Investors Turn to Stocks as European-Bond Returns Plummet
With bonds in Europe offering record-low returns, investors are instead pouring money into stocks of solid companies that pay regular dividends.

While European stocks are surging across the board—Germany’s DAX index marked its 26th record close of 2015 on Monday—equities of well-rated, safer companies that pay out regular dividends are particularly appealing.

The move is driven by the European Central Bank’s bond-buying program, which has pushed government-bond prices sharply higher, reducing yields on the debt and forcing investors to look further afield for a decent return.

So far this year, European equity dividend funds have seen the fastest pace of inflows since the 2008 financial crisis. Already, the tide of money into these funds, seen as alternatives to bonds, has outstripped the amount for all of 2014. The net inflow of money to equity income funds in Europe totaled $10.2 billion from the start of the year through March 11, according to the data-tracking company EPFR Global, compared with a total of $7.7 billion in 2014.

“You’re getting people selling traditional fixed income to buy equities. This hunt for yield is only just beginning,” said Tony Lanning, who manages multiasset funds at J.P. Morgan Asset Management. “We think with German [government bonds] yielding next to nothing, buying a good quality German company yielding 2.5% is a safe way to buy equities.”

Bond yields, which fall as prices rise, plummeted in anticipation of the ECB’s €60 billion ($63 billion) a month bond-buying program, which began last week. Yields are less then zero percent on €1.8 trillion of European government debt, according to Bank of America Merrill Lynch.

Making the leap into equities isn’t possible for some investors. Banks, pension funds and insurance companies have to hold large amounts of government bonds for regulatory reasons.

Retail investors have more freedom, though equities are still a riskier bet for savers. But defensive stocks such as utilities and pharmaceuticals tend to pay out steady dividends. Their share prices are generally less volatile because the companies’ performance is less closely tied to the health of the wider economy than so-called cyclical stocks.

“Bond yields are at the lowest they have been since the Black Death. To us, it seems a sensible idea to own good quality, long-term sustainable businesses with pricing power,” said Jeremy Whitley, head of U.K. and European equities at Aberdeen Asset Management.

The recent uptick in interest in stocks with respectable dividends forms part of a longer-term growth trend. There are now more than 200 global income funds, compared with just 30 back in 2008, according to Stephane Mattatia, global head of the macro group at Société Générale SA. Over this period, a net $142 billion has poured into global equity income funds, according to EPFR.

“With bond yields having fallen so far, retail investors are increasingly looking to take on more risk and go into European equities,” said Toby Nangle, head of multiasset allocation at Threadneedle Investments. “We’ve seen a steady and secular increase in demand for income-type products, both in equities and multiasset funds.”

The ECB’s recent dose of monetary stimulus, known as quantitative easing, is “the obvious trigger” for the flow of investment into bond-like equities, said Greg Herbert, co-manager of the global equity income fund at Jupiter Asset Management. “If you’ve got negative interest rates in most other areas of the market, equities are definitely the path of least resistance.”

As money has poured in, European equity dividend yields—dividends as a percentage of stock prices—have declined from about 4% last October to about 3.25% now, said Mark Nichols, manager of the European growth and income fund at F&C Asset Management. Average yields on U.S. stocks are less than 2%, while those in vast portions of the fixed-income market are lower still.

“European equities have never been this cheap, relative to bonds, in the last 100 years,” he said.

Finding the right investment is a separate matter. There are still plenty of higher-yielding stocks out there, but these companies tend to be riskier and are more likely to slash their dividends, said Mr. Mattatia. The amount of stocks that pass SocGen’s internal screening process for identifying dividend-paying companies with healthy and growing businesses is at an all-time low, he added.

Frances Hudson, global thematic strategist at Standard Life Investments, notes that defensive stocks with a steady dividend yield have become “something of a crowded trade.”

Smaller, emerging companies with good dividend growth tend to have more attractive valuations, noted Mr. Herbert. Many investors believe there are still opportunities among large-cap stocks as well.

The insurance sector is the top pick for Phil Cliff, manager of M&G Investments’ pan-European dividend fund, because, he said, insurers are generally well capitalized and offer increasing dividends, with yields in the region of 5% or more. He is also overweight pharmaceutical stocks, which can provide chunky returns if the company in question hits upon a breakthrough drug.

“We’re very much focused on companies that can grow their dividends through time,” he said.

Write to Christopher Whittall at christopher.whittall@wsj.com
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The move is driven by the European Central Bank’s bond-buying program, which has pushed government-bond prices sharply higher, forcing investors to look further afield for a decent return.