As interest rates, and, therefore, savings accounts and cash ISAs, set to remain lower for longer, as confirmed by a dramatic global central bank dovish about-turn, the search for yield is set to continue.
Investors have been looking for investments that can pay them an income, particularly in or near retirement, ever since rates tumbled to multi-year lows after the financial crisis. That has culminated in higher demand for alternative assets, including some esoteric areas like aircraft leasing and ever-more exotic fixed income instruments.
But there’s still plenty of income to be found in the traditional equity asset class. The UK’s blue-chip FTSE 100 index continues to pay a high yield, currently inflated by such negative sentiment surrounding UK shares.
Elsewhere, Asia continues to see higher pay-outs and Japanese companies are returning more cash to shareholders than ever before. Of course, the US is still fertile ground for all types of investor, but one under-appreciated market for income-seekers is its North American counterpart, Canada.
In 2018, dividends paid by Canadian companies produced the fastest underlying growth among all major developed economies, at 11.8% to a record $41 billion, according to the latest dividend index compiled by asset manager Janus Henderson.
Canadian dividend payments took a hit when the oil price slumped between 2014 and 2016, with the sector accounting for a high portion of the index. But since 2016, dividends have grown by almost a third.
Canada has a disproportionate number of companies that pay high dividends, according to Dean Orrico, manager of LSE-listed Middlefield Canadian Income (MCT), yet generally North American income funds eschew large parts of the market in favour of the US.
True, Canada’s big dividend payers are almost as highly concentrated as the UK’s, with oil and banks accounting for the vast majority of 2018’s increase in payments – nine of the 10 top contributors were, in fact, from these two sectors.
Canada also has a few sectors that are not represented, healthcare and technology, for instance. As a result, the trust invests in US companies in order to give shareholders greater diversification.
That said, Orrico says the Canadian market – and its economy more generally – is more diversified than many may think. “We can offer investors much more than energy and commodities,” he explains.
Indeed, he thinks the fact that Canada is predicted to grow GDP in 2019 at between 1.5% and 2% despite oil prices having declined recently to around $50 proves just how much diversity there is.
That said, oil and banks are big components of Middlefield’s portfolio. Orrico picks out three sectors he’s finding income from in Canada today.
Banks
The banking sector is a key component, with three Canadian banks being part of the portfolio. Two of these – Bank of Nova Scotia (BNS) and Canadian Imperial Bank of Commerce (CM) – are in the top 10. All three have bumped their dividends between 2-3% annually in recent years, he says.
In fact, Orrico adds: “Our Canadian banks have not missed an annual dividend bump since the end of the second world war. It’s become a very cultural thing that they now if they ever stop doing that there would be major concerns in the market.”
He expects this to continue and remains positive on the outlook for the sector.
Oil Pipelines
With such a reliance on oil, you would imagine the price of the commodity would be important to Middlefield’s returns. However, Orrico has been trying to reduce its reliance on something that is difficult to predict.
“[Oil] has been a very difficult market, so the way we’ve chosen to play it over the last five years has been to get exposure to the pipeline companies,” he explains. Indeed, of his 30% exposure to oil, two-thirds of that is towards pipelines.
Pipeline firms are able to grow their cashflows and revenues regardless off the volatility of the oil price because they sell their capacity to host pipelines on what is known as a “take-or-pay basis”. This means the companies who take capacity must pay for the pipelines they buy, whether or not they fill them.
Enbridge, the largest oil pipeline company in the world, is the largest position in the fund, at over 5% of assets. It has a dividend yield of around 6.5% and upped their pay-out by 10% last year and have committed to the same rise for the next two years.
Enbridge is well placed, Orrico adds, because there has not been a new pipeline built in Canada for 30 years. “So, while oil production has gradually increased, we haven’t had a new pipeline built because of regulatory and environmental issues.”
But Enbridge is now in the process of replacing one of its older pipelines, which runs from Canada to the US. The project should be completed in late 2020 and will help bump up capacity and, in turn, drive cashflow higher and give further comfort in bumping up the dividend.
Real Estate
The final area Orrico is finding fertile ground is real estate, which is the largest sectoral weighting in the fund. He thinks real estate investment trusts (REITs) are “the single best equity income vehicle of any”.
“They’re the most stable, they grow their dividends on average between 3% and 5% every year, they can grow organically through acquisition and they have amongst the lowest payout ratios.”
Indeed, the recent global pivot from central banks to dovish policy that means rates are now likely to stay at historic lows, is a tailwind for REITs because investors usually underweight real estate as rates are going up.
There are three sub-groups Orrico likes in particular in real estate in Canada. One is industrial, which, he says, has gone from being “the most boring sub-group” to one of the most exciting due to the emergence of e-commerce.
“Before, you put up a warehouse on the outskirts of town, you got one tenant on a 10-year lease which went up typically by inflation every year – stable but pretty dull. That’s been completely turned on its head in the last three years almost entirely on the basis of e-commerce, on which the fundamentals are extremely strong.”
Apartments are also a sub-sector he likes, as there is a growing trend for renting, rather than buying. Particularly, migration to Canada is around 350,000 ar year, with around 40% going to Toronto.
“Given the relatively high price of single-family homes, immigrants tend to rent before they buy,” he explains. “Millennials definitely are renting more than they are buying so the demand for rental stock has been very significant and I don’t see that slowing down any time soon.”
Meanwhile, the office market in Toronto continues to blossom as the city becomes a hub for artificial intelligence and the big US tech companies start to base themselves there. The Toronto office market currently has a 2% vacancy rate, which is the lowest in 40 years, he adds.
Funds to Gain Exposure to Canada
Of course, Middlefield, which has a four-star Morningstar performance rating having almost doubled the MSCI Canada’s return since inception, will be one of the purest ways of investing in Canada for UK investors, but there are a few other vehicles, which are rated highly by Morningstar analysts.
While there are no investment trusts with a positive rating with particularly significant exposure, there are some open-ended offerings.
Two of these, the Silver-rated BlackRock Gold and General and Bronze-rated JPM Natural Resources, are focused more on commodities. The pair has 48% and 21% invested in Canada respectively.
The more diversified, Silver-rated M&G Global Dividend fund, meanwhile, has 18% exposure. Companies in the portfolio include Methanex, Gibson Energy and Keyera.
A few Toronto-listed exchange traded funds are highly rated by Morningstar. These include the Gold-rated Vanguard FTSE Canada ETF (VCE) and Vanguard FTSE Canada All Cap ETF (VCN).
Other Gold-rated ETFs are BMO S&P/TSX Capped Composite ETF (ZCN) and iShares Core S&P/TSX Capped Composite ETF (XIC).
