Walking a High Wire for High Dividends
August 25, 2015
Focus elsewhere for dividends.
If you didn’t see the recent report from Richard Bernstein of Richard Bernstein Advisors entitled “The Black Widow Returns” check it out. It’s a great piece, with a warning for investors who are stretching for dividends at this point in the credit cycle.
Bernstein’s, who manages the Redwood Global Equity Strategy Class, contention is that investors are ignoring the risks associated with higher yields, whether in REITs, MLPs, Emerging Market debt.
High dividends yields alone, can be concerning for the following reasons:
1. Dividend yields climb as stock prices fall – when dividend paying companies get into trouble, their stock price falls, and their dividend yield, (dividend amount divided by stock price) increases. High dividend yields, particularly those that stand out in a peer group, can be a sign of trouble, and that a dividend cut could soon be coming.
2. Companies may choose to pay out significantly all of their cash flow in dividends. A payout ratio is the amount of cash flow that available to cover a stated dividend policy. As a company’s payout ratio reaches 100%, it limits that amount of financial flexibility a company may have. Companies can have payout ratios of more than 100% for a short amount of time, often to avoid cutting their dividend, however a policy of paying out more than 100% of cash flow is unsustainable, and would either require more equity or debt to finance if a dividend cut was not imminent.
3. Significant dividends can also be a sign of a low growth business. Companies that pay out a significant amount of their cash flow, are signalling that they are no longer re-investing in the growth of the business.
An excerpt from Bernstein’s report shows that high yield dividend equities are in a bear market. Meaning, those investors who have been selecting securities for yield alone, have been punished of late. What’s more, is that the safety that investors feel comes with dividend investing is also much less protection than is likely anticipated.
While many investors seek safety in higher yields, high yields themselves are often a sign of problems present or looming. In addition, companies with yields and no growth, are susceptible to periods of inflation or rising rates as they tend to trade very much like bonds.
Bernstein is widely touted as one of the top investment strategists on Wall Street, and perhaps the World. He earned that reputation through his twenty year career at Merrill Lynch, most recently as their Chief Investment Strategist.
Bernstein has successfully transitioned from strategist to portfolio manager in large part because his approach has not fundamentally changed. The Redwood Global Equity Strategy Class is less than a year old, however a similarly managed fund with Eaton Vance in the US has very performed well and attracted over $1 billion USD.
Bernstein takes a top-down approach, meaning, he does not pick individual stocks, but manages his portfolio exposures (geography, capitalization, sector, style) through his quantitative analysis of market cycles.
The Redwood Global Equity Strategy Class top-down investment approach is unique in Canada, and we believe can be a great complement to the many value-oriented global equity funds available.
In addition to the Redwood Global Equity Strategy Class, managed by Richard Bernstein Advisors, we have two strategies in the Redwood fund lineup that provide clients exposure to dividends and dividend stocks, without the inherent risks of chasing securities for yield alone.
Redwood Emerging Market Dividend Fund
High dividend yields alone can be a sign of danger. High dividend yields can often be at risk of being cut, or may not be supported by cash flow.
The manager of the Redwood Emerging Market Dividend Fund, readily sacrifices dividend yield, or accepts a lower dividend yield, in exchange for higher quality, cash generative companies and higher growth rates.
While not a perfect comparison, we have used the WisdomTree Emerg
ing Markets Equity Income ETF – an index of the highest yielding emerging markets stocks – against the return of our Redwood fund.
We can see that in 2013, a divergence occurred between high dividend stocks, represented by the WisdomTree ETF and dividend growth stocks, represented by the Redwood EM Dividend Fund.
Investors focusing on yield alone, have seen their capital erode, whereas investors focused on dividend growers have since a meaningful gain, in what has been a difficult period for emerging markets.
With little materials exposure, the Redwood Emerging Markets Dividend Fund is an excellent diversifier for Canadian investors.
Redwood Floating Rate Preferred Fund
Floating rate preferred shares offer attractive yields that will grow as interest rates rise. Floaters currently represent approximately 6% of the outstanding preferred shares, but are estimated to grow to over 20% of the market by 2020.
Floating rate preferred shares offer solid dividend yields today, while protecting Canadians’ buying power into the future with increasing dividend yields as rates increase.
Here’s why one would own this fund:
• Safety of capital by investing in investment grade companies, where risk of default is low
• High nominal and tax adjusted dividend yields, with preference of payment and capital over common shareholders.
• Floating rate preferred shares are a growing part of the preferred market
The Redwood Floating Rate Preferred Fund was launched in June to provide Canadians access to a consistent stream of tax efficient income from investment grade companies.
For more information visit www.redwoodasset.com