Invesco Canada blog

Insights, commentary and investing expertise

Marina Pomerantz | August 23, 2018

Managing a dividend portfolio when rates rise

Recent monetary tightening in Canada and the U.S. has put dividend investing in focus, and some investors may be tempted to migrate their income portfolios toward the perceived safety of bonds.

Given this backdrop, it’s important to understand how your dividend portfolio is managed. The investment philosophy that underpins Invesco Global Dividend Class1 applies to the dividend-investing space in the current market environment.

Dividends account for approximately 50% of investment returns in the Global universe,2 so including dividend-paying stocks in a diversified investment allocation for clients has proven to be a good strategy across market environments. Moreover, an analysis of historical market performance reveals that dividend-growth stocks outperform after the U.S. Federal Reserve (Fed) increases its key rate.3

The Invesco Canada Global Equities team believes there are several elements of our investment process that, when applied to dividend investing, are particularly attractive in the current environment.

With a focus on quality, our selection process favours free-cash-flow generation and high returns on invested capital. We apply these criteria to dividend investing by looking for companies that display strong growth in free cash flow – the cash that remains available to them after they pay their obligations to employees and suppliers – because it is the lifeblood of the business. It represents the “dry powder” that the business can reinvest back into operations to earn high returns and generate growth. Alternatively, management can return the cash to shareholders.

We believe this approach helps enable us to find companies that can grow their dividends sustainably. Evidence of this can be seen by the fact that Invesco Global Dividend Class tends to have a higher dividend growth rate4 than its peer group, higher ROIC and a lower payout ratio.5 This makes sense because the businesses in our Fund have more reinvestment opportunities at high rates of return; thus, they can retain more cash in the business to generate future free-cash-flow growth.

We also seek out companies with organic growth and a sustainable competitive advantage. These criteria lead us to firms that have growing and resilient earnings and cash-flow streams that are protected by unique elements in their business model and/or industry structure.

Oftentimes many dividend-paying companies have low growth and rely on debt or constant issuance of equity to fund their operations. When interest rates rise or market conditions become less conducive to equity issuance, such companies face challenges with accessing capital or covering their rising interest-rate burdens. Consequently, they may suffer declines in their stock prices.

Our approach generally allows us to avoid such companies in favour of businesses with sustainable growth that can partially fund operations through internal cash-flow generation. This helps us populate our high-conviction dividend portfolio with businesses that can compound wealth in multiple market environments.

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1 On July 27, 2018, Trimark Global Dividend Class was renamed Invesco Global Dividend Class.
2 Source: Morningstar Research Inc., as at December 31, 2017.
3 Copyright 2016 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. Average performance after all rate hikes since 1972. Dates of rate hikes: 1/15/73, 8/31/80, 4/9/84, 9/4/87, 2/4/94, 3/25/97, 6/30/99 and 6/30/04.
4 As measured by the Fund’s 10-year dividend growth rate.
5 Source: FactSet Research Systems Inc., as at June 30, 2018 or earliest available. The peer group for Invesco Global Dividend Class consists of the top 10 category peers, which are defined as those “dividend funds” in the Global Equity category with the largest average market capitalization. Invesco Global Dividend Class has the 8th-largest average market capitalization against those peers. Funds of funds and index funds have been excluded from the comparison.

The information provided is general in nature and may not be relied upon nor considered to be the rendering of tax, legal, accounting or professional advice. Readers should consult with their own accountants, lawyers and/or other professionals for advice on their specific circumstances before taking any action. The information contained herein is from sources believed to be reliable, but accuracy cannot be guaranteed.

Commissions, trailing commissions, management fees and expenses may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the simplified prospectus before investing. Copies are available from your advisor or Invesco Canada Ltd. at invesco.ca.

These are the personal views of the author as at the date indicated, and not necessarily the views of Invesco Canada. The views expressed above are based on current market conditions and are subject to change without notice; they are not intended to convey specific investment advice. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions considered to be reasonable, there can be no assurance that actual results will not differ materially from such expectations.

Invesco® and all associated trademarks are trademarks of Invesco Holding Company Limited, used under license.

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