What are fixed dividend stocks?

Fixed dividend stocks, usually called Fixed Div, are ordinary shares with contractual dividends. They represent a synthetic underlying asset that fixes the dividend level of an existing stock for the entire duration of the product for which it serves as the underlying asset. This allows the issuer to eliminate the risk associated with future dividends of the underlying stock, as it is no longer subject to changes in the company's dividend policy. This is one of the reasons why the issuer can offer more attractive conditions to the investor.

Generally, issuers base these underlying assets on historically distributed dividends, market expectations, or forecasts announced by the company.

💶 Dividends

Dividends are periodic payments made by the company to reward its shareholders. Their level varies each year and depends on the company's financial performance. In 2020, the average dividend yield over five years for CAC 40 stocks was 3.3%.

At the time of dividend payment, the stock price drops by the same amount as the dividend, all other things being equal. This is because the dividend is deducted from the company's value, reducing the value of each share. This drop in value is often temporary.

In France, dividends are most often paid annually. Some companies, like TotalEnergies, pay them semi-annually or quarterly. In the United States, the norm is to pay dividends quarterly.

⚙️ Issuer hedging strategy

When an investor wants to launch a structured product, the issuer must protect itself against risk — hedge — accordingly. The issuer bears the opposite risk to the investor's bet. They will need to buy and sell options and a certain amount of the underlying asset. The issuer's goal is to realize a margin at the product's launch and maintain or even improve it through effective risk management in response to market fluctuations.

The issuer also anticipates the dividends of the underlying stock, which must be considered in the creation of the structured product. If the issuer buys shares to hedge, they will receive the corresponding dividends. Trading rooms base their estimates on historical dividends, dividend growth, and the company's dividend announcements, applying a haircut — a discount — over time. However, it is difficult to predict dividend levels over long maturities, so they must roll over their positions to ensure the level of dividends received.

To mitigate this risk, issuers originally created customized indices that eliminate dividend risk. These indices feature a fixed dividend level expressed as a percentage or in points. In recent years, banks have started offering the same on stocks—contractual dividend stocks.

📈 Comparative evolution of ordinary stocks and contractual dividend stocks

The price of contractual dividend stocks can deviate from that of the ordinary stock on which it is based, depending on the actual dividends distributed by the company. If the actual dividend level is higher than the contractual dividend level, the fixed div stock outperforms the reference ordinary stock. Conversely, if the actual dividend level is lower than the contractual dividend level, the fixed div stock underperforms.

During the Covid crisis, some companies, particularly in the banking sector, benefited from government measures to support their cash flow, provided they committed not to pay dividends or buy back their shares. This significantly penalized the performance of contractual dividend stocks compared to ordinary stocks.

🧮 Different calculation formulas

There are two ways to calculate the level of a fixed div underlying asset:

• it can be created in the form of an index. This allows the investor to track the underlying asset transparently and publicly—an essential criterion for French life insurance. For example, the Solactive TOT 2.48 AR index, launched in 2017, reinvests the gross quarterly dividends paid by TotalEnergies and deducts a fixed charge of €2.48 per year from the stock's performance;
• it can be directly indicated in the product's calculation formula in the regulatory documentation. This makes tracking the underlying asset's evolution much more complex, as the investor must recalculate the performance themselves based on the level of contractual dividends.

In both formulas, the contractual dividend amount is linearly subtracted, and the actual dividend amount is reintegrated when paid. It is important to be careful with the calculation rules and check whether the contractual dividends are deducted only if dividends are paid or if they are deducted regardless. It is also crucial to verify that the reintegrated dividends are gross and not net dividends.