For decades, the dividend investing playbook in Canada was simple. Step one, invest in dividend stocks. Step two, make lots of money. That’s pretty much it.
Canadian dividend funds and portfolios all performed more or less the same – that is, consistently beating the broader stock market over the long term.
From 2000 to 2020, the S&P/TSX Composite Index generated a total return of 6.3 per cent a year, versus 9.7 per cent for the Dow Jones Canada Select Dividend Index. Can’t argue with that.
But the game has changed. In a higher interest rate environment, the dividend space is a lot trickier to navigate.
For the better part of 40 years, bond yields moved in one direction, from the double-digit peak of the early 1980s to the near-zero lows of the pandemic in 2020.
This historic, structural downtrend served as a near-constant tailwind for a generation of dividend investors.
Declining bond yields reduce competition in the income space by making dividends more attractive by comparison. They also cut borrowing costs for companies carrying debt – helpful in capital-intensive sectors like utilities and real estate investment trusts, which also happen to be generous with dividends.
Not only has a basket of dividend stocks been a spectacular performer in Canada for a very long time. It has also been less volatile and has held its value better in a falling market, according to an analysis by Craig Basinger, chief market strategist at Purpose Investments.
“Canadians have unconditional love for dividends for good reason,” Mr. Basinger said.
Few ideas in Canadian investing command that kind of loyalty. Most other hot themes have crashed and burned at some point, such as technology, marijuana, gold, forestry, or energy, Mr. Basinger added.
Not dividends.
Even over the last five years, as high inflation made an unwelcome return and ended the era of ultralow interest rates, dividend stocks have still done well, posting about 15 per cent annualized returns.
No one is complaining about 15 per cent a year. The problem is, that’s in line with how the TSX itself has performed. Both have been equally volatile, as well. The advantage of dividend strategies seems to have vanished.
“In a higher or more normal yield environment, perhaps the defensiveness of the dividend factor doesn’t hold,” Mr. Basinger said.
It would be one thing if dividend investors merely had to settle for market returns. Dig a little deeper, however, and you can see a more important pattern developing.
Divergence within the dividend universe is rising, quickly. Up until the pandemic, the group traded pretty much in unison, rising and falling within a very small range of one another.
Since then, the variance between major dividend funds in Canada has roughly tripled, Purpose’s analysis showed. “Suddenly, it matters how you are getting your dividend exposure,” Mr. Basinger said.
Lately, success in dividend investing has been more a function of choosing the right sector. Last year, it was gold stocks. Then it was oil and gas. Lately, the big banks have risen to the top of the leaderboard. If your chosen dividend fund, or do-it-yourself alternative, has been skewed toward the right industry at the right time, you’ve done well.
There is risk in concentration. How confident are you that you could correctly choose and time the next hot sector in the dividend space? In such an environment, diversified dividend exposure within a well-rounded portfolio may be the smarter move. Just don’t expect the same market-beating edge dividends provided in years past.
The winds could always shift again. Maybe this is but a brief interruption to the golden age of dividend investing. Perhaps we go back to the way things were – the rise of protectionist politics fizzles out, globalization regains its footing, the oil supply disruption ends, excess inflation disappears once and for all, and bond yields resume their four-decade decline toward zero.
It’s a nice fantasy.