CHICAGO With all the angst in the market lately about rising rates bruising bond prices, where can you find reasonable income with less sensitivity to interest-rate movements?
The answer, surprisingly enough, is dividend-growing stocks. These cash-rich companies not only have the ability to raise payouts but their returns are still competitive with bonds in a low-rate environment.
Dividend growers can offer better performance than bonds because total return rises as the dividend yield is increased. (Total return is a stock's appreciation plus reinvestment of dividends and capital gains before taxes.)
C. Thomas Howard, an emeritus professor of finance at the University of Denver, found that annual returns of stocks in the Standard & Poor's 500-stock index rose from 0.22 percent (for large companies) to 0.46 percent (small companies) for every percentage-point hike in yield from 1973-2010.
When Howard compared dividend growers with companies that cut payouts, the difference was even more pronounced. He discovered that dividend raisers outperformed dividend cutters by 10 percentage points, on average, during that period.
While dividend growers are much less volatile than non-dividend-paying stocks - Howard found their standard deviation to be eight percentage points lower - they won't dodge all market risk. Prices will still get battered in any broad-based downturn.
An exchange-trade fund such as the SPDR Dividend ETF, which focuses on a variety of North American dividend payers, for example, lost almost 23 percent in 2008. Still, that was about 14 percentage points better than the drop in the S&P 500 in that dismal year.
The SPDR fund tracks the S&P High Yield Dividend Aristocrats Index, an elite group of companies with consistent growth in dividends because of robust cash flow. The fund includes household names such as AT&T Inc, Clorox Co and Chevron Corp. Not only do these companies pay high dividends, they have durable business models and can find ways to grow even during sluggish economies.
The fund charges 0.35 percent annually for expenses and currently pays a 2 percent yield.
BULL MARKET FOR DIVIDENDS
As the Federal Reserve considers pulling back its $85-billion-a-month bond-buying program, which could drive a stake into the 30-plus year bond bull market, dividend-paying stocks have held up especially well. For the year through, September 6, the SPDR ETF is up nearly 20 percent for the year, besting the S&P 500 by 1.5 percentage points.
A worthy addition to a high-dividend portfolio would be the PowerShares International Dividend Achievers ETF, which gives you non-U.S. stock exposure.
The PowerShares fund is up almost 14 percent for the year through September 6 and yields just over 2 percent. You'll pay 0.56 percent in annual expenses. It holds large companies such as Vodafone Group PLC, AstraZeneca PLC and BHP Billiton PLC.
It's not often that stock funds are less volatile than bonds, but the current environment favors companies sitting on cash, paying healthy dividends and increasing profits, versus fixed-payment bonds, whose prices that could drop further when rates rise.
Contrast dividend-achieving stock returns with a broad-basket U.S. bond fund such as the iShares Core U.S. Total Bond Market ETF, which is down 3 percent for the year through September 6.
While I hold this fund in my 401(k) - and don't plan to sell it because it represents a broad swath of U.S. bonds - it has been volatile as the Fed ruminates over monetary policy and the possibility of raising rates in a recovering economy.
Keep in mind that if the U.S. economy slows down or there is another global financial calamity, investors could retreat from stocks en masse and back into Treasuries.
(The author is a Reuters columnist. The opinions expressed are his own.)
(Follow us @ReutersMoney or here Editing by Lauren Young and Douglas Royalty)