Value Investing: Tools and Techniques for Intelligent Investment

Chapter 30. Asset Fire Sales, Depression and Dividends^[30]

I have been trying to construct a portfolio around three basic ideas. Firstly, cash (as a deflation hedge), secondly deep value opportunities (in both fixed income and equity markets) and, finally, sources of cheap insurance (such as TIPS and gold). A new opportunity has arisen: dividend swaps. In Europe, the UK and Japan these appear to be priced for an environment worse than the Great Depression! Dividend swap prices imply a decline of over 60% peak to trough in dividends and then no recovery at all! They may also act as an inflation hedge. As a neophyte to this market, I fear I may be missing something, but it sure looks like an asset fire sale to me.

• A client recently suggested that I looked at dividend swaps from a deep value perspective. As I have often remarked, in the words of Winnie the Pooh, 'I am a bear of little brain and long words bother me', so it was with some trepidation that I embarked on some research into these assets.

• However, I was pleasantly surprised. Dividend swaps are relatively easy to understand (at least they appear to be – but I may have missed something!). Effectively this market allows investors to trade dividends separately from equities. As such they can also provide us with an insight into the market's view of the future path of dividends.

• The picture they paint isn't a pretty one. On current pricing, dividends are expected to decline peak to trough by over 60% in the UK, Europe and Japan. ...