Finance - Theory: Can you immunize a portfolio with dividend yield?
Hi all,
I have a 2 part finance-theory question I was hoping to collectively source here. It is has 2 parts:
a. Can a fund, such as a pension plan, immunize a portfolio using dividend yield rather than bond yields as is traditionally done? Why/ Why not? What would be the risks from this? b. Can a fund, such as a pension plan, use dividend yield as a measure to hit their actuarial rate of return? Why / Why not? What would be the risks from this?
Overall I'm trying to get a deeper understanding of the differences between the cash-flows from bonds and stocks and how they could be use to either immunize or (to a high degree of accuracy) hit the actuarial rate of return assumptions on a fund. Ie: if you have a 6% actuarial rate of return, could you create a portfolio of dividend yielding stocks with a collective yield of 6% to effectively ensure your actuarial rate of return is hit?
No. The basic concept behind a bond is that short of default, you get face value back at the end. With a stock there is nothing but the yield and the future value of the stock. A company like Sears could pay out 10%. If it goes under after two years, you still have huge losses. There are smart ways to utilize yield, but this isn't one.
Ya with bonds there is safety and stability of principle (short of default). The bond is also a contractual obligation that the company has made to pay back its debt with interest. There is no such obligation for a company to pay a dividend or maintain any certain level of dividend payment (see GE). The other key to immunization is matching the duration of the liabilities (or at least attempting to). There is no true duration in equities (although I've seen it argued that stocks do have duration given how valuations have historically been negatively correlated with interest rates).
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