By Jim Atkinson
The financial markets have frustrated most investors over the past decade, plus. The S&P 500 has been more volatile than is comfortable for most investors and so-called safe fixed income investments have offered paltry yields. Put that in context with a large segment of the population that is nearing or entering retirement, and it is no wonder why many investors are seeking alternative investments.
The phrase "alternative investment" can mean investments in less common asset classes, such as commodities, as well as approaches such as long/short or market neutral strategies. Most alternative investment strategies seek low-correlation with equities, and increasingly, many of them are steeped in complexity. The idea behind alternative investments is the explicit recognition that traditional, long-only equity strategies have failed--and will continue to fail--to provide sufficient returns for investors.
However, there is one time-tested, long-only strategy that benefits from sideways or even downward trending markets that uses a straight-forward and easily repeatable process. The simple alternative to alternative investing is likely right in front of your eyes, that is, traditional dividend investing. Specifically, investing in high quality companies and then reinvesting their dividends over time until it is time to begin collecting the income stream.
Historically, both stock and bond investing was much more focused on generating income. This income orientation was lost during the bull market euphoria of the 1980s and 1990s. Those saving and investing for retirement are almost certainly seeking a singular objective of maximizing their retirement income. Yet, ironically, prior to the events of the most recent financial crisis, the most common path to that objective was to eschew income in favor of capital gains during the so-called "accumulation phase" with the plan of using those gains to invest in income generating securities at a later point near retirement, during the so-called "pay out phase."
More recently, of course, the plan has been to replace a large part of the equity risk inherent in growth stocks with alternatives in an effort to generate gains, often replacing that now well-known risk from equity draw downs with more opaque and less understood ones. Additionally, the task of translating capital appreciation into income producing securities remains. Might we suggest a more direct approach?
The dividend reinvestment strategy benefits greatly from flat (good) or declining (better) markets. This is because the reinvested dividends are accumulating more shares at lower prices. The strategy benefits even more from a flat or declining market when systematic purchases are added to the mix. The key is helping your clients understand that downward price movements can actually be hugely beneficial for building a future income stream. Counter-intuitively, the decline in principal is actually a meaningful benefit for income investors reinvesting their dividends who are thinking of income as their final outcome.
For example, the historical trend of a company like Coca-Cola shows that the stock will experience long-term dividend growth while the share price will fluctuate, sometimes greatly, but will likely move generally in line with the growth rate of the dividend. In some years the stock will lose value and in others it will gain. There may be periods of incredible sideways boredom and other periods of great panic and great excitement.
Investors seeking to maximize their income over time should have a distinctly counter-intuitive view on where the stock price should go in the interim. Investors reinvesting their dividend or otherwise adding to their position can do well in a weak or sideways market provided they follow a disciplined approach and, crucially, invest in high-quality stocks able to generate sustainable cash flow through a full market cycle. The point being that the company will continue to pay dividends even if its share price falls significantly.
Advisors prepared to follow this approach over the long-term will find that the ebb and flow of the day-to-day fluctuations in their principal--which are caused by short-term market movements--will actually work in their favor.
This means that advisors must have an investment methodology that is focused on company fundamentals and not merely focused on the current dividend or dividend history. The dividend only represents the outcome resulting from a company's ability to create and generate wealth. While finding companies with such characteristics may seem daunting, we have identified a universe of more than 300 stocks that have achieved 10% cash flow returns on investment (CFROI) every year for the last ten years, which of course includes the depths of the financial crisis of 2008, often referred to as "the ultimate stress test."
Your client's likely biggest worry today is that the stock market will decline or continue its volatile sideways pattern for a number of years. This is, in fact, the primary driver in the explosion of interest in retail alternative investment products. If in fact either fear is realized, a systematic dividend strategy represents a truly viable--and simple--alternative strategy.
Our advice to advisors looking to build a sustainable stream of income for their clients' retirement: Don't let a bad market ruin your life . . . embrace it.
Jim Atkinson is CEO at Guinness Atkinson Asset Management and president of Guinness Atkinson Funds. As the Funds' co-founder, Jim has been instrumental in developing the company's core investment themes of innovation and profound global change, which includes increasing global energy demand, environmental concerns and the shift to alternative energy, as well as the rise of China and Asia.