Sustainable Dividends for Sustainable Investors

Dividend-paying stocks rarely capture headlines. In any given year, the market’s highest fliers are typically fast growing companies; they’re often unprofitable, let alone at the stage of their corporate life cycle where they’re returning cash to shareholders. Dividend payers are often dismissed as boring, especially during times of market exuberance.

Yet dividends remain a fundamental pillar of equity investing. Retirees and others looking to extract income from their investment portfolios rely on regular payouts, especially when bond yields are low. Reinvested dividends account for a significant share of equity market return—roughly one third for the 20 years through the end of 2021. Several studies over the years have demonstrated that dividend payers possess a long-term performance advantage relative to the overall market.

Of course, there are risks associated with equity-income investing. The market’s highest yields often belong to the shares of troubled companies whose shareholder payouts are ultimately unsustainable. Reducing, suspending, or eliminating a dividend is often the first response to distress. Scores of companies across the globe cut their payouts in 2020 amid the pandemic-driven downturn, though it doesn’t take a crisis for competition and balance sheet pressure to jeopardize dividends. Investing without regard to dividend durability can be perilous.

A selective approach is also advisable for investors with sustainability-related objectives. Significant dispersion exists between companies carrying significant environmental, social, and governance-related risk, and those for whom ESG issues will likely have little financial impact. Avoiding ESG risk is becoming ever more critical, as companies face pressure to deliver for all stakeholders.

Dividends and sustainable investing are infrequently paired. Many economic sectors that tend to be dividend rich, including energy, basic materials, and industrials, are also areas of heightened ESG risk. Yet research can uncover businesses across the economy that effectively manage issues like carbon emissions, workforce relations, and business ethics.

For sustainable investors with equity income objectives, the Morningstar Sustainability Dividend Yield Focus Indexes highlight attractive dividend yields while mitigating ESG risk. The indexes employ proprietary, forward-looking screens to identify companies that are well-positioned to sustain their dividends due to competitive advantage and financial health. The indexes’ screens have been effective predictors of dividend durability over the long term. Meanwhile, the indexes use company-level ESG risk assessments from Sustainalytics, a global leader in sustainable investing research. The goals are income, return, and ESG risk mitigation.