The value of yield
FUND MANAGER WARMS TO TECH COMPANIES THAT ARE NEW TO THE DIVIDEND SPACE
With monetary policy driving much of t he economy and asset prices since the global financial crisis, fixed income investors are being forced to navigate an unusually volatile environment.
The Bank of Japan has formally gone negative in terms of interest rates, and European economies are experiencing negative yields through market action.
The U. S. seems to be going in the other direction, although investors recently saw another non- decision of sorts from the Federal Reserve. A 25- basis- point hike at the Fed’s December meeting now seems likely, and it’s up to the economic data to prove that thesis wrong.
The low-rate environment makes the goal of generating enough income to live much more challenging, which is why dividend- paying equities have emerged as an important part of the fixed income space in recent years.
Joanna Bewick, portfolio manager at Fidelity Investments, believes that with stocks making up 50 to 60 per cent of many investors’ portfolios, if they are not deriving every basis point of income possible out of these assets, money is being left on the table.
However, equities typi cally come with higher volatility than bonds do, and valuations are elevated in traditional high- dividendyielding sectors such as utilities and telecoms.
“I think the opportunities lie in not buying the highestyielding names,” she said, noting that lofty yields often signal a problem with the stock price.
Instead, Bewick highlighted sectors that are relatively new to the dividend space, including technology.
“They offer growth plus dividends, and that’s the best of b` oth worlds,” she said.
One holding that fits this criteria is Apple Inc. ( AAPL/
NASDAQ). “They’ve made a lot of things cool, and one of those things is dividends,” Bewick said. “It’s an example of a tech company with tremendous growth prospects, but is also offering a dividend. That’s the combination we’re looking for.”
She also highlighted the beaten- up industrial, materials and energy sectors, where higher- quality names that are poised to survive the commodity downturn, represents some value.
On the traditional fixedincome side, the portfolio manager i s underweight sovereign bonds — in the U. S. and the rest of the developed world.
In order to make up that yield, she has tilted toward corporate debt, and is overweight high-yield bonds.
The downdraft in oil prices had pushed high-yield spreads out very wide, and that gap collapsed this year with crude’s recovery.
“We’ve had a historic years in terms of strong returns from high yield,” Bewick said. “When you see some credit healing in that space, it has a huge impact on spreads and can offer terrific returns.”
That said, oil has been stuck in the US$40 to US$50 per barrel range, so the healing isn’t done, even with reports this week that OPEC had agreed to limit production.
Investors should also remember that there is a sympathy factor at work in high yield, whereby other sectors may move in tandem with energy, since it makes up about 15 per cent of the asset class.
“The defaults have been concentrated in the energy space — and are at a higher rate that at any time since the financial crisis,” Bewick said. “But much of that is behind us, and the rest of the highyield space looks pretty good in terms of credit metrics.”
That’s why she believes the strong performance of high yield can continue.
The price performance will unlikely be as strong as it was during the energy rebound, but Bewick believes that starting with a 6.5- percent coupon provides a huge cushion for any sort of price move.
Another area of focus for Bewick is inflation. While investors have had the luxury of very low inflation for many years, the portfolio manager thinks that can lull people into complacency.
“If you’re compounding two- per- cent inflation over 10 years, you’ve lost more than 20 per cent of your buying power,” she said.
That’s why Bewick has been buying real- return bonds in Canada. She’s not calling for a huge uptick in inflation, but she does think inflation protection is cheap.
“You want to buy it before you actually need it,” Bewick said. “Now is a good time.”