Few strategies have matched asset owners' investment objectives as precisely as liability-driven investing, but it is very expensive to implement. Given how relatively inexpensive the stocks of quality firms that pay high dividends are (compared with U.S. growth equities and investment-grade bonds), should dividend stocks be more heavily weighted in an LDI strategy going forward?
Sizable market: Bonds suitable for LDI are a small subset of the total fixed-income market, and while quality equities with strong dividends are also a small subset of the total U.S. equity market, the great news for investors is that there are trillions of dollars in securities in which to invest.
Whither yields? In 2007, LDI bonds yielded what now seems like a massive 6.2%. With growth stocks in vogue, dividend stocks still pay out significant dividends and now outstrip the yields on LDI bonds.
Maybe growth, too: Bonds are the best tool to manage cash flows, but the returns are fixed. In a quantitative-easing and growth-stock world, quality dividend stocks might provide a more cost-effective strategy. And growth in cash flows from increased dividends may provide a significant benefit down the road.
A good mix: Many investors include growth assets in an LDI portfolio, and those with both high-quality bonds and stocks have realized the best return pattern. With yields this low, investors could tilt more to inexpensive dividend stocks.
*An adjusted market-cap-weighted universe of the Morningstar U.S. Dividend Valuation index. Source: P&I analysis of Bloomberg LP data/div>