Kathleen Dobyns
If they are reliable payers, high-dividend stocks can help investors in two ways: they boost the income from an equity portfolio while offering potential capital appreciation.
- Smart dividend stock selection avoids yield traps by using forecast dividends and excluding high-risk stocks with negative returns.
- The FTSE Global Equity High Income index provides almost double the dividend yield compared to traditional indices while maintaining diversification and stability.
- High-dividend stocks tend be less volatile, with the FTSE Global Equity High Income index showing lower historic volatility than the FTSE All-World index.
Building a high-income equity portfolio requires sophistication
Building a successful high-dividend portfolio requires some sophistication. The same is true for the designer of a high-dividend index.
On the one hand, stocks with higher dividend yields are often mature companies with established cash flows and a history of consistent dividend payments, which shows a commitment to returning cash to shareholders.
However, a high yield could also signal a lower-than-average prospective earnings growth rate (which, in turn, could limit the potential for share price appreciation).
High-income stocks can provide investors with a degree of stability in volatile market conditions, but a naïve stock selection approach—choosing companies with the highest historic dividend yields—would probably leave the investor exposed.
This is because an abnormally high dividend yield (often referred to as a “yield trap”) is often a precursor of a dividend cut: traders usually anticipate such cuts by marking down share prices and dividend yields are calculated using backward-looking data.
To meet growing investor interest, FTSE Russell launched the FTSE Global Equity High Income index series in May 2024. The index series uses a simple, capitalisation-weighted methodology to reflect the performance of global stocks with relatively high tax-adjusted dividend yields, while also addressing concerns over such possible yield traps.
Seven construction steps
The index series follows seven intuitive design steps, as outlined below:
- High-dividend indices vary in the complexity of their construction methodologies. For this index series, we’ve chosen a simple rank-and-select rule to choose constituents.
- We use forecast dividends, rather than trailing (historic) dividends to rank potential index constituents; although there is a close alignment between the two measures and past dividends are often a reliable indicator of future payments, forecast dividends cover almost all the global equity markets and are more responsive to changes in market conditions.
Forecast dividend coverage by cumulative index constituent weights
Source: FTSE Russell, data as of September 2023. Past performance is not a guide to future returns. Please see the end for important legal disclosures.
- We rank potential index constituents by net-of-tax yield, recognising the fact that index users often receive dividends after a deduction for withholding tax.
- To reduce the risk of yield traps, we exclude stocks with zero forecast or trailing dividends and those in the bottom fifth percentile of companies with negative one-year returns. This step screens out some of the stocks most at risk of cutting dividends.
- To enable easier country or regional carve-outs of the index series, we rank stocks within each of the eight regional universes for the FTSE Global Equity Index Series (Asia Pacific ex China ex Japan, China, Japan, Developed Europe, Emerging Europe, Middle East & Africa, Latin America and North America).
- To ensure relatively low concentration risk, to maintain diversification and to aid investability, we select the top 50% of securities by dividend yield within each regional universe and weight them by market capitalisation.
- To constrain turnover while ensuring regular index maintenance, we incorporate buffer rules and rebalance the index annually, with the quarterly removal of securities with zero forecast or trailing dividends.
A near-doubling of the index dividend yield
Applying these construction steps to the FTSE All-World index (via a back-test) resulted in a consistent near-doubling of the index’s dividend yield between 2002 and 2024—see the chart.
FTSE All-World and FTSE All-World Equity High Income index dividend yields (%)
Source: FTSE Russell, data from 31/12/99-30/9/2024 (30/9/02-30/9/24 for the FTSE All-World Equity High Income index). All performance presented for the FTSE All-World Equity High Income index prior to the index inception date is back-tested performance. Past performance is not a guide to future returns. Please see the end for important legal disclosures.
As equity dividend yields are on the decline, this could be a valuable set of selection rules for income-seeking investors—and the FTSE All-World Equity High Income index yield is calculated net of tax. But what about the effect on returns and risk?
Return and risk statistics
The total returns of the FTSE All-World Equity High Income and the FTSE All-World indices were broadly similar for most of the 22-year period, with the FTSE All-World Equity High Income index returning 9.07% per annum between September 2022 and September 2024 and the FTSE All-World index returning 10.14% per annum over the period.
In fact, the two indices’ total return ratio stayed close to 100 between 2002 and 2017, after which the outperformance of select low-dividend or zero-dividend stocks, particularly in the US equity market’s tech sector, helped the FTSE All-World index to pull ahead.
However, the FTSE All-World Equity High Income index had lower annualised volatility than the FTSE All-World index, confirming the observation that higher-dividend stocks are often stable businesses with higher cash flows and are somewhat less risky than the market.
Total return comparison: FTSE All-World Equity High Income index/FTSE All-World index
| Total return p.a. (2002-2024) | Standard deviation p.a. (2002-2024) | |
|---|---|---|
| FTSE All-World Index | 10.14% | 15.49% |
| FTSE All-World Equity High Income Index | 9.07% | 14.75% |
Source: FTSE Russell, data from 30/9/2002-30/9/2024, 30/9/2002=100. All performance presented for the FTSE All-World Equity High Income index prior to the index inception date is back-tested performance. Past performance is not a guide to future returns. Please see the end for important legal disclosures.
Further information for equity income seekers
As global interest rates head lower, investors are seeking sources of portfolio income. The FTSE Global Equity High Income index series is a comprehensive market capitalisation-weighted benchmark representing global stocks that pay relatively higher dividend yields.
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