Canadian equities markets delivered solid, double-digit returns last year, but managers of Canadian dividend and income equity funds believe that 2011 could be relatively less rewarding.

“In 2009 and 2010, we had periods categorized by declining interest rates and economic recovery,” says Juliette John, vice president with Calgary-based Bissett Investment Management Ltd. , a unit of Toronto-based Franklin Templeton Investments Corp., and manager of Bissett Canadian Dividend Fund. “As we move into 2011, when the recovery is more mature, our view is that corporate earnings are likely to be less robust on a year-over-year basis. The comparisons are going to be much tougher to maintain.”

John does not anticipate strong earnings growth, which would push share prices and multiples higher.

As the economy improves, says John, it’s likely that the Bank of Canada will withdraw some of its monetary stimulus this year by resuming the upward trend in the overnight bank rate. “This tends to limit multiple expansion for equities,” she says. “Combined with weaker earnings growth, it could limit the amount of capital appreciation that investors might enjoy in 2011.”

She says stock-picking will be more important in 2011 than in the past two years: “To us, a more yield-oriented portfolio might do well on a total-return basis. If capital gains are within the single-digit range, individual securities with a 3%-5% yield could be in a really good position to not have to generate outsized capital gains. They would also be less volatile.”

A bottom-up investor, John focuses on companies that generate strong cash flow, pay above-average dividends and have demonstrated dividend growth. The Bissett fund, which contains about 35 names, has 35.2% of assets under management in financial services, 22.8% in energy, 15.1% in consumer discretionary, 10.2% in telecommunications and smaller holdings in sectors such as utilities.

One top holding is Thomson Reuters Corp. A long-term position, it has been a laggard since Thomson Corp. acquired Reuters PLC two years ago. But the merged firm is expected to reap the benefits once it completes the integration this year.

“It has a really strong enterprise with respect to the financial markets,” says John, noting that the stock trades at 16.8 times earnings. “Whether it’s the legal, health-care sector or professional services businesses, they are strong, free cash-flow generating businesses. We believe the dividend growth will be above average once the integration is all done. But the valuation will expand once investors become more confident with the business.”

Thomson Reuters’ stock price is about $40; the stock has a 3% dividend yield. John has no stated target.

Another favourite is Bank of Nova Scotia. “What makes it different from other banks is its discipline,” says John. “It has assembled a very strong portfolio of assets in markets outside of North America, which tend to be higher-growth and underserved. The opportunities are better for earnings growth, relative to the other Canadian banks.”

At $57 a share, Scotiabank’s stock is trading marginally higher than its peers, at a price/earnings multiple of 12.5, says John: “But the multiple is warranted because of the strong management, and we expect earnings to grow at a faster rate than its peers.”



Equally cautious is Michael Sim-pson, vice president of Toronto-based Sentry Select Capital Inc. and co-manager of Sentry Canadian Income Fund.

“There are challenges on a number of fronts,” says Simpson, who shares duties with portfolio manager Aubrey Hearn. “Some European countries have varying levels of debt that have to be worked out sooner or later. Canadian manufacturers have a headwind in the form of a strong dollar. Forecasts call for the dollar to trade between par [with the U.S. dollar] and US$1.05 at the high end. And higher energy prices could be a headwind, for both consumers and businesses.”

He adds that high gasoline prices act as a tax on consumers, and thus slow consumption.

Although global growth has resumed, inflation has also accelerated, particularly in emerging markets. However, as long as the global recovery is continuing, and China is using excess savings to invest abroad, including in North America, says Simpson: “This is good for Canada and other commodities-producing countries. Certain regions of Canada will be big winners.’

Looking ahead at potential equities returns, Simpson argues that conditions are in place for a positive year: “Forecasts are calling for 3% [gross domestic product] growth in the U.S., and slightly less for Canada. Credit is a lubricant for the market, and it’s still growing.”@page_break@Bottom-up investors, Simpson and Hearn have allocated about 22.5% of the Sentry fund’s AUM to energy, 19.7% to real estate investment trusts, 14.6% to consumer staples and discretionary, 13% to industrials, 9% to utilities and infrastructure, and 6% to financial services. There are smaller holdings in areas in such as health care. Says Simpson: “The financials have had a great run.”

One top financial services holding in the Sentry fund is CI Financial Corp. The mutual fund company is “extremely well run, with strong profit margins,” says Simpson. “There was speculation that Scotiabank would take over the rest of the shares it didn’t own, but the bank took a different route and bought the rest of DundeeWealth Inc.”

Pointing to other fund-industry takeovers, he adds, “We see continued consolidation. At some point, Scotiabank might take over CI or someone else will bid for [its] stake.”

CI pays a 4% dividend and has a history of dividend growth. Its shares are trading at about $21.60. Simpson’s 12-month target is $23.

Another favourite is Montreal-based Alimen-tation Couche-Tard Inc., North America’s second-largest operator of convenience stores, especially dépanneurs in gas stations. The company generates about 65% of its revenue from gasoline sales.

Couche-Tard’s stock is trading at about $26.80 and pays a 0.8% dividend. Simpson’s 12-month price target is $31.



This Year Will Continue to see positive returns, despite all the challenges ahead, says Domenic Monteferrante, first vice president, Canadian equities, with CIBC Global Asset Management Inc. in Montreal and manager of CIBC Dividend Growth Fund.

“We’re still in the healing stages in the developed world,” he says. “The sovereign-debt situation in Europe, which could lead to austerity measures, and a high deficit situation in the U.S. are structural issues that will take time to sort themselves out. We can’t expect a robust economy. But corporations are in much better shape than governments or consumers.”

Based on a belief that global growth is improving, Monte-ferrante says, corporate earnings will be positive. “We would favour equities over fixed-income, on a relative basis,” he says. “In some cases, you can get decent dividend yields that compete with bond yields. Plus, you have the option of capital appreciation, which we think will be challenging for fixed-income.”

Although market pullbacks are possible this year, Monteferrante says, they will create buying opportunities to add to existing holdings or acquire new ones: “It could be the market as a whole, or just specific sectors. But we could expect some opportunities over the course of the year.”

Interest rates may edge higher, he adds, but “not enough to derail the economy. Having said this, dividend-paying stocks could do well in this environment.”

Running a 70-name fund, Monteferrante is aiming for a dividend yield in the CIBC fund that is 1.2 times higher than the S&P/TSX composite index’s yield of 3.36%. From an asset-allocation viewpoint, about 36% of the CIBC fund’s AUM is in financials (which includes a 6% REIT weighting), 23% is in energy, 11% is in materials, smaller weightings are in sectors such as industrials and telecommunications, and about 4% is in cash.

One top REIT name is RioCan REIT. A landlord and owner of shopping malls, RioCan stands to benefit from the arrival of Target Corp., the U.S.-based firm that has acquired Zellers. “This could help support higher rental income from adjacent stores,” says Monteferrante. “This is early days, of course. But there is underlying support.”

More important, RioCan pays a 5.9% dividend. Its stock is trading at about $23.30. Monteferrante has no stated target.

Another favourite is Enbridge Inc. Although the utility is seeing earnings growth of about 10% a year, dividend growth is higher because capital expenditures are not as demanding as they have been in the past five years. The stock is trading at 20 times 2012 earnings, or at a premium to the market, but Monteferrante argues that the multiple is warranted because Enbridge has been a consistent performer: “Is it so overvalued that we think of trimming it? No. I believe the company could deliver over time.”

Enbridge’s stock price about is $58 and yields 3.4%. IE