Cash, fixed income, equity and where to put them – asset allocation, in other words – is what plays on the minds of portfolio managers these days, more than I can ever remember. With the seemingly herculean efforts of governments and central banks around the world to continue to prop up anemic and crumbling economies, transparency and clarity comes at a premium. And because fiscal policies are so important to a healthy growing economy, especially with the burden of debt that many industrialized nations carry, it seems too often these policies and outcomes are held hostage by ideology and political interest. As investors, we really are up against one of the most complicated, frustratingly opaque investment environments in recent memory. The big question is, How do we deal with it?
The great Greek mathematician Archimedes said of the principle of a lever, “Give me a place to stand, and I shall move the Earth with it.” Similarly, central banks and governments around the world have all tried to exert influence over the markets, of an Earth-moving magnitude – not least of which is the U.S. Federal Reserve Board.
We all recognize that we need to “move” the debt burden through the fulcrum of the capital markets and their participants – banks, companies, and households. One can think of the lever as monetary policy, dictated by the Federal Open Market Committee, strategically placed to achieve the greatest force to move our object. We’ve witnessed three rounds of Quantitative Easing (QE) by the Fed – three attempts at resorting to this monetary lever, each with diminishing marginal returns and lessening effect on the credit markets and employment.
The objective, of course, is to get people back to work so that subsequent economic growth can then do most of the heavy lifting – diminishing the impact of debt on the current fiscal situation. Having the economy grow lessens the constraints that debt places on budgets through its ongoing servicing.
But I wonder what Archimedes would say if he had an opportunity to work the problem? The problem is that our pry bar (monetary policy) isn’t rigid enough to bear the Earth-moving load anymore. I think of it more along the lines of over-cooked pasta now – very thin overcooked angel hair pasta.
Let’s recap: A huge debt burden, successive rounds of QE with diminishing impact, anemic GDP growth on the verge of constantly tipping back into negative GDP growth, and increasing fiscal austerity. Last but not least, a risk-reward tradeoff that has been skewed via a false equilibrium brought about by central banks using the proverbial monetary lever to reduce bond yields. How has the risk-reward decision-making process been skewed?
As of Dec. 31, the dividend yield for the S&P/TSX Composite Index was 2.93%. The 10-year Government of Canada bond yields 2%. The question every investor needs to ask is, “Where is the risk”? Today, in a bid to stimulate growth and employment, central banks have reduced interest rate to historical lows. This has helped push bond prices higher, all while investors piled into yield-bearing instruments during the near collapse of the U.S. banking system through 2007-08.
Recently, we’ve seen these same bonds start to decline in price, nothing major and nothing too dramatic. However, could this portend the start of bond re-pricing, or, without the double-talk of technical niceties – bubble bursting? I don’t know for sure – no one does. However, I know that there’s some value in equities, equities of good businesses that pay dividends.
Dividend equity investing has paid off handsomely over the past five years. In most cases, well diversified dividend equity portfolios have performed very well relative to a Canadian market that has just broken even. Furthermore, the dividend strategy has exhibited far less volatility than the overall market, making it easier to stay invested for a longer period of time and hence a better chance of seeing success.
In the meantime, investors in dividend equities get their quarterly dividends. It’s important to note that not all dividends are made equal, it’s paramount to invest in companies that have shown a track record for strong dividend growth while controlling for payout ratios. This does two things: It tells me that the management of the company has the expertise to grow the business, and it reassures me that if we run into volatile markets, I can collect my dividend and wait out the roller coaster.
In the end, one can’t rely on one mechanism to do the job, that’s why I still own bonds. I have, however, reduced my durations by holding short-term bonds, thereby lessening the impact of any increases in interest rates. Portfolio managers and individual investors alike must find their own portfolio levers to mitigate risks. Right now, it’s about finding solid dividend stock.
Mark Taucar is a Senior Portfolio Manager at R.N. Croft Financial Group Inc., where he manages overall investment strategy. He works with institutional and individual investors seeking access to enhanced-income strategies with risk mitigation. Mark manages the Active Management Portfolio Program Canadian Conservative Equity Pool and Active Management Portfolio Program Income Pool for clients of R.N. Croft Financial Group Inc.
Notes and Disclaimers
© 2013 by R.N. Croft Financial Group Inc. The information contained in this article is provided by R.N. Croft Financial Group Inc. (CFG) for general informational purposes only and is not intended to provide, and should not be relied upon as providing, legal, accounting, tax, financial, investment or other advice, or a solicitation to buy or sell any securities. The information was obtained from sources believed to be reliable, but cannot be guaranteed to be current, accurate, or complete. Commissions, trailing commissions, management fees, and expenses all may be associated with managed investments, and investment vehicles mentioned involve risk of loss. No guarantee of performance is made or implied. CFG is not responsible for any errors or omissions contained herein.