In the ever-evolving world of investment, where trends come and go like fleeting moments, one theme has undeniably captured the attention of investors over the past year: dividend fundsAs we dive into the details, a quick glance at available resources reveals that there are a staggering 44 dividend funds currently waiting for issuanceFurthermore, the China Securities Index Company recently announced the launch of several new low volatility dividend indices—500, 800, and 1000—which signifies that this investment avenue is not just a passing trend but might be preparing for a broader emergence.

This has led many investors to ponder a critical question: are dividend themes merely ephemeral spurts of excitement or a more substantial shift in investment philosophy? In the context of the current market climate, where uncertainty looms over numerous sectors, such inquiries are timely and relevant.

The Rise of Dividend ETFs

Most narratives in the capital markets are intrinsically tied to yield, and the popularity of dividend themes is no exceptionThe China Securities Dividend Index has consistently outpaced the broader market from 2021 to 2023, indicating the potential that dividend-focused funds possess in garnering investor enthusiasm.

However, it is essential to remember that dividend investments are often characterized by a "slow and steady" approach

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For instance, during the bull market between 2019 and 2021, dividend stocks significantly lagged behind growth stocksInvestors tend to gravitate toward assets capable of rapid returns in buoyant markets, leaving the steady income streams of dividends sidelined until market volatility heightens.

The distinction between dividend stocks and growth stocks is crucial as the former is typically associated with businesses in mature stages, which tend to reinvest less actively and return profits to shareholders through dividendsConversely, growth stocks represent significant potential for capital appreciation, albeit often accompanied by higher risk.

In fact, dividend investment has validated its worth within China's A-share marketThe oldest dividend index fund, tracking the China Securities Dividend LOF since its inception on March 18, 2011, boasts returns of 167.89% to date, starkly contrasting the 11.97% gained by the CSI 300 Index over the same duration.

At this juncture, one might start to wonder about market dynamicsThe CSI 300 ETF has skyrocketed in size over recent years, with the combined assets of the top four ETFs exceeding 500 billion yuan, while all dividend funds collectively account for just over 100 billion yuan.

This begs the question: why do dividend indices with superior long-term returns exhibit such a lackluster reception? While popular indices like the CSI 300 and SSE 50 boast robust utility characteristics, many investors tend to flock to these indices during euphoric market conditions, favoring growth stocks, while dividend indices often seem to lack the market allure.

Some astute mutual fund investors may have noticed that among various fund managers, many are tagged with growth and value labels, yet few focus on dividends

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This ties back to the aforementioned point: new investors often fixate on the most 'cutting-edge' opportunities, leaving the steady, defensive dividend options overlooked.

In 2023, the A-share market experienced turbulence, leading to decreased risk tolerance among investorsThe allure of certainty in investment returns has become significant, paving the way for rapid growth of dividend fundsResearch by Guoyuan Securities indicates that, as of May 10, 2024, there are 124 dividend funds with a total asset size close to 127 billion yuan.

Among the various segments, the expansion of passive income funds is more pronouncedBoth passive index dividend funds and active equity dividend funds are well represented, with a total of 54 products each, accounting for 88% of the sectorAdditionally, passive index dividend funds dominate in terms of size with a 60% market share, indicating a broader confidence in these investment vehicles.

Who Reigns Supreme in the Dividend Space?

The performance of index funds significantly relies on the productivity of the underlying indicesNotably, dividend indices encompass numerous subcategories, yet they share a common selection criterion focused on the levels of cash dividends from stocks.

For instance, the aforementioned CSI Dividend Index, which targets the top 100 listed companies with high cash dividend yields in the Shanghai and Shenzhen markets over three years, is one of the most widely used comprehensive dividend indices, hosting the largest number of tracking funds.

Another noteworthy index is the Central Enterprise Shareholder Return Index, which quickly gained popularity since its launch in 2022. This index selects the top 50 securities based on past three-year average cash dividends and repurchases as a percentage of total market value

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The component stocks solely belong to the central enterprises under the State-owned Assets Supervision and Administration Commission (SASAC).

The attraction of the Central Enterprise Shareholder Return Index stems from its dual appeal: the “central enterprise” aspect combined with the promise of dividendsSince the “12-Character Plan” proposal in 2022, various measures have been introduced to boost the value of state-owned enterprise dividend assets, with the latest “National Nine Articles” proposing to enhance the investment value of listed companies.

Since the three-year action plan for state-owned enterprise reform, enhancing quality and efficiency has become a crucial evaluation target for state-owned enterprises, with the return on equity (ROE) for these companies continuing to expand relative to the broader market.

In 2023, another star index emerged—the National New Hong Kong Stock Connect Central Enterprise Dividend IndexAs the name suggests, it encompasses three appealing elements: “central enterprise”, “dividend”, and “underestimated Hong Kong stocks”. Naturally, public funds have jumped at the chance to invest in this index.

True to expectations, on May 30 of this year, three ETFs based on the National New Hong Kong Stock Connect Central Enterprise Dividend Index were formally approved, marking the debut of ETFs tied to this index less than eight months after its introduction.

How Long Will the Dividend Style Remain Popular?

As the dividend ETFs continue to gain traction, some investors harbor doubts about the longevity of the sustained popularity surrounding dividend styles

How much longer can this trend last?

In capital markets, consistent winners are a rarity, thus it becomes imperative to assess what phase the dividend investment is currently inOne might consider the following dimensions to evaluate this.

First, is the valuation showing signs of being overly inflated? Trees, like markets, cannot reach the sky; therefore, valuations cannot soar indefinitelySince 2023 commenced, major dividend indices have witnessed significant price increases, leading to higher valuations than seen in the past three yearsNevertheless, the absolute PE (TTM) value of these dividend strategy indices remains relatively low, hovering below the 40th percentile over the last decadeThus, current valuations have not breached previous ceilings.

Second, consider the scale of dividend fundsCompared to the end of 2022, the number of dividend funds has surged by over 20%, while the total assets have risen by more than one-thirdHowever, their overall numbers and market size account for less than 2% of all equity fundsComparatively, high dividend funds in international markets such as the US and Japan represent a far greater proportion in size and quantity relative to China's public fund sector.

Third, analyze the level of market congestion in tradingSince the Chinese New Year, the trading volume of the CSI Dividend Index accounted for less than 4% of the total A-share trading, placing it in the 20th percentile over the past ten yearsFrom a medium- to long-term perspective, the trading congestion level does not appear significant

Moreover, data from the 2023 fund annual reports reveal dividend industry mainstay stocks hold a share of about 5.3% in their respective portfolios, also positioned within the 20th percentile over the last five years.

From a dissemination perspective, it can be argued that dividend investment has not yet reached a state of widespread popularityEvaluative data from platforms indicates that engagement with dividend-related assets trails far behind sectors such as food and beverage and pharmaceuticals.

Fourth, consider interest rates and the overarching market trendThis aspect warrants significant attention when evaluating dividend-focused investmentsHistorical data reflects that the relative excess returns of the CSI Dividend Total Return Index against the CSI 300 Total Return Index demonstrate a certain negative correlation to interest rate levelsSince the start of this year, the central market interest rates have been on a decline, establishing a conducive environment for dividend strategies.

All of the above evidence points to the prevailing strength of the dividend investment style being attributed to an overarching adaptable environment, not solely based on its inherent dividend propertiesTherefore, factors such as a stabilizing economic climate, low market interest rates, and reasonable sector valuations will suggest that the effectiveness of dividend strategies may endure in the medium to long-term.

Why Are ETFs Embracing Dividends?

2024 is on course to be a “dividend year,” where not only are dividend-focused funds thriving, but ETFs are also jumping on the dividend bandwagon

The surge in popularity of dividend funds can be attributed to increasing market uncertaintiesThe underlying assets of dividend funds typically consist of companies renowned for their ability to provide stable dividends, thereby offering relatively assured cash returns during periods of market indecision.

However, the rise of dividends among ETFs merits deeper considerationIn the landscape of investment philosophies, “snowballing” and “cashing out” represent two distinct schools of thoughtIn a surging market, the “snowballing” strategy often gains traction, whereas during downturns or stagnant conditions, investors start to pay attention to “cashing out.”

However, it’s important to recognize that these strategies are not inherently contradictoryTake Warren Buffett, the proverbial champion of “snowballing,” for example; his portfolio often includes a substantial cash reserve as he exercises patience, waiting for strategic opportunitiesUltimately, the difference lies in an investor's judgment regarding market conditions.

Returning to the topic of fund dividend distribution, it must be noted that dividends are not simply funds materializing out of thin airThough the returns on dividends do not change post-distribution, receiving dividends can result in other tangible benefitsFor instance, investors can receive distributions without incurring redemption fees, ensuring a level of cash inflowMoreover, dividends can help hedge against significant capital depreciation, particularly during market downturns.

Historically, dividend-focused funds have resonated most with middle-aged professionals approaching retirement

However, trends in capital markets outside of China illustrate that as economic growth slows and societies age, the appeal of dividend-based assets continues to rise, suggesting increasing penetration rates.

Regrettably, in a market previously known for its aggressiveness, its most fervent investors seem to be fading awayIn a realm where new capital is difficult to acquire, a monthly dividend mechanism—often deemed contrary to historical reinvestment strategies—gains increasing acceptance among investors.

Similarly, the Chinese market has witnessed the emergence of ETFs encapsulating both “dividends” and “monthly distributions.” The recently launched Dividend 100 ETF (159589) tracks the CSI Dividend Index, selecting stocks with high cash dividends and consistent performance among 100 companies in the A-share marketOn the other hand, investors looking to invest in undervalued Hong Kong stocks might find the dividend ETF for Hong Kong stocks (subscription code 520903) more suitable for gaining a foothold in this investment avenue.

From a product design perspective, both Dividend 100 ETF (159589) and the Hong Kong Dividend ETF (subscription code 520903) have established dividend clauses, specifying that the fund’s yield evaluation dates are the last business day of each month, facilitating the distribution of returns at least once per quarter and a maximum of three times per quarter, targeting up to 12 distributions annually under eligible circumstances.

As we assess the current dynamics of dividend assets, a critical question looms: is this merely the culmination of a temporary market trend or the inception of a new chapter? Only time will tell.

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