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Achieving your investment goals with factors: generating income

Achieving your investment goals with factors: generating income

30-11-2018 | 市场观点

Factor-based strategies can help generate income. Sixth and last article of a series on how factors can help investors achieve specific goals.

Speed read

  • Income is a key driver of returns
  • High income leads to higher and more stable returns
  • Income is a key variable in many factor strategies

The context

Although many investors tend to focus more on growth in value, dividends and coupons account for a significant portion of long-term returns on equities and bonds. In the US stock market, for example, roughly half of equity returns have come from dividends and half from price changes over the past century. Moreover, stocks characterized by an above-average dividend yield tend to deliver higher and more stable returns over time.

The quest for higher and more stable returns has caused many investors to turn to strategies featuring high-income characteristics. In recent years, as bond yields have fallen across the developed world, these strategies have been gaining considerable traction, in particular among those asset owners interested in factor investing. A recent FTSE Russell survey of asset owners found that income generation ranked sixth among the top investment goals that led them to consider factor-based strategies.

Income-related variables have indeed played a key part in determining some of the most commonly-admitted factors. Carry, which can generally be defined as the return on an asset when prices remain constant, is an obvious case in point. This also holds true for other proven factors, such as value, quality and low risk. Some prominent academics even believe that for equities, income can be considered a factor in its own right.1

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Scientific basis

Since the 1970s, many academic papers have suggested that stocks featuring high-income characteristics achieve significantly higher risk-adjusted returns over the longer term. A good example of this is a 1988 research paper2 by Nobel prize winner Eugene Fama and fellow researcher Kenneth French showing the power of dividend yields for forecasting US stock returns.

The graph below illustrates the importance of income for long-term equity returns, as it shows the US stock return decomposition, going back as far as 1900. Over this very long period, equities have delivered a total return of 9.5% per year, 4.5% of which came from dividends and 5.0% from price increases.3

Figure 1: Equity return decomposition of US stocks since 1900

Source: Shiller and Robeco.

In a 2017 paper, Ralph Koijen, Tobias Moskowitz, Lasse Heje Pedersen and Evert Vrugt looked at this topic from a different angle. They took the concept of carry, which until then had been applied almost exclusively to currencies, and documented a carry premium for an array of asset categories, including global equities, global bonds, commodities, US Treasuries, credit, and options.

More recently, Robeco’s Guido Baltussen, Laurens Swinkels and Pim van Vliet looked for longer-term trends by analyzing the evidence for various factors, including carry, across multiple asset classes over more than two centuries.4 They found that carry had been one of the most profitable factors over the entire sample period, delivering strong and relatively constant Sharpe ratios in the major asset classes.

Other considerations

While carry strategies look like the obvious way to reap the benefits of high-income investing, these are by no means the only option available. As already mentioned, income-related variables also play a crucial role in the definition of other proven factors, such value, quality or low risk. That is why, in equity markets, value and low-risk investing typically involve selecting stocks from firms with high and stable dividends, and quality investing involves selecting stocks that are more conservative.

For example, generic value or low volatility indices, such as the MSCI Value and Minimum Volatility series of indices, generally feature higher dividend yields than their parent indices. The same can be said of Robeco’s Value Equities strategy and Conservative Equities strategies, our approach to low volatility investing. Robeco Quality Equities strategy, on the other hand, is by design tilted towards companies with lower net stock issues compared to the market index.

A final consideration for those wishing to focus primarily on income is that high dividends, for instance, can be transitory. Therefore, in order to ensure a high income over the long term, investors should not forego other variables. This is where efficient factor approaches that emphasize high income but also take into account other parameters, such as price momentum, might come in.

1See for example: Dimson, E., Marsh, P. and Staunton, M., 2017, ‘Factor based investing: The long term Evidence’, Journal of Portfolio Management, Special Issue 2017, Vol. 43, No. 5, Pages 15–37.
2Fama, E. and French, K., 1988, ‘Dividend yields and expected stock returns’, Journal of Financial Economics, Volume 22, Issue 1, October 1988, Pages 3-25.
3See our recently published article on this topic: Van Vliet, P., Polfliet M., Mosselaar J.S., 2018, ‘High dividend investing: buy them stable & strong’.
4See our recently published book of collected research articles: Baltussen, G., Martens, M. and Van Vliet, P., 2018 ‘Quant Allocation − Collected Robeco Articles’.

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