As bond yields hover around multi-decade lows, investors continue to turn to different asset classes, such as equities, in search of income opportunities. In this search, however, investors need to remain cognisant of the risk to the sustainability of future dividends.

Systematic analysis of historical dividend behaviour and financial strength can improve dividend reliability.

The FTSE Sustainable Yield Index Series measures dependable yields of companies around the world and addresses the challenge of finding a benchmark that accurately reflects a long-term sustainable approach. The systematic methodology of the indices mean they could also form the basis of exchange-traded funds (ETFs).

Back-tested historical data, provided by FTSE Russell, show that between September 2003 and July 2015 the indices produced gross returns in excess of their parent indices at a lower level of volatility. This was seen across a number of regions including the UK, Japan, the US, All-World, Developed and Emerging Markets.

Vera Cady, FTSE Russell Research Analyst, commented: “Analysis of the FTSE Sustainable Yield Index Series hypothetical historical index returns highlights that the indices have recorded high yield, high absolute and risk adjusted returns and low tracking error relative to their market cap-weighted benchmarks.”

The indices were developed to address the inclusion of stocks in some high-yield indices without reference to the likelihood that a dividend will be paid. Naive index methodologies, which look purely at historical dividends, overlook the possibility that these payments may not continue if a company experiences deteriorating fundamentals. To address this the FTSE series uses a thorough and robust screening methodology.

In order for a prospective company to enter the index, it must first have a forward 12-month dividend yield in excess of the average dividend yield of its home country. Forward dividend yield figures are based on an average of analyst expectations. Further to this, the company must not have cut its dividend or lowered its forecasted dividend in the past. This is complemented by an analysis of the company’s financial and operational strength as quantified by measures of profitability, capital structure and operational efficiency.

There are currently no ETFs tracking the FTSE Sustainable Yield suite; however, similar products are available such as the Lyxor Quality Income ETFs and the SSGA SPDR S&P Dividend Aristocrats ETF range. Investors can also look to FTSE RAFI Equity Income Index Series for a quality income index suite which is also fundamentally weighted.