Weakening returns from equity markets should encourage investors to boost holdings of high yield bonds, emerging market debt and stocks that pay up a high dividend, according to ING Investment Management, part of the Dutch conglomerate ING.

In a report entitled Searching for Yield, it says structural factors such as an ageing population and benign nominal growth in developed economies will drag on stock market returns in the long run. It predicts firms will raise dividends by an average of 10 per cent this year and in 2012.

“There are a number of factors having a negative impact on yield. An ageing population, for example, slows down output growth, the active labour force shrinks, and the productivity of elderly people is relatively low. All of this could result in the growth of gross domestic product in the developed world declining by roughly one third when compared to the recent past,” said Valentijn van Nieuwenhuijzen, head of strategy at ING IM.

“Governments reducing their budget deficits and banks bringing their balance sheet positions in line with the real economy will also have a negative impact on growth, and low nominal growth is theoretically reflected in low yielding financial markets at the aggregate level,” he said.

Corporate high yield bond yields have declined to below their levels before the financial crisis, but ING IM said default rates in this sector will remain relatively low.

“Historically, the 12-month default rate has shown an average of 3-4 per cent, with a recovery rate of 35 per cent. After rising to 13 per cent in 2009, the default rate has been steadily falling, in line with the economic recovery. In January 2011, there were no index-eligible defaults, leaving the trailing 12-month default rate near an all-time low at 0.8 per cent on a par basis and 2.3 per cent on an issuer basis,” the report continued.

As for emerging market debt, the report said economic conditions such this asset class are still improving rapidly.

“This category suffers from its past, which was marked by great volatility, partly due to the high political risks. Markets still need to get used to the fact that the situation in developing countries and the way they are governed have fundamentally improved,” said Rob Drijkoningen, head of global emerging market investments at ING IM.

As for stock markets, high dividend-paying equities are the place to be, the report adds.

“Companies which are known for paying out high dividends are increasingly being placed in the spotlight. Many companies have stable cash flows and large amounts of cash on their balance sheets, which are increasingly being used for paying out dividends. Dividend yields have exceeded the yield on government bonds for some time now, but for certain sectors the average yield on corporate (investment grade) bonds has been surpassed as well. In Europe, this is especially the case for defensive sectors such as telecoms, utilities and healthcare,” said Nicolas Simar, head of equity value investments at ING IM.

“So far, dividend increases have not kept pace with the large rise in earnings that we have seen in 2010. This means that there is room for growth. In Europe, the gap between earnings growth and dividend growth has risen to its highest level in nearly 40 years. Companies currently have large amounts of cash. We expect companies to increase their dividends by at least 10 per cent on average in both 2011 and 2012,” he said.