Defence That Pays: Dividend Equities as a Long Term Strategy

Defence That Pays
Dividend Equities as a Long-term Strategy

by Alfred Lee, CFA, CMT, DMS
Vice President & Investment Strategist
BMO ETFs & Global Structured Investments
BMO Asset Management Inc.
alfred.lee@bmo.com

March 29, 2012
Recent Developments:

• Despite the global macro-economic concerns that remain, year to date, investors have clearly favoured risk-assets as improving sentiment has led global equity markets to rally with significant breadth. Although, investors should not put too much focus on day-to-day headlines, last Thursday’s reading of Europe and China’s weak Purchasing Managers Index (PMI), shows how the global economic recovery remains vulnerable. While we have become more optimistic over the mid-term, we still remain concerned on the structural issues remaining over the long-term, and is why we continue to recommend that investors do not throw caution to the wind.
• News of Greece’s debt restructuring several weeks ago, has put concerns on the backburner; although we believe Greece’s solvency issues remain over the long-term. On a short-term outlook, this has lifted a major overhang on the equity markets. Investors should note, however, that credit default swap (CDS) prices of Portugal still remain elevated (Chart A). Moreover, China’s potential housing bubble and inflation handcuffs the nation’s ability to implement a wholesale monetary easing policy. Thus, unlike 2009, China will not be able to shoulder the global economy.
• The year-to-date rally in risk-assets hinges on whether U.S. economic data can sustain or continue to build positive momentum. Although we have increased our recommended allocation to Canadian equities, we still remain defensive in our composition. Concerns on China should weigh on some commodity-based equities over the short-term, so we recommend that investors look at non-cyclical areas such as dividend paying equities in Canada.
• In addition to being more defensive in nature, lower bond yields should lead investors to look to dividend paying equities to source yield. Currently, the 10-year government bond yield is less than the dividend yield of the S&P/TSX Composite Index (TSX) (Chart B). An aging demographic searching for income distributions should provide a further tailwind for dividend paying equities over the long-run.
• Improving economic data has also recently led the yield curve to shift upwards (Chart C), which has negatively impacted bonds, especially those of longer maturity. As we have become more bullish on equities over the short- and mid-term, investors may want to consider reallocating some bond exposure to dividend paying equities as a way of maintaining overall portfolio yield while decreasing duration risk. Investors should keep in mind that equities and fixed income do react to risk in different manners and therefore should keep in mind their overall portfolio risk composition.

Investment Idea:

• Investors may want to consider the BMO Canadian Dividend Equity ETF (ZDV) as an efficient way to gain exposure to a basket of 50 large and some mid-cap Canadian dividend paying stocks. Currently, the underlying portfolio yields 4.5%, diversified across eight different sectors and a management fee of only 0.35%. In addition to being eligible for a dividend reinvestment plan (DRIP) like our other BMO ETFs, ZDV pays a monthly distribution. We continue to recommend defensive holdings such as ZDV as core positions and more cyclical oriented themes around the peripheral as more tactically oriented themes.

Chart A: CDS Prices on Portugal Remain Elevated

Source: BMO Asset Management Inc., StockCharts.com

Chart B: Canadian Bonds Yielding Less than Canadian Equities

Source: BMO Asset Management Inc., Bloomberg,

Chart C: Yield Curve Shifting Upwards Will Impact Fixed Income

Source: BMO Asset Management Inc., Bloomberg

*All prices as of market close March 27, 2012 unless otherwise indicated.

Disclaimer:
Information, opinions and statistical data contained in this report were obtained or derived from sources deemed to be reliable, but BMO Asset Management Inc. does not represent that any such information, opinion or statistical data is accurate or complete and they should not be relied upon as such. Particular investments and/or trading strategies should be evaluated relative to each individual’s circumstances. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment.

BMO ETFs are managed and administered by BMO Asset Management Inc, an investment fund manager and portfolio manager and separate legal entity from the Bank of Montreal. Commissions, management fees and expenses all may be associated with investments in exchange-traded funds. Please read the prospectus before investing. The indicated rates of return are the historical annual compound total returns including changes in prices and reinvestment of all distributions and do not take into account commission charges or income taxes payable by any unit holder that would have reduced returns. The funds are not guaranteed, their value changes frequently and past performance may not be repeated.