Investment manager DNR Capital has attempted to reproduce the long-standing Dogs of the Dow investment strategy, using a local sharemarket index. It did not work.
Dogs of the Dow is an investment strategy that attempts to beat the market index (in this case a US market index, the Dow Jones Industrial Average) by buying high-yielding stocks.
At the beginning of each year an investor buys the highest yielding stocks in the index. The premise is that blue chip companies do not alter their dividend to reflect tradjng conditions and, therefore, the dividend is a measure of the worth of the company.
In contrast, the share price fluctuates through the business cycle. Companies with a high dividend relative to the stock price are near the bottom of their cycle and should be about to enter the recovery part of their stock price cycle.
The strategy was first publicised in 1991, when it was outlined in Michael B O’Higgins’ investment book, Beating the Dow.
Since the financial crisis it has been a successful strategy, producing returns that beat the Dow.
DNR Capital portfolio manager Scott Kelly has tried to replicate a Dogs of the Dow strategy using the S&P/ASX 20 index but underperformed over all periods out to 10 years.
Kelly says: “Dogs of the Dow has proved to be a successful strategy in the US market, showing an average return of 200 basis points over the last 19 years.
“Investors looking for yield in Australian equities have concentrated their exposure to the top 10 companies, which contribute more than 50 per cent of S&P/ASX 200 dividends paid, so we thought it would be a worthwhile exercise to consider how a Dogs of the Dow strategy might work here.
“We analysed a notional Dogs of the ASX 20, investing $1000 into the highest yielding stocks of the ASX 20 at 31 December and constructing an evenly weighted portfolio of 10 companies each year.”
The strategy underperformed the S&P/ASX 200 by 5.6 per cent a year over five years and by 5 per cent a year over three years.
Kelly says the exercise showed that pursuing a high-yield strategy is simplistic and fraught with danger.
“High yields can indicate companies are facing structural headwinds and dividends might be at risk of being cut,” he says.
In addition, sources of yield shift over time. Over the past five years, yields from materials and energy companies have increased substantially, while for consumer discretionary, utilities, Telstra and industrial companies, it has declined.
Kelly says: “Assessing a company’s dividend sustainability is core to our equity income portfolio. We look for quality companies that can demonstrate the ability to sustain and grow dividends over time.”
