Bill Gross, manager of the PIMCO Total Return Fund (the world’s largest bond fund) until his departure in September 2014, recently published a decidedly bearish outlook for 2015. His main concern is that stimulatory monetary policies may have run their course and that investors may increasingly shy away from risky investments despite ongoing low interest rates.
He concludes his outlook by suggesting that at some point during 2015, asset returns in many categories may turn negative and suggests that investors focus on high quality assets with stable cash flows. This would include high quality corporate bonds as well as low-levered companies with attractive dividends.
Only time will tell whether 2015 will turn out to be an anus horribilis for investors in risky assets. However, real estate markets, bond markets and global equity markets have all performed well over the past five years with the U.S equity markets leading the way. Many risky assets seem to be, at best, fully priced and a 10-20% wider equity market correction during the year will not be surprising.
How can investors manage the volatility and downside risk?
The question is how investors should position themselves in a market environment where the reward for risk taking has been driven to abnormally low levels while the reward for holding cash or short dated deposits remains minuscule.
I have previously written about the attraction of dividend-paying companies that qualify as “dividend champions”. These companies generally have track records of consistent and growing dividend payments, rock solid balance sheets with low levels of debt, ample cash flow to cover the dividend payments, and reasonable growth prospects.
Unsurprisingly, the returns provided by investments in these types of companies continue to be attractive. To provide two North American examples, in the U.S, the S&P 500 index has returned 96% over the past five years compared to the 113% return provided by the Dow Jones U.S. Select Dividend Index. Over the past year, the dividend-paying companies performed 2.8% better than the broad equity market.
In Canada, the picture resembles the U.S. situation with dividend-paying stocks outpacing the general market by a wide margin over the past five years and also over the past year, albeit by a narrower margin. The table below provide the statistical backdrop. Although not indicated in the table, the volatility (read risk) of the dividend paying stocks was also lower than the overall market.
|Index||Currency||1-Year Total Return||5-Year Total Return|
|Dow Jones U.S. Select Dividend Total Return||USD||14.7%||113%|
|S&P 500 Total Return||USD||11.9%||96%|
|S&P TSX Canadian Dividend Aristocrats||CAD||11.0%||76%|
|S&P/TSX 60 Total Return Index||CAD||9.7%||42%|
Source: Thomson Reuters
In my view, investors can further protect their downside risk and improve their investment returns by applying some carefully selected filters to further enhance the quality of the portfolio. The criteria suggested above, as part of the “dividend champion” selections, could guide investors to select stocks that will be able to provide reasonable returns over the medium term.
In an article titled “A 6-Stock Dividend Champion Portfolio for 2015” on December 19, I highlighted stocks that could provide investors with acceptable returns over the medium term supported by attractive starting yield of 4.3% for the overall portfolio. The portfolio included Toronto-Dominion Bank (TSX:TD)(NYSE:TD), Telus Corporation (TSX: T)(NYSE: TU), H&R Real Estate Investment Trust (TSX: HR.UN), TransCanada Corporation (TSX: TRP)(NYSE: TRP), Fortis Inc (TSX: FTS), and North West Company (TSX: NWC).
A difficult year ahead
Market volatility (and bear markets) cannot be avoided but investors can management the volatility of their portfolios by focusing on high quality dividend-paying stocks with reasonable growth prospects.