The Value of Dividends. Searching for Income in a Low-Rate Environment. The Value of Dividends. Highlights. Long-Term Total Return Driver

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1 The Value of Dividends The Value of Dividends Searching for Income in a Low-Rate Environment Matt Oldroyd, CFA, American Century Investments Vice President, Client Portfolio Manager, Value Equities Highlights From December 1926 to December, dividend income comprised 34% of the total monthly return of the S&P 500 Index. Dividends contributed an average of 13. of the total return during the recent bull markets while accounting for 34.7% of the total return during bear markets. As millions of baby boomers enter retirement, the demand for income-producing securities and dividendbased investment products is on the rise. The Equity Income Fund s low 56% participation on the downside is an attractive relative differentiator. Currently, dividend-based strategies are appealing to investors on a return and yield basis, especially relative to traditional fixed-income options such as Treasuries. The effect of compounding: dividends over an extended time frame can be quite powerful. At American Century Investments, stocks with sustainable dividends are a key component for many of our Value portfolios. They represent the long-term commitment of management to investors, are a reflection of the quality of the businesses, tend to be more buoyant in adverse market conditions, are the most predictable part of return and provide a consistent flow of income for investors. Our Equity Income portfolio, which has an explicit focus on dividend-paying stocks, has served investors through thick and thin, participating in up markets while providing downside protection in down markets. We believe that dividend-paying stocks are poised to be the focus of income-hungry investors for years to come, as the search for income in a low-rate environment continues to be a challenge. Long-Term Total Return Driver Dividends have been a major contributor to equity returns on a historical basis, making them a significant source of income and total investment return. From December 1926 to December, dividend income comprised 34% of the total monthly return of the S&P 500 Index, with differing levels of participation over the decades as illustrated in the figure below. Figure 1: Dividend Income as a Percent of Total Monthly Return (S&P 500 Index) % % 39% 26% 34% 1 14% 1940s 1950s 1960s 1970s 1980s 1990s 1926 to Time Period Source: S&P Dow Jones Indices LLC. Data from 12/31/ /31/. Past performance is not a guarantee of future results. 1

2 In a couple of periods, such as the 1940s and 1970s, dividend income accounted for more than half of total return. During the decades of the 2000s and 1930s (not pictured) periods when the market was under extreme pressure dividend income made up more than 10 of total return. During the 1990s, dividends accounted for only 14%, as the decline in stock prices was cushioned by dividends. Downside Protection While dividends provide a steady source of income for investors, they also play an important role in the portfolio during periods of volatility. Dividends provide investors with the opportunity to capture the upside potential of bull markets and can deliver much needed downside protection in bear markets, as illustrated below. Active portfolio construction is essential in managing downside risk the evolution of more sophisticated diversification methodologies has helped to reduce risk without materially compromising expected return. The goal is to produce solid risk-adjusted performance, which means that we are as concerned about limiting downside risk as providing opportunities for long-term capital appreciation. Figure 2: Average Dividend Return During Bull and Bear Markets Bull Markets Types of Markets 34.7% Bear Markets Source: S&P Dow Jones Indices LLC. Data from 12/31/ /31/. Bull markets period of , and Bear markets included 1990, and Past performance is not a guarantee of future results. When we dissect the returns of the S&P 500 Index during the last three bull and bear market cycles, dividends contributed an average of 13. of the total return during the bull markets while accounting for 34.7% of the total return during the bear markets (see Figure 2). Dividend income plays an important role in total return over time and represents a key lever in smoothing out returns. We believe that investing in high-quality businesses selling at a discount to fair value will generate attractive risk-adjusted returns over time, and will help provide income even in down markets. The average price return and dividend return for the S&P 500 Index during up and down markets from 1927 to is shown below in Figure 3. The average annual dividend return in up markets is and the average price return is approximately 19%. During market downturns, the average annual dividend return is 3%, while the average price declined 1. Figure 3: Dividends as Cushion During Negative Markets Average Annual Return % -1 Average Price Return Return Type The dividend is a component of a company s earnings and cash flow and is more predictable, while swings in stock prices can be partly attributed market sentiment and speculation. Over the past 30 years, the annualized standard deviation of price returns is 15., while the standard deviation of dividend returns is only 0.. The lower volatility of dividend income can translate into enhanced stability over various market cycles. Alternative for Income Seekers Average Dividend Return Source: S&P Dow Jones Indices LLC. Data from 1927 to. Past performance is not a guarantee of future results The combination of the current low interest rate environment and a demographic wave of investors starting to enter retirement age, have made dividend investing quite compelling. The Value investment team at American Century Investments sees this favorable dividend participation trend continuing long-term and view the appetite of 77 million income-hungry, retirement baby boomers as ample support for dividend-paying stocks. As millions of boomers enter retirement, the demand for income producing securities and dividend-based investment products is on the rise. 3% 2

3 Figure 4: Yields in Comparison Yield % U.S. 3-Month Treasury Bill 1.7 U.S. 10-Year Treasury Bond Yields on the 10-year U.S. Treasury are at their lowest levels in 20 years. Currently, equities and dividend-based strategies are quite appealing on a return and yield basis relative to traditional fixed-income options, as shown above. With inflation measuring at 2%, investors are faced with low nominal yields and negative real yields and, for income-oriented investors, low bond yields can be detrimental to cash flow needs and real purchasing power. Crossing of the Yield Streams 2.3 Equities From the mid-1950s until recent days, the yield of the 10- year U.S. Treasury bond has exceeded that of the average yield of the S&P 500 Index. The chart below gives us a clear view of the current investment landscape, including keen insight into variable stock and bond market valuations. While it is difficult to say with complete certainty whether the pattern swing will endure or be merely short-lived, the lowest bond yields in more than 50 years have generated vast interest in income-generating equities going forward. Figure 5: Stock Yields Now Exceed Bond Yields 3.19% Dividend Strategy Source: S&P Dow Jones Indices LLC. Data as of 12/31/. Equities yield is represented by yield of the S&P 500. Dividend Strategy yield is presented by the yield of the S&P High Yield Aristocrats index. Past performance is not a guarantee of future results. Yield 18% 16% 14% 12% 1 8% 6% 4% 2% Years 2013 Compounding Effect Another important feature of dividends can be observed through the effect of compounding over an extended investment time frame. Excluding dividends, the S&P 500 Price Return Index with a value of $1 on Jan. 1, 1930, would have grown to $66.48 by the end of. During the same time period, a total return index with dividends reinvested would have yielded an index value of $1, The compounding effect for the S&P 500 Index over several time periods is illustrated below. The percentages are various investment horizons, over each time period, based on the monthly data for the past 50 years. Figure 6: The Compounding Effect Return % 10.9% 23.1% % 1 Year 3 Year 5 Year 10 Year Time Period % 200.3% Source: S&P Dow Jones Indices LLC. Average returns calculated from monthly 1-, 3-, 5- and 10- year returns from 12/31/61 12/31/. Past performance is not a guarantee of future results. The chart below illustrates the raw compounding power of dividends as witnessed by the comparison of the S&P 500 Index (without dividends) and S&P 500 Total Return Index (with dividends). The important factor in all of this outperformance, of course, is the strength of the businesses. Investing in quality companies that pay dividends requires a long-term vision. We believe dividends are a sign of a company s earnings and cash flow strength, and they force companies to be prudent with their free cash flow allocations. Contributions from dividends may seem small on an annual basis, but the compounding action of reinvesting dividends adds up over time. Source: S&P Dow Jones Indices, Federal Reserve. Data from 12/31/1970 to 3/29/

4 Figure 7: Long-Term Power of Dividends Price $1,000 $900 $800 $700 $600 $500 $400 $300 $200 $100 $ Serving Investors Through Thick and Thin 1998 This chart below illustrates how the Equity Income Fund has served investors in both up and down markets since inception (September 1994). The story really comes to life in the capture columns on the next page. Active management by co-managers Phil Davidson, Kevin Toney and Michael Liss has consistently positioned Equity Income to participate in market surges during the past 20 years, as evidenced by the almost 7 capture rate on the upside. But what good is positive performance if it s wiped out by the next market decline? Equity Income s low 56% participation on the downside is an attractive relative differentiator Year Source: Bloomberg; Data from 3/31/1998 to 12/31/; values normalized as of 3/31/ Figure 8: Upside/Downside Capture Annualized Upside Capture % Annualized Downside Capture % Source: FactSet. Since inception: Data from September 1994 through March Results are net of fees. Dividend-paying companies play a key role in the portfolio s ability to provide both performance and protection. Thanks to an equity investment process that s extremely attentive to downside risk as well as reward, the Equity Income Fund fared better than its average Morningstar large-cap value peers during the last two bear markets by 18. during the recent Financial Crisis (10/9/07 to 3/9/09) and 47.1% through the tech bubble (3/24/00 to 10/9/02). Number of Months Returns Average Returns % 1 Year Return Capture % Description Positive Negative Positive Negative Positive Negative Positive Negative American Century Equity Income S&P 500 Total Return Source: FactSet. Since inception: Data from September 1994 through June Results are net of fees. Average Annual Total Returns as of 6/30/ Year 3 Year 5 Year 10 Year Inception Date Expense Ratio Equity Income Fund 18.03% 14.96% 7.76% 7.69% 8/1/ Data presented reflect past performance. Past performance is no guarantee of future results. Current performance may be higher or lower than the performance shown. Investment return and fund share value will fluctuate, and redemption value may be more or less than original cost. To obtain performance data current to the most recent month end, please call or visit americancentury.com/ipro. Performance reflects Investor Class shares. For information about other share classes available, please consult the prospectus. Data assumes reinvestment of dividends and capital gains. You should consider the fund s investment objectives, risks, charges and expenses carefully before you invest. The fund s prospectus or summary prospectus, which can be obtained by visiting americancentury.com, contains this and other information about the fund, and should be read carefully before investing. 4

5 Originally published by American Century Investments. Material presented has been derived from industry sources considered to be reliable, but their accuracy and completeness cannot be guaranteed. Past performance is no guarantee of future results. This information is not intended to serve as investment advice. The opinions expressed are those of Matt Oldroyd and are no guarantee of the future performance of any American Century Investments fund. This information is for educational purposes only and is not intended as investment advice Standard & Poor s Financial Services LLC. The S&P 500 Index is composed of 500 selected common stocks most of which are listed on the New York Stock Exchange. It is not an investment product available for purchase. Published in July This article is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this article should consult with his or her advisor. The information contained in this document has been obtained from sources believed to be reliable and is believed to be accurate at the time of publishing, but we do not represent that it is accurate or complete and it should not be relied upon as such. All opinions and estimates expressed in this document are as of the date of publication unless otherwise indicated, and are subject to change. The material and/or its contents may not be reproduced without the express written consent of CIBC Asset Management. CIBC Asset Management is a registered trademark of Canadian Imperial Bank of Commerce CIBC Asset Management Inc. licensee