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New research reveals growing institutional investor concern around dividends and increased focus on ‘smart beta’ to deliver income

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New research from ETF provider Source reveals the majority of institutional investors expect dividends to fall this year compared to 2015. Global dividend growth has been 9.3 per cent, but 72 per cent of institutional investors believe it will be 5 per cent or less this year.

This helps explain why over the next two years, almost half (48 per cent) of institutional investors believe that investing for income will become more important, compared to just 7 per cent who think it will become less so.   
 
Just under one in four (23 per cent) believe the trend for big firms cutting dividends will decline in 2016, and 59 per cent say the chances of investors being caught out by a ‘value trap’ – picking a stock that pays an attractive dividend but the dividend then falls sharply, or one that should pay a dividend but never does – will increase. Furthermore, only 44 per cent of institutional investors believe that the data on companies is transparent when assessing whether or not they will pay an attractive dividend.
 
To help address the growing challenge to find attractive dividend paying stocks, Source and Research Affiliates LLC, a global leader in smart beta3 and asset allocation, have launched three smart beta income ETFs. These aim to provide exposure to the new FTSE RAFI™ Equity Income Indices, which target high-dividend-paying stocks that have been screened to favour sustainable income. The ETFs will offer investors a choice between US, UK, and European exposure.
 
Source’s research4 reveals that 27 per cent of institutional investors claim to invest in smart beta strategies today, and of those that don’t, 31 per cent anticipate they will over the next two years. Furthermore, 57 per cent believe that more smart beta ETFs will launch over the next three years, and over one in four (28 per cent) believe institutional investors will increasingly focus on these types of strategies to enhance the dividends they receive.
 
Dr Chris Mellor, Executive Director, Equity Product Management at Source, says: “Many investors have been struggling to generate income in the current environment, with bond yields low and with most high-yielding equity strategies being overly exposed to low quality or low growth stocks. Our investors said they wanted a strategy that focuses on dividends and doesn’t give you exposure to low quality companies. This is precisely what we worked with Research Affiliates to develop, which has culminated in the new FTSE RAFI Equity Income Indices.”
 
To construct the indices, Research Affiliates uses fundamental measures to screen out those companies in poor financial health, and then from the remaining stocks selects the top 50 per cent in each sector based on their dividend yield. It then weights the constituents by the product of their dividend yield and RAFI Fundamental weight, which is based on four fundamental measures of the company’s size rather than its market capitalisation. The aim of this process is to build a portfolio of high-yielding, high quality stocks while avoiding excessive sector tilts and the biases that are inherent in market-cap-weighted indices. 
 
Rob Arnott, Chairman and CEO of Research Affiliates, says: "We're excited about our new Equity Income Index Series, and we are pleased to partner with Source to deliver these innovative solutions to investors. Although there are a number of dividend-based indexing strategies on the market, few seek to assure that the stock is attractively priced on measures other than the dividend yield, and even fewer filter to assure that the dividend is sustainable. We believe our extensive research in the smart beta area has allowed us to produce a truly superior way to earn solid and sustainable income from an equity portfolio."
 
These are also the first funds to be launched on Source’s new physical ETF platform, with assets managed by Legal & General Investment Management, the UK’s largest index fund provider, managing £288bn in index funds alone and the largest global manager of FTSE RAFI global indices, managing £8.9bn. The Source FTSE RAFI Equity Income ETFs will gain exposure to the physical assets in the indices, through an investment in the master fund.

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