It's a low-yield world. That's what rock-bottom interest rates have done to fixed-income investments such as bonds and guaranteed investment certificates.
So what's an income-thirsty investor to do? Three industry experts offer remedies for the income-deficient portfolio.
Les Stelmach, portfolio manager for the Franklin Bissett Canadian Dividend Fund, Calgary
Stocks with histories of paying steadily growing dividends are perennial favourites among investors of all stripes. Equities are obviously further up the risk curve than bonds and GICs, Mr. Stelmach says, meaning more price volatility as well as the possibility of a dividend cut amid tough economic conditions. But dividend stocks are less sensitive to inflation and interest rate hikes. Here are two large holdings in his fund to consider:
Enbridge Income Fund Holdings Inc. (TSE: ENF): Independent of Enbridge Inc. and behind the controversial Northern Gateway oil pipeline, this publicly traded income fund owns already-producing pipelines built by its parent company. Enbridge Income Fund has a history of a steadily growing dividend with a yield of more than 4 per cent. Mr. Stelmach says the yield is expected to grow even faster now that its parent firm plans to spin off more of its producing assets to the fund. "We've heard numbers that would suggest an annualized 10-per-cent dividend growth," he says. Unlike other pipeline investments the fund is less sensitive to interest rate hikes because it does not rely heavily on debt, but a prolonged slump in the energy industry could affect earnings.
Canadian Imperial Bank of Commerce (TSE: CM): All Canadian banks are typically good choices for dividend income, but CIBC – and its payout of almost 4.5 per cent – stands out thanks to its solid domestic retail banking base. "That base business provides a very nice platform to sell additional products and services, and CIBC has been at the forefront of using that to grow a pretty significant wealth management business, which is highly profitable and not as exposed to interest rates." The risks to the banking sector from Canada's faltering energy industry and its knock-on effects on the housing market are well managed by the Big Five, including CIBC, he adds. Even after reporting a drop in earnings, CIBC has ample profit margin to maintain and even increase its dividend, as it did in February after missing earnings expectations. "So there's a lot of inherent support and stability with the current dividend and certainly upside growth over time."
Mark Yamada, president of PUR Investing Inc., Toronto
Investors can borrow a strategy used successfully by endowment funds, Mr. Yamada says, which now hold mostly equities in their portfolios, using dividends and capital gains to provide income. The strategy is twofold. One, a portion of income is variable, so it can be adjusted accordingly when markets are down. Two, they invest only in low volatility stocks, which generate better long-term returns than equities with high volatility. Mr. Yamada says these exchange-traded funds (ETFs) below are two of many that can provide exposure to low volatility stocks.
Bank of Montreal's Low Volatility Canadian Equity ETF (TSE: ZLB): With a management expense ratio (MER) of 35 basis points, this fund "handily beat the TSX 60 simply by reducing volatility," he says. The fund invests in the 40 least volatile stocks among the 100 largest listed on the TSX. One downside is the fund's distribution, about 2 per cent, so investors may need to generate income through capital gains. Still, this strategy would have proven successful over the past three years, since the fund had an average annual return of more than 22 per cent. The strategy, however, may be difficult to emulate if the Canadian market is weighed down by a slumping energy sector.
iShares MSCI EAFE Minimum Volatility Index ETF (TSE: XMI): Mr. Yamada says a low-volatility portfolio should hold a handful of funds exposed to various geographical areas because "that way, when one fund is zigging, others will hopefully be zagging to offset losses." With that in mind, a number of low-volatility ETFs are available that provide exposure to rapidly growing emerging economies, including the iShares MSCI EAFE ETF, which has a MER of 0.37 per cent. While it does not have a long track record, and pays a distribution of only about 2.15 per cent, it has had an annualized return of about 22 per cent since inception about two years ago. The downside, as with all equity strategies, is that the fund is susceptible to bear-market risk, but less so than more aggressive strategies.
Hardev Bains, portfolio manager and president of Lionridge Capital Management, Winnipeg
Investors who cannot afford to lose significant amounts of capital should stick with fixed-income securities and instead draw on capital to make up shortfalls for their income needs, says Mr. Bains. To protect against interest rate hikes, the portfolio should hold only bonds using a laddered strategy with maturities of one to five years. "The best way for most individuals to invest in short-duration bonds is through ETFs," he says. Here are two ETFs that offer exposure to laddered bond strategies:
iShares 1-5 Year Laddered Government Bond Index ETF (TSE: CLF): With a MER of 0.17 per cent, this ETF uses laddering, rolling maturing bonds into new issues to take advantage of a rising-rate environment. The average bond duration to maturity in the portfolio is about 2.8 years, making it well positioned to take advantage of rate hikes. The trailing 12-month yield of this ETF, which is invested in Government of Canada, provincial and municipal bonds, was 3.38 per cent at the end of March, and its five-year annualized return is more than 3 per cent.
iShares 1-5 Year Laddered Corporate Bond Index ETF (TSE: CBO): For investors who can handle a little more risk, iShares's corporate counterpart employs the same laddered strategy, holding high quality debt from Canadian companies mostly with durations of three to five years, with many of its top holdings in the financial sector. With a MER of 0.27 per cent, the ETF's 12-month trailing yield at the end of March was 4.07 per cent and its five-year annualized return is about 3.75 per cent.