Price Effects during Dividend Periods: Alpha, Cash Flow and Tax

The pricing phenomenon of the dividend run up – an opportunity to generate alpha?

The chase for yield is a constant for equity income funds, especially in an inflationary environment. While some investment strategies favour large cap, high yield stocks, Realindex considers whether there is an opportunity to generate alpha from the phenomenon of the price of dividend-paying stock drifting up prior to the dividend payment date and the ex-dividend price drop off.

In evaluating whether the dividend run up generates an excess return, we consider two models: excess to the market where return to the dividend run up strategy exceeds holding a broad based market benchmark, and excess to a risk model where other factors are considered such as size of stock, value characteristics and its price momentum.

We find that there are various ways to implement dividend run up as an alpha source, drawing some high level conclusions from our analysis: 

• Excess return to the market:
  • Both dividend run up and drop off effects are larger in small caps
  • Both high (good value) and low yield (more expensive) stocks show larger dividend run up than for intermediate yield firms. For low yield stocks, the drop off effect is smaller than other stocks
• Accounting for risk factors:
  • The dividend run up effect reduces sharply, suggesting that much of the effect comes from a tilt towards some or all of these risk factors. For example, a tilt toward dividend run up in expensive small caps will earn a better return than the simple application of a broad based dividend run up strategy. Or, said another way, much of the return seen in the dividend run up strategy comes from embedded tilts to risk factors like size and value.
  • This risk factor effect in dividend run up is felt across all yields. The ex-dividend drop-off is also largely subsumed by these risk factors.

These features are worth considering for those investors seeking to maximise the dividend run up phenomenon.