An Active and Diversified

INSTITUTIONAL PERSPECTIVES January 2020

An Active and Diversified Approach to Dividend Growth

Key Takeaways

f In a lower interest rate environment where bond yields are also depressed, the quest for yield becomes more pronounced, and stocks are wellpositioned to provide it.

f An actively managed and diversified approach can find attractive dividend profiles in different sectors.

f We believe a maintaining a steady and growing dividend stream is appropriate for the current market environment.

Slower global growth and uncertainty surrounding international trade contributed to a shift in monetary policy in 2019, as the Fed reversed its tightening regime and investors bought up relatively safer Treasury bonds, pushing down yields. The length of the current bull market, now approaching its 11th year, combined with yield curve inversions we saw in 2019, has heightened concerns of a recession. It is a good time to examine the role of income and the value of an active approach to dividend investing.

In a lower interest rate environment where bond yields are also depressed, the quest for yield becomes more pronounced, and stocks are well-positioned to provide it (Exhibit 1). The need for a multifaceted dividend approach also becomes more pronounced. We believe the push for yield, sustained by demographic changes, low rates and late-cycle volatility, will reward a diversified dividend strategy that emphasizes not only attractive current yield but also dividend growth across the sector spectrum.

The quest for yield is pronounced given that income remains an important component of total return, and with the baby boomer generation in prime retirement age, the need for income will only grow. In the U.S., 76 million baby boomers face a $1 trillion funding gap in pensions, health care and other benefits. A strategy that seeks out companies with the ability to compound dividends over the long term should be able to help meet this gap over long periods.

Dividend growers have a history of being rewarded by the market over time (Exhibit 2). A look at the returns of S&P 500 stocks sorted by dividend policy shows that all dividend payers tend to outperform the broad market. It also shows it is equally

AN ACTIVE AND DIVERSIFIED APPROACH TO DIVIDEND GROWTH

Exhibit 1: Stocks Offer Relatively Competitve Income Source

18% 16% 14% 12% 10%

8% 6% 4% 2% 0%

S&P 500 Dividend Yield

10-Year Treasury Yield

As of Dec. 31, 2019. Source: Standard & Poor's, U.S. Treasury, and Robert Shiller, "Irrational Exuberance" for historical yields.

1930 1932 1935 1938 1941 1944 1947 1949 1952 1955 1958 1961 1964 1966 1969 1972 1975 1978 1981 1983 1986 1989 1992 1995 1998 2000 2003 2006 2009 2012 2015 2017

Exhibit 2: Returns of Dividend Stocks by Dividend Policy

15,625

Dividend Growers All Dividend-Paying Stocks S&P 500 Dividend Payers w/ No Change Non-Dividend-Paying Stocks

Dividend Cutters or E limin a to rs

625

S&P 500 Return

25 1972

1977

1982

1987

1992

1997

2002

2007

2012

2017

As of July 31, 2019. Source: Ned Davis Research. S&P 500 is the S&P 500 Equal-Weighted Total Return Index. Dividend policy indexes are equal-dollar-weighted with monthly rebalancing. Monthly data (log scale indexed to 100).

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INSTITUTIONAL PERSPECTIVES January 2020

important to avoid companies cutting or eliminating their dividends. The dividend environment remains supportive and the number of dividend payers raising their dividends remains high: for the 12 months ended December 31, 2019, 84% of the 423 dividend-paying stocks in the S&P 500 Index had increased their payouts, according to FactSet.

A Diversified Approach

The foundation of a successful actively managed dividend strategy is a focus on companies with not only attractive current dividend yields, but also rich histories of dividend increases. In terms of current yield, these are typically found in more defensive sectors such as utilities and consumer staples, or in income-focused areas such as real estate. A more diversified approach, however, can find attractive dividend profiles in different sectors (Exhibit 3). In the low-yielding health care sector, for example, we seek a balance of current yield -- our holdings have a higher average current yield than the S&P 500 -- and dividend growth. Holdings with lower current yields, such as managed care provider UnitedHealth Group and pet and livestock medicine and vaccinations company Zoetis, have exhibited strong dividend growth, increasing their dividends by over 200% and 100%, respectively, over the last five years.

The Value of Relative Growth

in Defensive Sectors

In an actively managed dividend portfolio, an emphasis on growth can also extend to high-yielding areas such as the utilities sector. Utilities stocks are mainstays of most dividend strategies: facing low elasticities of demand, utilities companies enjoy consistent revenue streams and typically pay large steady dividends to shareholders. Among utilities, however, our holdings achieve a higher dividend growth rate than the market while still collecting a sound current yield. The average three- and fiveyear dividend growth rates among utilities holdings are three and four percentage points higher, respectively, than the broad market sector (Exhibit 4).

This relative dividend growth advantage stems from our preference for utilities stocks that feature a balance of defensive and growth characteristics. For example, NextEra Energy, a hybrid utility encompassing a regulated utility in Florida and an unregulated power generation business, has paid a dividend continuously since 1947 and raised its dividend for 25 consecutive years. NextEra's great earnings and dividend growth is explained by its successful business model.

Exhibit 3: ClearBridge Dividend Strategy 5-Year Dividend Growth Rates by Sector (Weighted Average)

25

5-Year Dividend Growth Rate (%)

20

15

10

5

0

-5

Comm. Cons. Disc. Cons. Energy Financials Health Industrials IT Materials Real

Services

Sta ples

Ca re

Estate

ClearBridge Dividend Strategy

S&P 500

Utilities

As of December 31, 2019. Source: ClearBridge Investments.

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On the utility side, operational efficiencies have helped keep customer rates affordable and improved the company's relations with the state regulators, allowing NextEra to earn premium returns in the state while making sizeable investments into the grid. On the generation business side, NextEra was an early mover into a nascent renewable market several years ago, and now is among the largest renewable project developers and capacity owners in the country. Its large scale and expertise have helped it maintain its competitive advantage even with increased competition.

Exhibit 4: Relative Dividend Yield and Growth in Utilities Sector

12 10.58

10

9.50

Current Dividend Yield and Growth Rates (%)

8

6.41

6.06

6

4

2.58 3.05

2

0

Dividend Yield

3-Year

5-Year

Dividend Growth Dividend

Growth ClearBridge Dividend Strategy Utilities Holdings As of Dec. 31, 2S01&9.PSo5ur0c0e: CUletailriBtrieidsge Investments.

Finding Current Income in Growth Sectors

Further, in an actively managed dividend portfolio, an approach to income does not preclude finding attractive income opportunities in traditional growthoriented sectors such as information technology (IT). The IT sector is usually not a major contributor to income, as many IT companies offer low or no current income. Yet we are finding examples of high growth and high current yield in the IT sector, for instance in global semiconductor company Texas Instruments, which has paid an uninterrupted dividend since 1962 and has raised it annually for the past 15 years. Texas Instruments is relatively high yielding at 2.55% and is among the top IT dividend growers in the portfolio, with three- and five-year dividend growth rates of 25.6% and 20.0%, respectively. Our IT holdings have paid dividends consecutively for 20 years on average and have raised them annually an average of 10 years consecutively. They also have achieved strong dividend growth rates, averaging 15% over the past five years.

The Value of Dividend Payers

In sum, as the quest for income has become elevated and should remain so as we return to a period of lower interest rates, dividend-paying companies will become increasingly valuable. In our view, companies with healthy balance sheets, consistent cash flows that provide plenty of capital to effectively operate their business, and modest payout ratios remain in a good position to sustain dividend increases. We believe an actively managed dividend portfolio that builds diversified exposure to them, maintaining both attractive income levels and strong growth characteristics, is a sound approach in the current environment.

About the Authors

John Baldi Managing Director, Portfolio Manager ? 21 years of investment industry experience ? Joined ClearBridge in 2004 ? BS in Finance and Economics from Boston College

INSTITUTIONAL PERSPECTIVES January 2020

Michael Clarfeld, CFA Managing Director, Portfolio Manager ? 19 years of investment industry experience ? Joined ClearBridge in 2006 ? Member of the CFA Institute, CFA Society New York ? BA in History from Duke University

Scott Glasser Managing Director, Co-Chief Investment Officer, Portfolio Manager ? 28 years of investment industry experience ? Joined predecessor in 1993 ? MBA from Pennsylvania State University ? BA from Middlebury College

Peter Vanderlee, CFA Managing Director, Portfolio Manager ? 20 years of investment industry experience ? Joined predecessor in 1999 ? Member of the CFA Institute ? MBA from New York University's Leonard N. Stern School of Business,

MS in Math/Computer Science from the University of Technology, Eindhoven, Holland

ClearBridge Investments 620 Eighth Avenue, NewYork, NY 10018 | 800 691 6960



Past performance is no guarantee of future results. Copyright ? 2020 ClearBridge Investments. All opinions and data included in this paper are as of January 31, 2020 and are subject to change. The opinions and views expressed herein are of the portfolio management team named above and may differ from other managers, or the firm as a whole, and

are not intended to be a forecast of future events, a guarantee of future results or investment advice. This information should not be used as the sole basis to make any investment decision. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither ClearBridge Investments nor its

information providers are responsible for any damages or losses arising from any use of this information. Performance source: Internal. Benchmark source: Standard & Poor's. Neither ClearBridge Investments LLC nor its information providers are responsible for any damages or losses arising from any use of this information.

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