Given the persistently low interest rate environment and high prices for most sectors of the bond market, many income seeking investors have been enticed to search for sources of cash flow beyond their traditional bond portfolios. Recently, I’ve been researching equity income strategies as one potential component of a more diversified income-producing portfolio for the unusual circumstances of today. In thinking about ways to achieve some key objectives (like large cap equity beta, high quality companies, a variety of sector exposure, and steadily rising income to compete with potential inflation) the S&P 500 Dividend Aristocrats Index stands out. This index appealed to me because it seemed to directly address my criteria with a reasonably small number of index constituents at sixty-six, and a very straightforward methodology. I like indexes that are so elegantly simple they can be explained in a text message:
- S&P 500 companies that have increased their dividend every year for at least the past 25 years
- A few guidelines to ensure adequate liquidity and prevent sector over-concentration
- Equally weighted
While poking around at some financial statistics and ratios of the underlying companies, my thoughts moved to the qualitative realm. I was struck by the devotion to dividend policy required to qualify as a Dividend Aristocrat, as a majority of the Aristocrats have raised their dividend every year for more than forty years! The proud tradition of increasing dividends is ultimately a human decision, and I assume is deeply embedded in the management culture of these firms. I wondered if this culture resulted in any noticeable improvement in the areas of corporate governance. Could dividend-based performance metrics reduce the incentives for excessive risk taking that may be inadvertently encouraged through an over-reliance on stock price as a measure of managerial performance? The definitive answers to these specific questions would require an intensive study far beyond the scope of this blog, but general strength of corporate governance and managerial effectiveness could be more easily explored.
My thoughts moved on to the Social component of ESG, with particular interest in how dividend-focused companies treat their employees. Prior to 2020 it was well known that many companies had enjoyed year-over-year increases in earnings and used ultra-low interest rates provided by the Fed to issue debt to fund stock buybacks all while employee wage growth remained muted. I wondered if firms, which prioritized dividend policies, were distinguishable in any way when view through an “S” lens. As a shareholder, I want a fair return for my investment, but I also believe that a happy and motivated workforce can be an enormously powerful driver of long-term outperformance.
As my curiosity had already led me into deeper water than I was planning to swim, I decided to push a little further. Since there seems to have been at least ten million new ESG focused investment products and strategies introduced in the last six weeks alone, surely an index provider could offer some direction. After reading the ESG philosophies and methodologies of four different leading index providers, I found S&P Dow Jones to be most helpful in painting the pictures I wanted to see. Through their acquisition of RobecoSAM’s ESG ratings business in 2019, S&P now issues the SAM Corporate Sustainability Assessment (CSA,) which is an annual qualitative assessment of companies’ sustainability practices. I appreciate the rigor of their process and the fact that they break out Environmental, Social, and Governance, as separate categories providing a score for each in addition to the company’s overall ESG rating. S&P also hosts a convenient tool on their website which allows users to quickly retrieve the ESG scores for individual companies. I retrieved information for each of the sixty-six S&P 500 Dividend Aristocrats and here is what I found:
- 64% of S&P 500 Dividend Aristocrats carry an overall ESG score which places them in the top quartile of their respective industry
- 70% carry a Social score above their industry mean
- 52% carry a Social Score which places them in the top quartile of their industry
- 92% carry a Governance/ Economic score above their industry mean
- 80% carry a Governance/ Economic score which places them in the top quartile of their industry
Combining the S&P 500 Dividend Aristocrat Index with S&P’s ESG scoring using the SAM Corporate Sustainability Assessment (CSA) proved to be very helpful in organizing high-level thoughts and guiding further idea generation. It seems that the S&P 500 Dividend Aristocrat Index does have positive implications for constituent companies’ attitudes towards overall ESG sustainability. This is particularly pronounced in the areas of Economic Policy and Corporate Governance. While the Aristocrats scored well for their industries in the Social categories, those elements of the CSA were more broad than I had hoped, and include aspects of stakeholder engagement far beyond my simple question, “Is the company good to its employees”? Given the Social scores achieved and relatively small number of firms included in the Dividend Aristocrats, I am compelled to believe that they probably do in fact treat their employees well. Maybe a firm’s commitment to dividend policy does have carry over effects on its management culture, which help in promoting ESG sustainability.
Disclaimer: This is purely for educational and entertainment purposes and should not be considered investment advice. Any potential investment should be considered within the complete scope of an individual’s financial position, objectives and risk tolerance. Investing involves risk including the risk of complete loss. The author does not guarantee the accuracy of information included.
Disclosure: the author holds long positions in XOM, CAT, VOO.