Yield is getting scarce.
Not only are bond yields close to the lowest they’ve been in decades, but negative interest rates across select markets in Europe could also cause U.S. (and possibly Canadian) bond yields to sink even further.
Heck, if the U.S. embraces negative interest rates as President Trump so desires, global investors could one day find themselves ditching the bond market for bond proxies or defensive dividend stocks. Such a phenomenon would cause yields of your favourite bond proxies to drop, but their stocks would soar as a result.
Bond proxies
So, instead of trying to hunt for yield in the bond market, it may make more sense to look to the equity market for bond proxies that remain much more rewarding than most options available with debt securities.
Many bond proxies have become quite expensive over the past year, but I still think they’re more than worthy of their premium multiples given the fact that yield could become even more scarce moving forward should recession fears return.
Consider a bond proxy with monopolistic characteristics like Hydro One (TSX:H).
For those unfamiliar with the name, it’s an electricity transmission and distribution utility that has a virtual monopoly in the province of Ontario. About 99% of the business is regulated, meaning there is almost no room for the surprises or uncertainties that typically accompany stocks.
The Ontario government owns around 47%, so in terms of stability, it’s hard to match the company, which is a prime example of a bond proxy.
Being a highly-regulated company is both a blessing and a curse. As you may know, monopolies are subject to scrutiny from regulators, and Hydro One isn’t exempt. Such a company would naturally have the power to substantially hike rates without suffering from a significant loss of business. But with regulators only allowing the firm to hike rates by what are deemed as “fair,” Hydro One is destined to be a growth laggard relative to many of its peers in the utility space.
Slow and steady
The growth has dried up at Hydro One. And thus far, management has been unsuccessful with its attempt to break into the “growthier” U.S. market after its Avista deal fell through. Hydro One’s strong government influence may be seen as a massive vote of confidence for the firm’s stability, but it’s also a burden on the firm’s growth.
Fortunately, Hydro One is open to reducing its stake to around 40%, which could open up more acquisition doors in the distant future.
For now, Hydro One is a Steady Eddie with a growth problem, but that doesn’t mean you should ignore Hydro One, especially if you’re in the market for a bond proxy.
You’re getting a 3.9% yield at a reasonable valuation (17.7 times forward earnings) and an extremely low correlation to the broader equity markets (0.1 beta). For a retiree or extremely conservative investor on the hunt for yield, Hydro One is a solid bet. For everybody else, including millennials, the name is unlikely to deliver outsized results over time unless we fall into recession.
