Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and powered by Canada Life.

For today’s Soundbites, we’re talking about the impact of rising interest rates on dividend-paying companies. Our guest is Adam Rivers, assistant vice president, and portfolio manager with Mackenzie Investments. We asked about the implications of debt management on a company’s dividends, dividend-payers he likes right now, and we started by asking about the typical impact of rising interest rates on dividends.

Adam Rivers (AR): So, to the extent that a dividend-paying company has debt outstanding, the higher interest rates are obviously going to reduce the earnings, and therefore the company’s ability to pay that level of dividend. It’s more dilutive to the dividend growth, earnings growth going forward. So, assessing balance sheets and debt maturity schedules become quite important now in terms of how the debt is rolling over, what the refinance risk is, and what impact that could have on dividends.

The correlation between dividend-paying companies and higher interest rates.

AR: When we saw interest rates fall dramatically, this actually resulted in growth stocks and, in particular, technology stocks outperforming significantly the more value-oriented, dividend-oriented companies. The lower rates help higher-growth companies more. So, when rates started to rise off the bottom, you actually saw value- and dividend-oriented companies do quite well. And you saw tech start to underperform. You saw that reverse.

Competition for investor attention.

AR: Higher interest rates can make fixed-income assets look more attractive. Where it impacts is on fund flows. I don’t think that means that dividend stocks can’t perform well because certain fixed-income assets look more attractive than they have in recent history. But it depends on the sector. So, the most exposed to this idea would be those bond proxy-like sectors, areas of the market where their underlying assets have benefited from large institutional flows chasing yield, due to historically low interest rates. So, think utilities, think real estate, think infrastructure. These are areas that would be most exposed to that concept of yield competition. I think there’s a lot of asset allocators that are probably thinking about picking a spot to start moving some funds from equities into fixed income. But obviously a key differentiator between dividends and coupons is that dividends grow over time.

What dividend payers he likes right now.

AR: One sector we’re watching closely right now is the real estate income trusts, so REITS, and in particular the multi-family residential space. So, take a stock like Canadian Apartment Properties, CAPREIT [based in Toronto], the largest apartment landlord in the country. It’s down 34% from its 52-week high. So, we think there’s pretty attractive upside in a name like that. Another area would be the utilities sector, less on the regulated utilities but on the renewables side, independent power producers. Many of these companies have seen their multiple contract with rates, but the fundamentals remain sound. Capital Power [based in Edmonton] is a name we hold in our fund. They are a direct beneficiary from elevated power prices. So, they have quite a bit of merchant power exposure to Alberta, which is seeing very elevated power prices at the moment. So, they have a good tailwind there. Also, a name like that’s going to have much lower leverage so, again, less impact on cash flows from higher rates. And it’s already kind of at a lower valuation level. So, we like some of these power producers like Capital Power.

And finally, what’s the bottom line on dividend-paying companies in a rising-rate environment?

AR: Not all rising-rate environments are created equal. I would say the rising-rate environment has been positive for dividend investors. When we were more in that reopening normalization phase of the increase in interest rates, and the markets were quite strong, you saw value take leadership, you saw dividend investors outperform growth, catching more of the upside. Looking forward, I still think the outlook is good for dividend investors, relatively speaking. I think expectations for equity returns are going to be more moderate over the next few years. If you look at history, dividends generally represent 40% to 50% of investors’ total return. But if we have more moderate equity returns, that number could increase to 70% to 100%. And I think that plays to the benefit of dividend investors.

Well, those are today’s Soundbites, brought you by Investment Executive and powered by Canada Life. Our thanks again to Adam Rivers of Mackenzie Investments.

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