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  • Dividend yield and dividend growth have accounted for the majority of stock returns over time.
  • Flexibility to invest in high-quality stocks from around the world can lend consistency to a portfolio.
  • Concerned U.S. equities may slow? Worried rising rates will hurt your bond portfolio? Global dividend stocks potentially can address both.

Many investors have come to believe the phrase "no pain, no gain" applies to their investment portfolio, feeling that in order to capture returns they need to accept some potentially painful risks. The portfolio managers of the BlackRock Global Dividend Fund disagree. They have found that a high-quality portfolio of global dividend-paying stocks can offer the benefits of growing income and capital appreciation potential, but with lower volatility than the broader stock market.

  • Why Dividends? Dividend yield and dividend growth have accounted for approximately 90% of long-term stock returns, much more than multiple expansion and valuation moves.1
  • Why Global? No single region can contribute strong equity returns all the time. Flexibility to select high-quality stocks from around the globe can lend some consistency and help protect a portfolio against secular slowdowns. U.S. investors are also 50% underallocated to international equities,2 which historically have yielded more than U.S. stocks (currently roughly 130 basis points more).3
  • Why Now? Investors are concerned that U.S. stock markets could slow down and that rising rates will hurt the value of their bond portfolios. Global, dividend-oriented strategies potentially can address both of these worries.
  • Why Always? High-quality, dividend-growing stocks have shown to offer a long-term inflation hedge, income for retirement needs and protection during slowdowns.

What are the primary challenges that investors face today?

We believe there are three key questions on investors' minds: 1) How do I invest in a slow-growth environment; 2) how do I generate income in a world of still low, but unsettled, interest rates; and 3) how can I protect and grow my savings in a volatile market.

Let's tackle each. How do you invest in a slow-growth environment?

First and foremost, investors need to understand that not all countries are experiencing the same levels of growth. The much slower growth seen in the highly indebted developed markets, including the U.S., is countered by higher growth in emerging markets. That means investors need to expand their exposure beyond U.S. borders, and they certainly have room to do so. The data reveals U.S. investors are underallocated to international stocks by as much as 50%: While non-U.S. companies make up 54% of the world's market cap, they collectively represent just 27% of U.S. investor assets.

We believe investors should seek growing income through dividends and incorporate international exposure, including emerging markets (EM) exposure, into their portfolios. Foreign equities are attractively valued relative to the U.S. right now. Emerging markets, in fact, have lagged behind developed markets over the past year, making for particularly attractive valuations on a relative basis. Importantly, EM exposure does not require direct investment in far-off, little-known lands. It can be achieved through owning internationally diversified, global businesses—our preferred method.

Dividends Have Driven Returns Over Time Chart

Let's discuss that second big question: How do investors navigate interest rate uncertainty?

It's the right question to be asking today. Despite a recent uptick in rates, traditional sources of stable yield, including some government bonds and cash instruments, are still delivering negative returns after inflation. And in an environment of volatile rates, the value of those traditional bond investments is in danger because as rates rise, bond prices fall. A continued overreliance on these types of traditional core bonds could very well hurt investors going forward.

Meanwhile, the yields on international stocks are higher than those available from many government bonds today, and offer greater protection in the face of rising rates. The research shows that global equities have achieved positive returns on 64% of days with rising rates (as measured by an increase in the 10-year Treasury yield).4

In addition, global equities have provided 8% more income that the U.S. bond market since June 2003.5 This is quite exciting. We view stocks as claims on future cash flows, similar to the claims on coupons offered by fixed income. It is now more expensive to buy these future cash flows through bonds than it is through stocks! Another reason to be wary of fixed income today is that, because bond coupons are fixed, the purchasing power of a typical fixed income investment will be eroded by inflation over time. Companies that can exercise pricing power are able to pass cost inflation onto the end consumer by increasing prices, which ultimately means dividend payments can increase.

But aren't stocks too volatile?

Broadly, they can be. But we're focused on a distinct subset of the market—those high-quality companies with the proven ability to pay and grow their dividends over time. These companies' stocks tend to be meaningfully less volatile than global equities in general. In fact, we have found they can be anywhere from 20% to 40% less volatile than the market.

That speaks precisely to our third main theme—investing amid volatility. In our experience, it is possible to invest in such a way that produces an equity portfolio with approximately one-third less volatility than the broader market. We search for dividend growth and yield, and we aim to invest only in the highest-quality companies that benefit from globally diversified revenue streams. These are "transnational" companies that do not derive their revenue from a single market, but have operations and senior executives spread throughout the world. Their headquarters location has little to do with where they generate revenue. Transnationals also have the ability to access emerging markets and other higher-growth areas using local expertise.

McDonald's,6 an iconic American brand, is just one example. Per the company's website, just 30% of its exposure is in the U.S.; 40% of revenue is generated in Europe. Another example is UPS.7 While a U.S.-listed company, "Big Brown" actually ships parcels in 200 countries daily. That's quite a global reach. We like to see this kind of diversity in a company's revenue stream. In short, we like high quality for low volatility. We invest in 50 to 70 of what we believe to be the highest-quality stocks in the world. High-quality companies historically have provided lower levels of volatility, weathering adverse market conditions better than their low-quality counterparts.

Stocks Are Out Yielding Bonds Globally Chart...And Offer Protection Amid Rising Rates

How do you identify the "highest-quality" companies?

We invest worldwide in companies that operate in industries with high barriers to entry as well as those that benefit from competitive advantages relative to peers. These companies tend to be much more cash generative and, in our view, are better placed to navigate challenging market environments. We also focus on companies with solid balance sheets—we particularly like to see low financial leverage. These types of companies also tend to be better at navigating market volatility.

Finally, we want to select companies that are committed to returning cash to investors, via dividends, as well as increasing shareholder value over the long term by growing that cash flow. While there is no guarantee dividend-paying stocks will continue to pay dividends in the future, we believe that quality, with a focus on companies that can grow earnings and free cash flow, is a key aspect of successful dividend investing during low-growth environments, which is exactly where we are now.

In a nutshell, high-quality companies typically have three very important attributes: 1) consistent cash-flow generation throughout the entire economic cycle; 2) healthy balance sheets with low levels of debt; and 3) a history of growing dividends, which demonstrates a commitment to shareholders and sends an important signal about management's confidence in future cash returns.

For investors seeking income, why not choose based on a stock's current yield?

Many investors make the mistake of focusing exclusively on the stocks with the highest yields. However, a very high yield often signifies a company is distressed and may not be able to pay its dividend going forward. While an above-average yield is an important component of total return, we believe a company's ability to consistently raise its dividends is even more powerful over the long term, through the compounding of growth on growth. Ultimately, the hunt for continued growth is crucial because, over the long term, we believe the majority of an equity investor's returns will come from the powerful combination of dividend growth and yield.

Some people will always believe equity investing requires more risk for more return.

Conventional finance theory does state that the only way to earn a greater return is through accepting greater risk. Our research turns this relationship on its head because, over the long term, we've found the lower-volatility stocks (higher-quality companies) have produced better risk-adjusted returns than higher-volatility stocks (lower-quality companies). In fact, this finding is gaining wider acceptance among academics and industry peers. A further benefit to investing in high-quality companies is the resulting minimization of the volatility drag— in other words, losing less money on the downside makes it easier to grow wealth over the long term.

So even retirees could employ a high-quality, global dividend strategy?

Absolutely. Retirees are exactly the type of investors who need to keep ahead of inflation so that their nest eggs do not expire before they do. Traditional income sources (i.e., cash, bonds) typically have not offered that kind of income growth. This point has become increasingly important as the average time in retirement has expanded to well beyond 20 years.

Has the popularity of dividend investing made it less of a "find" today?

That may be true for some of the highest-yielding stocks. Many of these have been overbought and are quite expensive now. However, we're not focused on the highest dividends. We're looking for quality companies with a proven ability to maintain and grow their dividends. Notably, the valuation of the Global Dividend Fund portfolio (in P/E terms) has only changed slightly since 2010, whereas the broader market has fluctuated within a much wider range. It is also interesting to note that the general category of equity income investing still makes up a very small proportion of the overall asset management industry.

Dividend Growers Help Prepare - And Pay - For Retirement

What's the advantage of a global approach?

A global approach affords investors the flexibility to better navigate regional trends. So, for example, if you're worried about a slowdown in U.S. equities, a global strategy can help to offset that for a more consistent experience over time. Although investing globally historically involves special risks, it also has offered the benefits of enhanced diversification and higher yields when compared with a strictly U.S.-centric portfolio. Diversification does not ensure a profit, but it has been shown to reduce volatility. Following a tradition of returning more capital to shareholders, foreign companies' dividend yields have consistently hovered approximately 100 basis points above those of their U.S. counterparts (see graph at right).

Anecdotally, relative to historic levels, U.S. stocks are currently fairly priced based on price-to-earnings and other commonly used equity valuation metrics, while the stocks of foreign developed nations are generally trading at a 15%-40% discount. In fact, our observation reveals the valuation spread between the U.S. and Europe is the largest it has been in decades. This allows us to invest in high-quality, global businesses at relatively attractive prices. Consider Sanofi,8 which comes at what we believe to be an attractive price just because it happens to be listed in France. The kicker is that Sanofi only generates about 30% of its revenue from Europe. Compare that to our earlier example of McDonald's, which generates 40% of revenue from Europe.

Higher Yeilds, Ample Opportunities Abroad

How should investors incorporate global dividend stocks into their investment portfolio?

Although the dividend-paying companies in which we invest are equities in simple terms, we believe the characteristics we discussed here make these stocks behave very differently from normal equities. For that reason, we believe they should be thought of as a separate asset class. Ideally, global dividend stocks should represent a core component of a portfolio, as they have shown to be a successful long-term investment. The low-volatility nature of these stocks, in our view, allows investors to increase their absolute allocation to equities without appreciably increasing their exposure to equity risk.

Investment Opportunity 'Made in the USA'

The go-anywhere BlackRock Global Allocation team offers insight into today's markets and discusses how they're navigating an uncertain world.

1 Based on research published by GMO.
2 Investment Company Institute, European Fund, Asset Management Association, MSCI, and Morningstar Inc., as of 12/31/12.
3 Based on findings from Ned Davis Research. See also "Higher Yields, Ample Opportunity Abroad" graph above.
4 Sources: BlackRock and Morningstar Direct. Equities represented by the MSCI All-Country World Index for all days in which the 10-year U.S. Treasury yield rose, between June 2003 and June 2013.
5 Sources: BlackRock and Morningstar Direct. Global equities represented by the MSCI All-Country World Index and bonds by the Barclays U.S. Aggregate Bond Index. Data from June 2003 to June 2013.
6 McDonald's represented 2.70% of the BlackRock Global Dividend Fund portfolio at 9/30/13.
7 UPS represented 1.76% of the Fund portfolio at 9/30/13.
8 Sanofi represented 2.85% of the Fund portfolio at 9/30/13.

Investing involves risk, including possible loss of principal.

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/ developing markets, in concentrations of single countries or smaller capital markets.

Carefully consider the Funds' investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds' prospectuses or, if available, the summary prospectuses which may be obtained visiting the iShares ETF and BlackRock Mutual Fund prospectus pages. Read the prospectus carefully before investing.

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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are those of the portfolio managers profiled as of November 2013, and may change as subsequent conditions vary. Individual portfolio managers for BlackRock may have opinions and/or make investment decisions that may, in certain respects, not be consistent with the information contained in this report. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

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