CVS – Here’s How to Marry ESG and Dividends. And 5 Picks for a Start.
Although there aren’t that many funds or indexes that combine income with ESG investing, there are plenty of stocks that do.
For investors looking to find them, however, it helps to use more stock-picking tools than just positive ratings on companies’ environmental, social, and corporate governance practices.
“It actually behooves investors to screen on yield or P/E—or some kind of a statistical valuation framework to make sure you are not overpaying for quality,” says Savita Subramanian, head of global ESG research at (BofA) Securities.
ESG investing has been growing strongly in recent years as more investors push firms to be good corporate citizens, whether it’s being more inclusive, cutting down on pollution, or making boards of directors more accountable to shareholders.
|Company / Ticker||Recent price||Market Value (bil)||Dividend Yield||YTD Total Return|
|Home Depot / HD||$326.18||$344||2.0%||24.2%|
|Intel / INTC||54.06||219||2.6||10.5|
|PepsiCo / PEP||156.39||216||2.7||7.1|
|Texas Instruments / TXN||190.91||176||2.2||18.3|
|Amgen / AMGN||225.53||128||3.1||0.3|
Note: Data through August 31
Sources: Morningstar; FactSet
Options for incorporating ESG with equity income, however, have been somewhat limited for individual investors when it comes to indexes and mutual funds, as this column pointed out last week.
Alex Bryan, director of product management for equity indexes at
says that one alternative for investors looking to marry ESG and income is to use a traditional broad ESG strategy as the core of a portfolio along with an allocation of dividend stocks as a supplement.
Examples of broad ESG stock strategies include the
Vanguard FTSE Social Index
fund (ticker: VFTAX) and the
Fidelity US Sustainability Index
“At least in the interim, that’s one way of achieving it while still providing broad diversification, low costs, and using the existing tools out there today,” he says.
Index funds aren’t the only vehicle through which investors can access stocks that blend ESG with income.
Matrix Asset Advisors, based in White Plains, N.Y., and which oversees nearly $1 billion, recently added an ESG overlay to its dividend income strategy in separately managed accounts.
In researching this addition, the firm’s chief investment officer, David Katz, and his team reviewed the holdings for the Matrix dividend income strategy from Dec. 31, 2010, through June 30 of this year.
They next divided those holdings into two buckets, one for stocks that earned favorable ESG grades and the other for stocks that fell short on that front—mainly in sectors like energy and utilities. In vetting companies for their ESG compliance, Matrix uses Morningstar’s Sustainalytics firm and other data providers.
The ESG stocks had an annual return of 12.51%, versus minus 0.29% for the non-ESG stocks, over that decadelong stretch.
He points out that the non-ESG stocks were dragged down by energy stocks. “Energy companies had a fairly miserable decade,” Katz says.
Over the period that Katz analyzed,
(XOM) had an annual return of 2.5%, versus 14.7% for the S&P 500 index.
(CVX) returned about 5.4%. Their stocks were recently yielding 6.5% and 5.6%, respectively, but neither company scored well on the ESG metrics used by Matrix.
By adding ESG considerations to an income portfolio, says Katz, “you can still get pretty diversified portfolios and do well with an ESG focus.”
“We are not trying to sell this is as, ‘Hey, this is going to enhance your returns,’ ” he adds. “But what it does show is that you can do well by doing right.”
While ESG investing has its critics, financial professionals increasingly see ESG adherence as an indicator of corporate health.
Subramanian characterizes ESG as a financial factor that helps “determine the future financial stability” of a company along with its business and operational risk. Another discovery: “Companies with good scores on ESG tend to experience a decrease in future earnings volatility, relative to companies with poor scores,” says Subramanian.
That’s an important consideration for income investors because volatile earnings can presage a dividend cut. “If you are a dividend investor and care about the sanctity of your dividends, you should care a lot about earnings volatility,” Subramanian says.
She also points out that ESG can enhance stock performance when it’s melded with other factors such as dividend growth or dividend yield.
For example, from the end of 2005 through June 2019, the top 20% of companies in terms of dividend yield among the stocks covered by (BofA) Securities had an annual return of 8.4%, according to the company. But when that yield factor was blended with good ESG scores, the annual return was 9.8%.
Although it isn’t that easy, investors looking to meld ESG with income can also pick stocks on their own. But it takes a lot of legwork.
For a few stock ideas, Barron’s turned to Morningstar, which recently put out a list of dividend stocks to which Sustainalytics assigns a low ESG risk rating. From that list, Barron’s selected the five stocks with the largest market caps and yields of at least 2%.
Morningstar considers all of these companies to have durable business models and the ability to sustain their competitive advantages over a 20-year period. That bodes well for their dividends.
Past is not prologue, however.
“The hardest part is predicting the future,” says Subramanian. “You can have a company that looks great up to a certain point, but all of a sudden it implodes. But that’s where ESG will help”—to avoid investing traps.
And it’s certainly another factor for income investors to keep in mind.
Write to Lawrence C. Strauss at [email protected]