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Dividend Payers' Worst Year Yet?

Segment's business model is focused on compressing client costs and taxes and letting the market do its work. We operate this way because taxes and costs are controllable to a remarkable extent, and the benefits of doing so are repeatable. Stock pickers and trading-centric methodologies forfeit these benefits in search of market-beating returns.

Our methodology's mechanics rely on internalizing as many functions as possible, making us different from traditional wealth managers who rely heavily on external contractors like mutual funds, which often charge hefty, opaque fees. This internalization means we essentially run an asset management business without charging any additional fees, resulting in significant client cost savings.

We run three equity investing strategies that we custom mix-and-match for individual clients based on issues like cash flow, risk tolerance, return expectations, and tax status. Our most popular strategy is the Segment Rising Dividend Tax-Efficient Portfolio, which we call "Segment Dividend." This strategy is now available to other advisors as a Separately-Managed Account (SMA) on the Natixis and Envestnet platforms.

The Wall Street Journal recently wrote an article on dividend payers having a particularly bad 2020, potentially leading one to believe that focusing on dividends has been a losing strategy this year. Not so for Segment.

The article showed that the S&P 500 Dividend Aristocrats, which contains 65 companies with long histories of paying large and increasing dividends, has provided 2020 returns of -0.7%. The similar Dow Jones 30 has also just produced +1.1%, while the S&P 500 has produced a 2020 return of +7.3%. Despite the Segment Dividend Strategy having more in common with the Dividend Aristocrats index than the S&P 500, we have nonetheless kept pace with a year-to-date return of +6%. Some clients have done far better than that if they allowed us to buy the March dip. These results are remarkable mainly because the S&P 500 has no dividend focus, has higher volatility, and contains super-growth names like Amazon and Nvidia, both top-10 components. Our strategy must exclude both because they pay no dividends, and the laggard of the two has contributed year-to-date performance to the S&P 500 of +72%. To say we are at a natural disadvantage to higher-risk strategies is an understatement, but dividend investing has tax advantages as recompense for long hold periods and patience.

We ran an attribution analysis to find the sources of our excess return over the Aristocrats. We discovered that our holdings of Danaher, Apple, Taiwan Semiconductor, Microsoft, Home Depot, Nike, and Equinix REIT made all the difference, and in that order. The additional influence was an underweighting to energy. What we have concluded over the 14 years of this strategy's existence is that a focus on maximizing yield can be hurtful to overall return. Dividend money comes from somewhere, and unusually large payments often hinder the company's growth prospects or may be an indicator of underlying problems. Remember that dividends are fixed cents-per-share payments. When a company's share price falls, that makes the dividend look large. Many investors get mesmerized by this, and to their detriment.

Managing for dividend payments over a lifetime can yield extraordinary results, but that must be coupled with a temperance to avoid pursuing dividend income at all costs. Dividend income is a wonderful thing to have, but it cannot be a strategy in and of itself. Otherwise, we would simply shop the High Yield Stock Quote column of the paper like many do and resultingly suffer their same fate.