Global dividend funds one of the few sectors where pros reliably gain an edge

Low interest rates played a big role in fuelling an equity bull market that lasted for more than a decade, but caused many investors to under-appreciate the current and recurring income streams that dividends can provide.

Consequently, dividend funds have not featured prominently on investors' radar for the past decade. In an era where growth stocks dominated market sentiment and made headlines, dividend stocks were undervalued, unpopular and forgotten.

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An aggressive series of interest-rate hikes by central banks since 2022 to combat rising inflation has put dividend-paying stocks back in the spotlight. As recession fears built, investors preferred the defensive nature and reliable income stream that dividend strategies can offer. After a long period of fading investor interest, the regime shift in central bank policy sparked renewed investor appetite for dividend strategies. Assets reached record levels of €130 billion (£11 billion) in December 2023.

While global equity income strategies enjoyed record inflows, the popularity of regional equity income strategies has been subdued. Europe-oriented and especially UK-focused dividend strategies have remained out of favour. The Brexit vote and its economic implications, coupled with uninspiring performance, have made investors shun UK stocks. That does raise the question of whether investors should take advantage of the cheaper valuations and abundance of dividends in the UK market or if UK equity income is yesterday’s strategy.

While Europe and the UK are home to a vast universe of robust dividend-payers, investors are increasingly opting for the significantly wider opportunity set that global approaches offer. Going global enables portfolio managers to invest in sectors that might be hard for regional strategies to get exposure to.

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The technology sector is a striking example, as several US-based tech companies display many characteristics that dividend investors look for. Established businesses, sound balance sheets, and high cash flow generation, coupled with above-average dividend growth, make these companies attractive options for diversification, resulting in a more balanced portfolio of dividend yield and dividend growth.

Active landscape

The success of actively managed equity funds has been under scrutiny in recent years. Morningstar’s European Active Passive Barometer shows that active managers in very few categories have 10-year success rates of more than 50%. That said, actively managed global dividend funds successfully beat passive rivals over 60% of the time over the past 10 years – making it one of the few categories where stock-pickers have reliably generated outperformance. The value that human fund managers add has put active dividend funds back in the spotlight.

Actively managed funds continue to dominate, controlling 91% of assets versus 8.7% in passive vehicles. Index-tracking exchange-traded funds (ETFs) are gaining share, gathering 21% of recent inflows due to cheaper fees. But the broader universe and flexibility in yield requirements provide active managers more tools to balance income and growth. This has shown up in superior risk-adjusted returns.

Actively managed dividend funds also emphasise forward-looking fundamental analysis to assess not only the potential for dividend growth but also the sustainability of dividends. This approach involves analysing a company's competitive advantages, cash flow generation, profitability, balance sheet quality, and capital allocation decisions.

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Actively managed dividend funds offer greater flexibility compared to passive strategies. They can hold high-yielding stocks alongside those with low or no dividends, enabling portfolio managers to consider a broader range of stocks. Moreover, actively managed dividend funds are not bound to immediately sell a stock if it cuts or cancels its dividend, allowing them to take a more pragmatic approach.

Passive offering

Passive dividend funds have seen significant growth in Europe, amassing more than €10 billion in assets. These funds offer various methodologies, including plain dividends, quality, and ESG-focused strategies, catering to investors with different preferences and goals.

One advantage of passive strategies is their cost-effectiveness. Passive funds offer lower costs, with an asset-weighted Morningstar Representative Cost for passive funds standing at a modest 0.38%, compared to 1.26% for active funds.

Index providers have also expanded methodologies beyond plain dividend yield to include quality and ESG criteria. This lets investors choose based on their preferences between high yielders, stable payers, sustainable dividends, or a blend. Some trackers equal weight stocks while others optimise for debt metrics or carbon footprint.

That said, passive dividend funds often prioritise high dividend yields, which can lead to sector concentration and increased risk of dividend cuts if those yields are unsustainable. In contrast, some actively managed dividend funds balance yield with dividend growth, creating more balanced portfolios.

In conclusion, the dividend landscape in Europe has experienced a revival, with both active and passive strategies finding their place in investors' portfolios. The choice between active and passive depends on individual preferences, risk tolerance, and investment objectives.

Monika Calay is director of passive strategies at Morningstar.