How to Find Dividend Income as Risk-Free Rates Surge

By David Mazza, Christopher Clark & Sam O’Connell, OppenheimerFunds

With the U.S. Federal Reserve (Fed) hiking short-term interest rates for a second time this year, yields across the Treasury curve have increased. Many market strategists continue to expect the Fed to hike at least once more in 2018, which is pressuring many core fixed income strategies.

These moves have also wiped out the premium that existed for U.S. equity dividend yields for the first time since August 2008! In other words, investors who gravitated toward riskier assets like dividend-paying equities to help meet their income needs once again have less-risky options available to them. Furthermore, opting for these less-risky options does not require taking on significant interest-rate risk.

By David Mazza, Christopher Clark & Sam O'Connell

Rising Rates Are Hurting Most Dividend ETFs

Rate hikes have led to the underperformance of classic bond proxies. The consumer staples and telecommunication sectors have been hit the hardest, and are down 12.49% and 10.48%, respectively, year-to-date (YTD) through May 30 (Source: Bloomberg Finance, L.P., as of 05/18.)

. This has brought down the majority of dividend indices. In fact, 84% of U.S. equity ETFs with a trailing 12-month dividend yield greater than the S&P 500 Index are underperforming the broader market through the first five months of 2018. Those ETFs represent a whopping $375 billion in assets under management and the majority of the largest dividend funds.

Exhibit 2: Few Dividend ETFs are Outperforming the Market YTD

Number of Funds Assets Under Management ($B)
Outperforming 14 36.44
Underperforming 76 375.35

Source: Morningstar, as of 05/18.

This performance highlights the acute challenge that investors face when it comes to allocating assets in the face of rising rates. Should investors simply abandon dividend ETFs? We would argue against that strategy. Instead, we would suggest that investors continue to build multi-asset income solutions, but also evaluate what’s under the hood of their ETFs, because not all dividend strategies are alike.