Miserly bonds yield to generous dividends

Posted on: January 29, 2012 in: Canadian Equities, Dividends, Fixed Income with 0 comments



Miserly bond yields won’t pay for a nice dinner these days. For that, you need the generosity of dividend-paying equities. Add the promise of capital gains and you may even opt for the nicer bottle of wine.

Bond investors are suffering from the lowest yields in a generation. Quality, five-year corporate bonds are yielding about 2.4%. That’s about half the average for the past decade. Compare that to equity dividend yields, which, at about 2.7% for the S&P TSX 60 Index, are the best in a decade, barring a period of extreme valuations in late 2008. In other words, equity dividends are higher by a third of a percentage points than quality bond yields, and that’s before the dividend tax credit and before any capital gains. (See Chart of Yields below)

What brought us to this upside-down wonderland? Last year’s poor showing by Canadian equities, combined with the Euro-zone crisis saw panicked investors flock to the safety of quality bonds. They were the best performing assets last year. Quality corporate bonds with maturities of about five to seven years returned about 9% in 2011.

Bonds prices are now hitting their ceiling and cannot go much higher. However, nor will they fall soon with the U.S. Federal Reserve committed to near-zero rates into 2014 and our own Bank of Canada likely to follow suit. More reason then for investors to look elsewhere for income.

The other factor pushing up dividend yields are record corporate profits that are as high now as they were just prior to the 2008 recession. Companies have been spending those profits buying back their shares and on dividends – both good for equity investors.

Eventually, the upside-down will right itself, as investors shun bonds in favor of dividend-paying stocks. That will push bond yields up and dividend yields down. To benefit from this, we have been re-allocating our Canadian equity exposure to ETFs of higher dividend-yielding quality companies.

Two we considered were iShares DJ Canada Select Dividend ETF (XDV/TSX) and the Claymore S&P/TSX Dividend ETF (CDZ/TSX). Both have consistently outperformed for years.

XDV, with a current yield of about 3.9%, holds the 30 biggest companies by market cap that also pay a dividend. As a result, 55% of the ETF is in banks and insurers.

The yield on CDZ is lower at 3.2% and its price-to-earnings ratio is higher at about 15.3 times but it is much more diversified. It holds 60 companies, all of whom have consistently raised dividends over the last five years and have at least $300 mln in market cap, though the average is $8 billion.

Energy and industrial firms are the biggest sectors with nearly half the ETF weight, followed by financials (though not the big banks or insurers) and then consumer discretionary firms like Tim Hortons, Shaw and Cogeco.

Of the two, we opted for CDZ mainly because of its diversification. XDV’s overweight in financials, especially in a period of increasingly heavier regulation of banks and insurers, makes us nervous.

Its diversification has also helped CDZ far outperform XDV as well as XIU/TSX, the biggest S&P/TSX 60 ETF. Over the last five years, CDZ has returned 23%, compared to XDV’s 9.4% and XIU’s 8.0%. XDV’s financial overweight helps link its return closely to the S&P/TSX 60, which has a 32% financials weighting.

One thing to note: iShares bought Claymore a few weeks ago. It has not said it will change Claymore products and given the success and distinctive approaches of CDZ and XDV, I doubt these two ETFs will be affected and even if they are, it likely won’t harm unitholders.

The Claymore takeover may also be to the benefit of Canada’s other ETF managers, including BMO, Horizons, RBC and Vanguard as they carve out their own space from a growing ETF market place.

The biggest winners will be investors, more of whom are investing through ETFs, either directly or through investment managers. In fact, Morningstar said recently that U.S. firms managing ETF portfolios saw assets grow my 43% last year as investors opted for top-down, asset-allocation strategies that minimized stock-specific risk.

Dividend Yields rarely exceed Bond Yields





Charts courtesy of Bloomberg L.P. Click on Chart for Larger Image

archerETF Metrix 25 Jan 2012
Ticker/Exchange CDZ / TSX
Categories Equity / Canada / Multi-cap
Total Holdings 59
52 Week High 22.05
Recent Price 21.78
52 Week Low 17.92
Avg Daily Volume 102,344 shares
Avg Daily Volume ($) $ 2.2 Million
Total ETF Assets $ 570.2 Million
Allocation to 10 Largest Holdings 43.12%
ETF Annual Fee .64%
ETF Trading Currency CAD
ETF FX Exposure CAD
Annual Volatility 10.88%
Correlation to S&P TSX Comp. 85.82%
Return to Risk Ratio 0.58
Beta to S&P TSX Comp. 0.71
Price-to-Earnings Ratio 15.29
Use of Leverage No
Use of Futures No
6 month Return 2.80%
1 Year Return 7.32%
3 Year Return 22.78%
Dividend Yield Ind. 3.36%

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© 2011 archerETF Portfolio Management is a division of Bellwether Investment Management, a discretionary portfolio manager registered with the Ontario Securities Commission. This report is provided for information only and does not constitute investment advice. While we believe the information to be accurate and timely, we make no claim or warranty to that effect. Please seek professional advice before making any investment decision. We may hold positions in any or all securities discussed in this report.

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