Dividends Are (Finally) Getting Some Love
Episode 7613th July 2022 • Human-centric Investing Podcast • Hartford Funds
00:00:00 00:34:06

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Portfolio Manager Matt Baker explains why rising rates and high inflation have investors giving dividend-paying stocks a fresh look after an extended period of lagging growth stocks.


John Diehl [:

caught a ton of tuna off the shores of North Carolina. It was phenomenal.

Julie Genjac [:

that trip.

John Diehl [:

with a portfolio manager, Wellington Management, named Matt Baker. And and Matt

himself is a pretty big fisherman. And Julia reminded me of it when I was out there thinking

about the conversation that we recently had with Matt about how fishing relates to dividend

paying stocks, you would guess.

Julie Genjac [:

Matthew Baker, who's a senior managing director, partner and equity portfolio manager

and Global Equity Portfolio Management on the Quality Equity Team. He is the lead

portfolio manager of the Hartford Dividend and Growth Fund. He manages equity assets

on behalf of our clients. Drawing on research from Wellington Management's global

industry analysts, equity portfolio managers and team analysts. He currently manages the

quality value approach and provides research on the consumer, industrial and materials

sectors for his team. He works in the Wellington Management's Boston office. Prior to

joining Wellington in:

Group at MFS Investment Management, leading the global capital goods team. And before

that, he worked as an investment specialist at Bank Boston. Matt earned his MBA from the

University of Pennsylvania Wharton and his B.S. in finance from Northeastern University.

John Diehl [:

conversation, so let's go. Hi, I'm John.

Julie Genjac [:

John Diehl [00:01:52] We're the hosts of the Hartford Funds Human Centric Investing


Julie Genjac [:

hear their best ideas for how you can transform your relationships with your clients.

John Diehl [:

Julie Genjac [00:02:08] Matt, thank you so much for joining us here today on our Human

Centric Investing podcast.

Matt Baker [:

John Diehl [00:02:15] So, Matt, I have to ask you, we're at an interesting time in the

investment markets. And given that your expertize kind of in those dividend paying stocks,

it seems like investors have been chasing the returns on growth stocks for years and years

and years now. It's hard to remember that last value cycle almost that we have. Probably a

lot of financial professionals weren't even in the business the last time we saw, you know,

kind of a favoring a value oriented dividend paying stocks. What do you think is behind the

shift that we've seen recently? And I know no one has a crystal ball, but do you think that

maybe there's a newfound appreciation for dividends in the markets?

Matt Baker [:

interesting time right now. I think that that corresponds with my career, right? So I started


little bit of a reprieve. And then the great financial crisis and now now the inflationary

environment we're now. So these unique periods don't really seem to be too unique. When

you look at it over a long period of time, you know, there tends to be shocks every once in

a while. But you're absolutely right. Over the past 12 to 15 years, since a great financial

crisis, growth stocks have had. Outsized return versus value stocks. If you look historically,

the relationship over the past 15 years, 12 to 15 years has gotten very much out of whack.

So if you start at the point of 1 to 1, right. So growth and value are equal. Over the past

five or so years, that relationship has favored growth by about 40%. I do want to say

something real quick, though, before we kind of jump a little further down this discussion,

which is that, you know, in this environment, a lot of the debate has been between growth

and value. We need to change that debate going forward because it's not necessarily a

choice between growth and value. There are problems on both sides know in an

inflationary environment. It's not just the growth companies that have high valuations that

are problematic. It's also the value companies that I would describe more as deeper value

companies that are also problematic. Those companies probably don't have the ability to

maintain their margins in an inflationary environment. Those are going to be kind of tough

stocks to be in. So really what the sweet spot is, if you will, is is kind of the core right in the

middle. It's those companies that have a long history of generating cash flow consistently

and raising that cash flow and then paying dividends and raising dividends consistently

over time. Those are the companies that tend to outperform in more problematic


Julie Genjac [:

challenges on both sides of the coin, whether we're looking at growth or value stocks. And

I think it always occurs to me that times like this are an opportunity for a financial

professional maybe to step back and reeducate him or herself on some of the factors and

then in turn have engaging and interesting educational and coaching conversations with

their clients. If you were sitting in a financial professional seat right now with clients that

are uneasy or concerned or just really wanting to understand more, what would some of

those talking points be from a from a financial professionals perspective?

Matt Baker [:

by that is if you think about the last so I started in this industry in the year 2000. So I've

been in the industry for 22 years and I have gray hair and I guess I'm kind of more senior

in the industry these days, but I've only been in this industry for 22 years and as far as I

as maybe a two week period in:

was maybe a marginal concern. So what that means is unless you have more gray hair

than me, you probably haven't seen inflation. You probably haven't seen in an environment

where stagflation was being talked about or a rising interest rate environment. And so

what's interesting about that is the playbook that most investors would use or talk about or

the way they think about investing in stocks is fairly new. And if you think about that

playbook over the past 15 years, you probably want to fill a portfolio up with some very,

you know, big, fast growing tech companies. And that's great. You're trying to maximize

the potential for Alpha. But I think what was forgotten over that period, because we didn't

market with the exception of:

short lived. You know, you. You forget that dividends historically have pretty much

accounted for about 50% of the overall total return of a market. And in some environments,

specifically in the seventies and into the eighties, where you have inflation and stagflation,

that actually goes way up, right? So in the seventies into the eighties, the percentage of

the total return coming from dividends was more like 75%. So, you know, dividends have

always been an important part of an overall portfolio. I think it's just been forgotten about

over the past 15 years or so and when that percent of the overall return to the market has

gone way down. However, if you think about the environment over the past 15 years, there

was nothing normal about it. In the context of history, we had interest rates at zero pretty

much. We had quantitative easing the whole time and you were rewarded for taking risk.

The problem with that, though, is if you think about the more growth stocks over time, they

tend to return maybe a little bit more than quote unquote, you know, more stable stocks.

However, that's only in good times, but if you look at the standard deviation around those

returns. So in other words, how much volatility there is around those returns, it's that the

more stable stocks are over time return a much more favorable total return, because when

you go down less in a tough market, what you're actually doing is you're compounding that

value more over the course of a cycle. So when we think about investing, we're not

thinking about investing for this year. We're not thinking about investing for the next six

months. We're thinking about investing over the course of a long cycle. And you have to

have the ability to protect on the downside during those volatile times. And really way to do

that is with companies that have recently started to pay a dividend or have a consistent

history of paying and raising dividends and have less volatility than maybe the average

growth stock out there.

John Diehl [:

environment. As you as an investor look at these companies, is that that with inflationary

pressures on the companies themselves that they'll take in more revenue. Hopefully they'll

stick to their pattern of increasing dividends. Is that your expectation versus perhaps a

company that doesn't pay dividends? You know, no telling how and where they're going to

be able to reinvest. So is this the strategy with dividends that you're looking for consistency

in either maintaining or maybe even increasing the rate of their dividend?

Matt Baker [:

growth or growth versus value and I said it's not really that's not really the debate. It's kind

of this problem is on both sides. So with everything, it's nuanced. And I the way I would

answer your question is, again, in a nuanced way. It's not a choice of dividend or no

dividend because not all dividends are created equal and not all companies that pay

dividends are created equal. The reason we already talked a little bit about how dividends

add to the total return, it's actual you know, it's an actual return you can spend. But what

we didn't talk about is what the dividend signify. And this goes back to that free cash flow

generation, which is so important. Companies that have a history of generating free cash

flow, growing that free cash flow over time are the ones that tend to have stable and

growing dividends because you can't pay that dividend unless your cash flow supports it.

There are companies that have very high dividend yields, for example, but don't

necessarily have the cash flow to support that dividend. And while these are high yield

companies, the likelihood of a dividend cut is significantly higher in those companies, and

those tend to be more deeper value companies, not necessarily companies that can

sustain the dividend over a long period of time. So what we actually value and what we

think is the right thing to think about when when you're thinking about dividends and

protecting on the downside is that companies that have payout ratios that are appropriate

for their businesses. Right? So if you take a generic cyclical company that has a 90%

payout ratio at peak, well at trough, that's probably going to be a 200 plus percent payout

ratio, and that's unsustainable. So if we're investing in a cyclical company or if one is

investing in a cyclical company, you probably want a payout ratio that is much more

conducive to what this company would look like over the course of a cycle. Maybe at peak,

it's a 10% payout ratio on a normal in a normal environment, maybe it's 30% net, you

know, at a trough, maybe it goes up to 50% or so. But they can still maintain that dividend

if you think about. You know, a more stable industry, say consumer staples, for example.

You know, these companies might have a 50, 60% payout ratio. However, if you look

historically, the free cash flow would tell you that that's okay because these companies

generally, you know, generally. Generate a lot of free cash flow year in, year out, and it

doesn't really change too much. So the stability of that dividend, the higher payout ratio is

fine. So you have to think about the payout ratio if it makes sense for the industry the

company is in as how sustainable the dividend actually is. And it all comes down to again

that free cash flow generation. If you think about an inflationary environment, if you do not

have that consistent free cash flow historically, you probably don't have pricing power.

Right? And that's why your cash flow is kind of ebbing and flowing. And it's not maybe the

the the stable is business. If you don't have pricing power in this environment, there is

really no way you can maintain your margins. If you if you think about where we came into

this kind of higher inflationary environment, most companies had pretty much all time high

corporate margins. And now we're seeing input costs spike up just about everywhere. It's

funny that every company that we might meet with as an investor where I work, they're all

going to tell us that they can price they can price in this environment. But, you know, it

goes back to my comment about gray hair and being in this industry for 22 years. The

majority of managers and their own individual companies have never had to price. So, you

know, it's not that it's not that reasonable to expect every company that comes in here has

the knowhow and the management capability to price. But to to to drive pricing in this

environment, there are companies that have a long term history of pricing power in any

environment. These are the ones that we want identified. These are the ones that we want

to focus on, not companies that have had no pricing for 20 years. And then all of a sudden

they're going to be the price drivers of the industry. It's just not credible.

Julie Genjac [:

moving parts and the data shifts so rapidly from day to day, from hour an hour, minute to

minute. And I know that many financial professionals obviously are experiencing that as

well, especially in light of communicating these changes to clients. And that really brings

up the power of a team and thinking about how do we work together, how do we take in

information, process it, and then share it? I'd be curious for those financial professionals

listening with us. Obviously, your team is taking in so much data processing in real time

and then trying to push out messaging and communication. Can you give a little bit of

insight about what your process looks like, how you rely on your team? Because obviously

that's a very rapidly moving train that you all are aboard right now.

Matt Baker [:

I work on. However, that's not really our team. Our team is Wellington at large and we

have an enormous amount of resources here, not only on the value investing side, but on

the macro side, on the fixed income side. And we tend to have a pretty good in-depth

research effort on really what's going on in the world. And and sometimes, quite honestly,

it's too much. I mean, in this digital world we're in, we have such access to information

and, you know, you can get lost in in the trees or not see the forest. And so, you know, I

think the way I think about my job is trying to take all this information and distill it down to

what's important and not only what's important, but what are the likely ranges of outcomes.

And so as we were entering into this environment, that was the first part of the debate right

outside of growth versus value. The next stage was transient or sticky. And, you know,

there's there's as much research that would tell you last year that it was transient as it was

sticky. However, you know, when you think about the potential ranges of outcomes and

what's being discounted, the market was pretty much at all time highs. And we had this

potential for this inflationary environment, whether it was transient or sticky. You know, you

kind of have to make an assessment of that. But if the market's at an all time high and, you

know, you're thinking about this inflation being transitory, well, if you're right, I'm not sure

there's much upside to that. But if you're wrong is a potential huge amount of downside.

So you have to marry not only what you're what's being discounted today or what's

showing up today, but what are those potential ranges of outcomes? And are we

adequately reflecting those in the portfolio or how we're structuring somebody's portfolio?

You know, when it came to the conversation, a couple of things that that we noted here.

The you know, the inflationary pressure on the wage side was something that I would

argue was not transitory. It never really is. Once, once wage inflation occurs, it's hard to

put that genie back in the bottle, and that's actually a good thing. But that that would mean

that inflation is probably erring more towards the side of sticky than transitory. The other

thing I would say is, you know, if you think about the the transition, if you will, of walking or

walking, driving to your local retailer and fighting with all the other parents, for those in my

day, I guess it was a Cabbage Patch Kid, you know, fighting for those Christmas special

items. You know, about maybe 15 years ago, ten, 15 years ago, there was a shift, a big

shift online, and it happened fairly quickly. We have some of the world's most sophisticated

logistics companies not actually being able to forecast that demand well and, you know,

maybe being a little bit short of capacity. And in some cases, it took them a few years to

actually figure that out. I. I grew up celebrating a different holiday around that time, and so

I may be off in the dating, but I'm pretty sure Christmas has been around for thousands of

years, right? Or at least hundreds of years. And it took these very sophisticated companies

three years to get it right. We shut down different parts of the world at different times, all

these different industries at different times. And some of them back on turn, some of them

back off. There was no way this supply chain issue was going to be transitory unless your

definition of transitory is something that's like years. But if you kind of expected things to

snap back in six months, I think that was a little bit misleading. So, you know, the net of all

of this is you get all this information coming in. Sometimes the best thing to do is just take

a step back from it and just use common sense. Nobody's ever seen what happened in the

COVID environment ever before in their lives, whether you're a 70 year plus investor or a

two year plus investor. So to think that anybody really knew the outcome, I think was a

little bit, you know, maybe arrogant of the investment world. And so, you know, using

common sense, it was really likely that. You know, for the Fed or for anybody to get this

right would be such an amazing feat that it wasn't necessarily something I think that we

would have based a portfolio on. The other thing, too, is, you know, we go back to this

notion of of protecting on the downside because we haven't had downside in so long. You

know, I think investors or, you know, people helping people invest forgot what it means to

protect on the downside and how powerful that is when it comes to compounding. Right. A

really simple example is you take a $100 stock. The stock's down 50% or you have to be

up 100% from that point. Just to get back to either you have a stock that's down, you

know, 20%. Well, the makeup there to get back to even is significantly less. And the

compounding over a cycle then is superior. And there's all kinds of, you know, academic

research that would support that. I remember when I was at Penn, there was a famous

professor there that actually did a lot of that work. And that's something I learned very

early on in my career the power of compounding and protecting in the downside.

John Diehl [:

think as human beings we tend to think in black and white. We tend to think value growth

bearable. You know, it's it's easier that way. But I think listening to you as a portfolio

manager, you're often probably thinking about shades of gray. So you mentioned inflation

was the big question last year, the big debate. The question these days seems to be

recession. And so the question I have for you is, as a portfolio manager, how do you think

about the potential for a recession in the United States? And what is the implication then

on the kind of companies that you are investigating and investing in?

Matt Baker [:

thrown in the mix. I think that all bears to black and white. So, I don't know, maybe there's

a wolf in between or something. But, you know, I think I think that it if you think about a

recession and is it likely in the US or globally? I would say it's very likely. I think, you know,

in this environment where you have rising interest rates, you have an enormous amount of

pressure on the oil and gas industry right now. And on the food side that I don't see

abating any time soon, factors outside of any well, I guess not outside of Russia's control.

But, you know, since the Ukraine invasion, that has caused an enormous amount of

pressure on the ag cycle as well as on the energy cycle. I think that's here to stay for a

little while, not necessarily just because of Russia, Ukraine, but also because of the lack of

drilling to some extent in energy transition. That will happen over time. That's that's putting

some pressure on the supply side. So you do have to weaken demand. Some of that will

naturally occur. You know, I do spend time when I have free time on the water. And I

know, you know, from a boating perspective, at least, you know, the fuel dock that I get

fuel at is down about 45% year over year. You know, it's having a real impact right now.

People are just not using their boats as much. I would imagine that flows through all the

way down to cars and everything else. So that is kind of, you know, clamping down on

demand somewhat, but it is very likely, you know, a recession needs to occur here. And

that's not a bad thing given the environment we're in, because if we don't have a

recession, what's the outcome? Right. We could have a higher inflationary environment

with higher unemployment, and that is stagflation and that's the seventies. And that's not

an environment we really want to see again. So it sounds really awkward to say, but, you

know, a short, you know, maybe hopefully not too deep recession is actually a good thing

here. What type of companies does that mean we'll look at? Well, quite frankly, it's the

same companies we're going to look at in good times. It's the same companies we're going

to look at, you know, in in really aggressive times. It's those companies that have a long

history of generating free cash flow growth, doing smart things with that free cash flow.

One of the smart things we like to see is giving some of that back to investors in the form

of dividends and companies that have pricing power. These are the companies that, no

matter what the environment is, are going to be fine. You know, they're going to make it

through this environment. They'll be able to price to it. These companies also tend to have,

you know, reasonably levered balance sheets. They're not under levered. They're not over

levered. That's a that's an important thing. When you look at some of maybe the more

deeper value companies in the market, these tend to. Hey, maybe have dividends that

aren't sustainable. We might not have that free cash flow generation. See, probably have

stretch balance sheets. And let's face it, they're deeper value companies because they're

probably not great businesses and they probably don't have the ability to price.

Julie Genjac [:

know that they've done a lot of research around dividend paying stocks. And I'm just

wondering if there are a few key bullet points or takeaways that you'd be able to share with

us today based upon that breadth and depth of research that the Wellington team has

performed over time.

Matt Baker [:

companies and dividend paying companies and we mentioned that, you know, not all

dividend paying companies are created equal. So if we break it into different buckets, let's

talk about dividend cutters, dividend payers, dividend payers and then dividend growers. If

you look at that, those different buckets and you go all the way back to call of the early

seventies, what you'll find is dividend cutters, not surprisingly, were actually some of the

worst performers in that environment and actually have actually detracted value over that

period of time. That's about 50 years of attracting value. Non payers would be next.

Dividend payers have actually been pretty good performers. Dividend cutters were the

worst performers. Non payers were the second. Dividend payers did reasonably well, but

dividend growers out actually outperformed dividend payers by almost a 2 to 1 margin over

the last 50 years. Right. So even though you're paying a dividend, that doesn't necessarily

mean you're going to generate that same type of return unless you're consistently raising

those dividends. And this gets back to that that free cash flow growth as well. It's all

related. So again, you know, the work that we've done is is basically showing us that just

paying a dividend and keeping it flat for, say, ten years is really not adding that much value

at all.

John Diehl [:

gray and cycles and all that, just your thoughts on the importance of fundamental analysis

in markets like these, because there are times that we go through where people say

fundamental investors are not rewarded. It's different this time, so on and so forth. In

markets like this, is there a greater emphasis on the fundamental analysis work that you all

do at Wellington?

Matt Baker [:

back up a little bit and say in any environment, fundamental research is incredibly

important. You really have to know what you're owning, what you're buying. You know, you

really have to think through not only what the potential reward is, but what the risk is. And

there's all kinds of examples on companies you can look at to prove that out. But I would

say that in more stress times, it's not that fundamental research is more important, but it's

it's certain parts of what you're looking at fundamentally become more important. So

revenue growth in a in a in a more problematic environment probably is not something I

would focus on as much as maybe a balance sheet leverage or that free cash flow

generation or the ability to to sustain or maybe even grow margins in more problematic

times. So it's not that fundamental research becomes more important. It's just different

parts of what you what you might have been looking at historically might change in favor,

know other fundamental things that might have been less important. You know, if you go

back over the past 15 years, I would venture to guess that most investors would tell you,

you know, I don't think I would have, but most investors would tell you that revenue growth

was probably the most important thing to look at. That's obviously shifted now. Everybody

is kind of looking more at balance sheets and free cash flow generation and, you know, the

sustainability of the margins.

John Diehl [:

opportunity to show off here and I want to give proper credit. Okay. You mentioned that

your son had written an essay about fishing. And when you told me that little story, I think it

was your son. It reminded me of the conversation we just had about fundamentals. And so

would you just describe to everybody kind of what that essay was about and how it

actually relates maybe to what you do in your business?

Matt Baker [:

somehow buy my passion outside of work is being on the water and fishing in. And as we

get older and we think about our careers, we're asked to do lessons learned at Wellington

for some of the younger investors. And I've always tried to relate it back to fishing and.

Haven't been that successful at it, but my son seems to have it. So that was basically, you

know, we we spend a lot of the time in our free time fishing for tuna fish offshore. And one

of the first things I taught him was that the majority of the fish are actually caught before

you leave the dock. And that sounds weird, right? Because we're going out 70 miles. And

so I catch you catch a fish that far away. But what I mean by that is you really have to do

the research as to where you're going to fish before you actually go out. And, you know,

the ocean is very big when you're offshore. There's really no structure around. You know,

we fish the canyons, which is a big drop off. But what's important there is, you know, one

of the sea temperatures, what's a sea salinity? And we can look at all of that before we

even though we might be going:

targeting probably an area that's, you know, maybe a quarter mile in total. And we know

exactly where we want to go before we leave the dock that's doing the work. But, you

ht? Because we're also. Going:

God forbid, something happens, no one's coming to get us, at least not for a long time. So

you also have to make sure that you are thinking about every potential risk out there and

making sure that you are aware of all the risks and taking the precautions before you even

leave the dock. And so, you know, to me, that's that's thinking about the potential range of

outcomes. If I think about a stock that has 20% upside and 10% downside. Well,

mathematically, that's really no different than a company that has a 100% upside and 50%

downside. It's a 2 to 1 ratio. The range of outcomes on the second 100% upside, 50%

downside is probably so wide. I could drive my boat through it. I would much rather invest

in that company that is 20% upside, 10% downside. That to me is not only the same risk

reward, but a much less volatile structure and fewer potential ranges of outcomes. And

that, you know, is kind of what my son wrote his essay on. And, you know, he did a good

job of it. I might plagiarize it and actually use it for my lesson learned at some point.

John Diehl [:

the conversation we just had for sure.

Julie Genjac [:

work that John and I do with financial professionals, we're constantly encouraging them to

craft their own stories and examples regarding many different topics. And so I think for

those listening with us today, we would encourage you to craft your dividend story and see

how you might articulate that to clients and continue to educate them during these

unprecedented times. And we just can't thank you enough, Matt, for your time today and

the education and the insights. And thank you for all the work that you and your team and

Wellington are doing.

Matt Baker [:

Julie Genjac [00:33:27] Thanks for listening to the Hartford Funds Human Centric

Investing Podcast. If you'd like to tune in for more episodes, don't forget to subscribe

wherever you get your podcasts and follow us on LinkedIn, Twitter or YouTube.

John Diehl [:

transforming client relationships, email us a guest booking at Hartford Funds dot com.

We'd love to hear from you.

Julie Genjac [: