Equity Income: The Dividend Defense Against Inflation

Many investors are searching for assets that can help protect portfolios from inflation. Dividend-paying stocks offer surprisingly robust protection from inflation as well as solid long-term return potential in other environments when actively sourced from the right parts of the market.

Surging inflation has challenged investors to adapt to unfamiliar macroeconomic and market conditions. Even after receding slightly in August, US annual inflation remained at 8.3%, an uncomfortably high level last seen over 40 years ago. Rising prices threaten growth, corporate earnings and equity returns and it’s hard to find a compelling investment playbook for such high inflation. Yet it’s hard to predict whether inflation will persist at such extreme levels—and for how long. So how can investors find assets that are likely to perform well in today’s environment but will also do well if inflation recedes?

Classic Inflation Hedges Are Flawed

Some investors might turn to “classic” inflation hedges, such as commodities or real assets. History suggests that these assets tend to perform well in inflationary eras. But if and when inflation retreats, investors might be left in the cold. Assets held for inflation protection, such as commodity stocks or gold, are not reliable sources of long-term returns (Display). On the other hand, high-dividend stocks have delivered stronger risk-adjusted returns over time.

Dividend payers may not be top-of-mind for investors seeking high risk-adjusted returns, because the last decade hasn’t been kind to them. Over seven of the last 10 years through 2021, the MSCI USA High Dividend Yield Index and the FTSE High Dividend Yield Index underperformed the S&P 500. High-dividend payers are often seen as old, stodgy companies, like utilities or food manufacturers, with limited growth potential. As investors flocked to high-flying technology and internet growth companies, dividend stocks seemed like antiquated investment options.