PART 8. In a market rife with turmoil and lackluster government bond returns, investors seeking higher yields are well advised to consider the potential diversification opportunities outside Canadian borders.
Dividend and interest income is always desirable, but in times of market turmoil, reliability takes on even greater attractiveness.
In the fixed income market, short-term interest rates are trending downward, says MFC Global vice president and portfolio manager Danny Tomka, and treasury bonds are rallying, depressing yields. "You have an environment where the guaranteed government bond market in the developed world, for the most part, is providing fairly low yields."
Stock markets have been very weak, he notes, along with the stock prices of many world class, multinational companies. "Consequently, their dividend yields are quite high. The major banks and telephone companies have attractive dividend yields; Bank of America, for example, is around 6 per cent."
In the search for higher yields, it is essential for investors to look beyond North America, says Mr. Tomka. "When you look across the globe, the payout ratio - what companies earn and how much they pay out to shareholders - is higher abroad, particularly in Europe and the UK. Canada and the U.S. have a lower payout ratio. There is also a global phenomenon occurring in which the payout ratio is continuing to rise, meaning more and more of company earnings are being given back to shareholders in the form of dividends."
For investors who require income, those rising dividends can help supplement meager bond interest. "In a low interest rate environment, the fixed income payment that you receive on a bond doesn't change. If you buy a bond that originally yielded four per cent, you get $4 in interest per $100 until that bond matures. Dividends can grow, by increased earnings or by the dividend payout ratio rising. You might buy a company today with a four per cent or five per cent dividend yield, and in five or 10 years, it could be double that," he says.
Dividends also act as ballast when stock markets are volatile, providing downside protection - but not all dividend-paying companies make good investments. "We try to identify higher-yield dividend-paying companies, but we also like to ensure we're getting good value when we buy those companies," says Mr. Tomka. "It's one thing to get a high dividend, but if you're overpaying for that company, you have risk in the downside of the stock price."
Sector diversification is another very important reason to consider global dividend companies, says Alan Wicks, MFC Global portfolio manager and vice president. "In the Canadian market, there is a significant financial component that has a dividend yield. But outside of that, we really have no consumer staples or consumer discretionary sectors compared to the global market. Energy and materials companies, a major component of the Canadian market, do not for the most part pay significant dividends, with the exception of the oil and gas trusts. Internationally, there are great, brand name companies - more than 95 per cent of the world's economy is outside Canada."
For example, says Mr. Tomka, Ambev, the Brazilian beer company, pays a dividend of about 3.4 per cent. "Total, the French multinational oil and gas company, has a dividend yield of about four per cent, and HSBC, the global bank, has a 6.5 per cent dividend yield right now. Telefonica, the large Spanish telecom operator, which also has fast growing businesses in Latin America, currently has a dividend yield of about 5.5 per cent."
The key, says Mr. Wicks, is finding stocks that are undervalued and pay an attractive dividend. "In the future, hopefully, we'll get the best of both worlds. We get paid now, with dividends, and when the market turns around, we get capital appreciation."
The recent strength of the Canadian dollar has hindered overall returns on global equities, but Mr. Tomka views that as less likely to be an issue in future. "We think the Canadian dollar has had the majority of its run. It certainly may go a little bit higher, but with our GDP at 0.8 per cent last quarter, I don't think it will be the headwind that investors have faced over the last couple of years."
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