Income and resilience during unprecedented times

Following eight consecutive interest rate cuts by the European Central Bank (ECB), short-term bond yields have continued to move lower and appear much less appealing than even just one year ago. However, reaching for yield further along the curve involves higher risks—as demonstrated impressively by surging long-term yields in France and the UK due to fiscal and political uncertainties. As a result, while bonds and cash remain important elements of diversified portfolios, their role as near-exclusive income sources has been diminished. And of course, fixed income instruments offer only capped, or sometimes no, potential for capital gains.

On the other hand, dividend equities in Europe are experiencing somewhat of a revival. Germany’s €500 billion infrastructure package signals significant fiscal expansion¹, which is set to reshape the investment landscape for years to come. The shift is leading many investors to revisit equities for both growth and income. Dividends have long been central to the European equity experience. Over the past 20 years, over 40% of the total return from European equities has come from dividends² This is not a marginal contribution but a structural feature of the market, demonstrating the enduring role of dividends as a stabilizing element in returns.

European dividend yields currently stand above bond yields and cash rates, creating an income differential that may be attractive to long-term allocators. The widening spread has renewed focus on dividend strategies as a complement to traditional fixed income.

The Strength of Europe’s Dividend Culture

Dividends are not a side note in European equities — they are central to the way companies return value to shareholders. With a long-term average payout ratio of 68%, compared with 43% in the U.S. and 37% in Japan³ Europe continues to stand apart as a region where dividends are embedded in corporate practice.

This commitment is visible across a broad range of sectors. Financials are among the most important contributors, alongside areas such as energy and utilities. With aggregate common equity tier 1 ratios around 16%⁴, European banks have maintained strong capital buffers. This provides them with ample flexibility to return part of their earnings to shareholders through dividends, subject to regulatory and company-specific considerations.

These sectors highlight how consistent payouts and high ratios give Europe a distinct income identity. For investors, this entrenched dividend culture — underpinned by established payout practices and reinforced by sectoral breadth — makes income a defining feature of Europe’s equity landscape.

Dividends Through Market Cycles

A defining characteristic of dividends in Europe is their consistency across market environments. While  meaningful growth has been hard to come by in Europe as of late, dividends have generally been resilient to cycles and market shocks. This stability means dividends can provide a foundation of returns even when price movements are more volatile.

In addition, dividends may help support share prices themselves. Because dividend payments are often a key input in traditional equity valuation models, companies with stable and predictable distributions can be valued more accurately than growth stocks (where future cash flows tend to be more uncertain). These fair value approximations can serve as a floor during market downturns.

Rather than being tied to any one cycle, dividends may serve as a durable component of equity investing — helping smooth outcomes in the short term and enhancing value creation in the long term.

Introducing a Quality Lens

Income investors considering equities typically have three broad goals. The first goal is, of course, to generate an adequate income. Their second goal often is to protect their principal over the long run. And the third goal revolves around the potential for capital gains – otherwise, fixed income might be the more suitable option. Focusing solely on the headline dividend yield may well satisfy their first goal but fall short of the other two. Companies with particularly high yields can sometimes reflect falling share prices or financial strain rather than sustainable strength. We prefer a quality-focused approach to help distinguish between attractive opportunities and potential traps.

Key quality measures include:

• Return on Equity (ROE): a profitability metric, showing how efficiently a company generates profits relative to shareholder equity.
• Earnings variability: assessing the stability of earnings through cycles, which can provide insight into how dependable future profits might be.
• Leverage ratios: evaluating the balance sheet, as lower debt burdens may indicate financial resilience and stability.

Applied together, these criteria create a more complete picture of dividend sustainability. Combining yield with efficiency, stability, and financial discipline can help identify dividends that are attractive and sustainable and that leave room for future growth. The LibertyQ European Dividend Index illustrates this: its rules-based approach, which balances yield with quality filters, currently delivers a dividend yield of 4.8% compared with 3.2% for broad European equities, and an average ROE of 15.8% versus 11.9%.¹

Resilience and Diversification

By focusing on companies with strong profitability, steady earnings, and prudent balance sheets, this approach tends to emphasize businesses that are better positioned to maintain dividends through different phases of the market.

One of the outcomes of this process is that it frequently results in lower exposure to information technology within European allocations. This is not a deliberate sector bet, but rather a reflection of structural differences: many European IT companies reinvest heavily for growth and distribute little in dividends. For investors, this can be a feature rather than a drawback, as it creates a natural complement to U.S. equity exposures, where technology plays a far larger role in driving returns. Carmakers have also been largely absent from the LibertyQ European Dividend Index, as their cyclical nature is penalised in the methodology. This helped particularly during the Trump-induced volatility in the aftermath of the initial tariff announcement and the weak European trade agreement with the US.

In 2025 so far, this emphasis on dividends with a quality approach has demonstrated greater stability compared to the broader European market during periods of volatility.

Conclusion

With bond yields falling and modest cash rates, dividends have re-emerged as a potential income source. Europe stands out for its strong dividend culture, with higher but sustainable payout ratios and above-average yields compared with other developed markets. Over the long term, dividends have consistently accounted for a large share of European equity returns, underscoring their structural importance.

What distinguishes a European quality dividend approach is the additional focus on fundamentals. By emphasizing profitability, earnings stability, and prudent balance sheets, this strategy aims to deliver income that is not only attractive but also durable. In 2025, our quality-driven profile has already demonstrated greater resilience compared with the broader European market during periods of volatility — highlighting how dividends and quality together may help smooth outcomes when uncertainty rises. For global investors, this creates an allocation that may serve not only as an income source but also as a defensive anchor and diversifier, balancing U.S. growth and technology exposure with Europe’s established dividend culture and quality characteristics.