and dividend growth for the S&P 500. While earnings and dividends have grown roughly in line, the standard deviation for dividends growth was just 7 per cent, compared with 23 per cent for earnings growth. A similar pattern can be detected in Europe.

But could dividends be cut if economic growth slows? UBS says there are three reasons why they won’t be. Firstly, corporate gearing levels are forecast to fall next year leaving firms with more cash; secondly, earnings in the first half of this year have been stronger than expected and lastly dividends were cut aggressively in 2008-2009, leaving less room for more cuts.

UBS has picked companies that have the highest dividend yields yet low betas relative to the overall market. These include BAE Systems, Unilever, Marks & Spencer, France Telecom, Telefonica, Orkla and energy company E.on.

One of the easiest ways to get exposure to a dividend strategy is through exchange-traded funds (ETF). Some companies including iShares have specific European funds that target high-yielding stocks, including its FTSE UK Dividend Plus fund. Provider db x-trackers also has a DJ Eurostoxx Select Dividend 30 fund. ETFs either distribute dividend income or re-invest it in the fund.

For investors who think bond yields can’t have much further to fall, an income strategy is a good way to play some of the safest, most robust stocks available in the market.