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Why sustainable yield will matter in 2017
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By Fund Library News Wire  | Tuesday, February 14, 2017



By Keith McLean, President and CIO, Sphere Investments

The current and forecasted interest rate environment will continue to make it difficult for investors to find sufficient yield in fixed income markets in 2017. This will force investors to look elsewhere and increase the demand for equity investment strategies that seek high yields. These high-yield strategies can expose investors to extreme-yielding equities that may be at risk of cutting their dividend.

An investment strategy focused on creating sustainable yield will avoid holding equities that are at risk of cutting their dividends and consider the financial and operating strength of prospective holdings.

Specific emphasis should be placed on companies with strong balance sheets, efficient operations, and the ability to generate cash flow. The Sphere FTSE Sustainable Yield Index ETFs look at the following key criteria to maximize the advantage of sustainable yield products:

Dividend sustainability: Companies included in a portfolio need to consider the ability of a company to pay their dividends on a sustainable basis.

Industry exposure: Industries are cyclical, and their correlated movements can increase the risk to high yield investors by exposing them to high levels of industry bias. Sustainable yield strategies take industry-relative factors into account to ensure a broader diversification across industries.

Country diversification: Global or regional high yield indices may have a country bias and lack diversification. Sustainable yield strategies utilize country-relative factors to ensure broader geographic exposure.

Liquidity: Low liquidity increases transaction costs for investors looking to enter or exit the investment strategy. This risk can be moderated by a portfolio construction process that uses appropriate weights for each portfolio constituent.

Holdings turnover: High yield strategies often use only the single yield factor to select its portfolio holdings. This investment approach can be enhanced in two ways: by utilizing multiple investment factors to build a portfolio and by using transaction buffers so that portfolio turnover enhances the strategy’s risk vs. return profile.

Investors would be wise to consider ETFs that address the risks and issues listed above with a goal of exposing investors to a well-constructed portfolio of equities that provide a high but sustainable dividend yield.

Reasonable yields: The methodology attempts to lower the exposure to companies that might cut their dividend by avoiding those with extreme yields, as these companies have been shown to be more likely to experience dividend cuts.

No dividend cuts: Companies that have cut their dividend within the past 12 months have been shown to be more likely to experience subsequent dividend cuts. As such, a company that has cut its dividend over the past 12 months or has a forecasted dividend cut cannot be added to the index.

Sustainable payout ratio: Research has shown that companies paying dividends that are a high percentage of their earnings are more likely to experience dividend cuts. Investors should look to companies with a reasonable and sustainable payout ratio to lower this risk.

Financial and operational strength: Companies with weak financial and operational metrics and/or showing weakening trends in these areas may be unable to generate sufficient cash flow to offer a sustainable dividend payment. Ensuring that companies have financial and operational strength and improving trends can help to avoid dividend cutters.

Finding yield will continue to be a challenge for investors in 2017 and beyond. Choosing ETFs that are focused on delivering a high, sustainable and predictable yield will be critical to successful asset allocation.

Keith McLean is President and Chief Investment Officer at Sphere Investments. With more than 20 years of equity investment analysis and portfolio management experience, Keith has a long track record of successfully managing billions of dollars of assets for some of Canada’s largest investment managers. This article first appeared in the Fall 2016 issue of Your Guide to ETF Investing, published by Brights Roberts Inc. Reprinted with permission.

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Commissions, trailing commissions, management fees and expenses all may be associated with fund investments. Please read the simplified prospectus before investing. Mutual funds and exchange-traded funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated. The foregoing is for general information purposes only and is the opinion of the writer. No guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

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