Euro zone revival dents appeal of dividend futures

Toni Vorobyova
Thursday, 14 Nov 2013 | 7:58 AM ET

* EuroSTOXX 50 dividend futures curve flattens

* No discount for longer-dated contracts 1st time in 2 yrs

* Scope for profits still seen in 2015 and beyond

LONDON, Nov 14 (Reuters) - Investor appetite for euro zone companies as the economy shows signs of recovery has fuelled a rally in dividend futures, making a trade seen as easy money for the past two years look less secure.

Dividend futures - bets on companies' payouts seen as less volatile than buying shares outright - were hard hit by uncertainty over firms' ability to reward shareholders during the financial crisis, as well as by excess supply from banks seeking to hedge their own dividend exposure.

This drove prices down so that for the past two years, the market consistently priced in a steep fall in dividends, offering potentially easy profits to investors as companies tended to pay out more than implied by the futures.

A nascent economic recovery, central bank stimulus, a strengthening currency and ebbing concerns about a euro zone break-up, however, have erased the discount on longer-dated futures for the first time since 2010.

"There is less of a crisis discount on the longer-dated dividends," said Simon Carter, European head of derivatives equity strategy at Deutsche Bank.

With the broad STOXX Europe 600 index hitting five-year highs, and 10-year Bund yields some 40 percent below their decade average, dividend futures were seen by some investors as among the last easy bets in Europe, with banks reporting fresh money in the market in recent months.


That has taken its toll on prices. While a year ago the one-year EuroSTOXX 50 dividend future priced in a 12.5 percent drop in payouts, it now implies a fall of just over 1 percent.

Although the EuroSTOXX 50 dividend yield is seen climbing from the current 3.6 percent to 3.8 percent next year and 4.2 percent in 2014, according to StarMine SmartEstimates, that relatively modest pace of expected growth means that for the near-term contracts the reward no longer necessarily compensates for the risk.

"It's less attractive ... than it was last year, when it was a very stressed market," said Antoine Deix, global head of dividend strategy at BNP Paribas.

"It (the 2014 contract) went up too high, too fast and the risk premium in 2014 is too low in my view."

Instead, he recommended investors look to 2015 and 2016 contracts, while those who can stomach more risk and are less affected by the need to mark investments to market should consider futures for 2017 and 2018.

Carter at Deutsche agreed on the limited appeal of 2014, which is now broadly bank's dividend forecasts:

"So people may be rolling (from 2014 into 2015) a little bit earlier than they might have done just because that upwards potential isn't quite there as it potentially used to be."

Indeed, to get meaningful returns from the 2014 future, the longer-dated contracts would have to trade at higher prices than those for this year. That almost happened last week, prompting funds and other investors to take profits.

"If there is an upward-sloping curve ... people will look to sell," said Rory Hill, co-head of equity derivatives for EMEA at Citi. "So it's not going to collapse from here, but it's probably going to consolidate here."

One reason for increased confidence in dividends has been the improving health of the banking sector and its commitment to resuming or increasing payouts. Such plans though can easily be scuppered by regulators or central banks.

Underscoring the risk, the 2014 dividend futures for Credit Suisse dropped 7 percent and those for UBS slumped 23 percent last week on news that lawmakers are considering a proposal that would require Swiss banks to hold far more capital than international rivals.

Payouts in other sectors, meanwhile, are dependent on a continued economic recovery, which still carries some risk.

"Some people have bought that (dividend futures) as an equity long trade and they are quite happy to hold that, but as a dividend trader it's certainly at the top end of the range, and probably more of a short-term sell," Hill said.