Dividend-yielding stocks are a favorite amongst retirees, so institutional investors cannot ignore them. As the Wall Street trend away from trading and towards asset management continues unabated, both the demand for and scrutiny of dividend stocks has grown, yet the price action has not inflated to the same degree that high-risk growth stocks has.
More importantly, in recent years a growing divergence in the performance of dividend-yielding stocks and funds points to the fact that more analysts are looking at these stocks more closely, going beyond free cash flow and looking at more significant fundamentals and macroeconomic trends that could impact their price in the near-term.
BDCs and the Indices
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Business development corporations allow VC type investing in the public market, with a focus on debt and convertible instruments. Earlier this year news broke that the BDCs would no longer be a part of the equity indices, mostly because their fees raise the cost of index-based funds. The decision makes sense, because BDCs act very differently from other stocks, but their removal caused a tremendous dip in the second quarter of this year. The stocks are now recovering.
For many income investors, this was a great buying opportunity; for others, it caused fear that aggravated the sell-off. Going forward, BDCs will likely see less of a correlation with index movers as the market is disassociating them, and pressures from the index funds will not hit the BDCs. Past performance is less indicative of future results here than ever before.
mREITs and the Fed
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Last year was one of the worst on record for REITs, particularly mREITs who lose a lot of money in an environment where interest rates are rising. This year has been a tremendous correction. While fear drove a tremendous sell off of these names a year ago, this year has caused a fevered demand for one reason and one reason only: the Federal Reserve. REITs were expected to face dividend cuts throughout 2014 as interest rates rose, but that didn’t happen. Not only are Treasury rates down year-to-date, but the Federal Reserve has made it clear that rates are unlikely to rise this year at all, and may not even rise until the end of 2015. The hint of raising rates “soon but not now” has been in the air since 2011, but this year investors just aren’t buying the story anymore. Instead, they’re buying high-yield stocks that profit from a low rate environment.
MLPs and BWP
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Again, the Fed was the main cause of price changes for MLPs, which are often seen as an alternative to high-yield bonds and whose prices sometimes track demand for bond funds accordingly. This year, MLP price volatility had nothing to do with rates, and everything to do with one company: Boardwalk Pipeline Partners. This natural gas processor cut its dividend in February for reasons specific to the company and to the nature of natural gas pipeline companies. This impacted the MLP industry as a whole, causing them to dip a little before the BDCs did. Those who trade distressed income-producing equities profited handsomely from buying on the fear in this market alongside those who bought the BDCs as fear hit them a couple months later.
Bond Funds and Demographics
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Finally, one of the biggest winners of 2014 has been bond funds. After a horrible 2013, bond funds are soaring. Back then, fears that the taper would cause yields to rise and bond values to fall caused tremendous capital outflows from bond funds, causing some interesting dramatic rumors about the bond royalty at PIMCO. This year, PIMCO is doing quite well, with their CEFs up nearly 10% on average for the year. Long-term Treasuries are also doing well, as are high-yield corporate and municipal debt.
Why is this? Demand for bonds is growing at a time when the market expected demand to decline. The market thought that the Fed’s taper would cause prices to fall for bonds and yields to rise, and this trend would be exaggerated by an improving economy that brought greater price inflation to the market. The opposite has happened: yields have fallen and the market’s expectations for inflation have fallen as well. The reason behind this is pretty simple—with the Fed failing to insert more liquidity into the market, the market now fears that the rate of inflation will slow because the money supply cannot expand to meet demand. This benefits bonds.
Conclusion
This year, income investors have been the clear winners, just like the high-flying growth investors were the big winners of 2013. It’s only mid-year, so the trend may reverse or slow, but the lesson to be learned is clear: an understanding of several asset classes and the macroeconomic trends that drive them will offer investors the chance to outperform, while those who do not understand the trends and simply follow momentum will often see their gains slow or reverse if they don’t get the timing exactly right.