In 2013, Cambridge added three exciting additions to our lineup of dividend funds – Cambridge Canadian Dividend Fund, Cambridge U.S. Dividend Fund and Cambridge Global Dividend Fund. Given the large number of dividend funds in the market today, you may be wondering why we are choosing to highlight these funds and what our view is on rates for the future (higher).
Just like the philosophy we take with our equity mandates, we believe these funds approach yield investing differently than what most investors are used to.
In a world of very low interest rates, companies who chose to pay higher dividends tended to be rewarded by the market with higher multiples. This has encouraged companies to raise payout ratios allowing them to grow dividends at a faster pace than the underlying growth in the business itself would justify. To be clear: rising payout ratios are not a sustainable source of dividend growth and payout ratios among high dividend payers are at very elevated levels. By definition, higher payout ratios mean less left over for investment which ultimately results in lower growth. A company paying a dividend which will not grow has a lot in common with a bond.
At the same time companies are reducing their ability to grow, prices of higher yielding names have approached record high levels relative to their large cap peers. In other words, these names are being valued like bonds, which currently have low yields (i.e. a polite way of saying “high prices”). If you are concerned about rising rates and think long duration bonds would not be a wise choice, why would owning bond-like equities be any different?
We are certainly not dismissive of the need for income, especially given the demographics of investors today. We do however believe there is a better way to balance the objectives of reasonable income with protecting against a potential rise in rates. This is why we are excited to be discussing these funds today. Earning a high yield achieves little, if capital is lost along the way.
Stocks you will find in these funds were picked using the bottom up research process you have come to expect from Cambridge. We are seeking out higher quality business models, run by competent and well-aligned management teams that have demonstrated a history of good capital allocation. While the yield of the security is considered, it is certainly not the most important metric we consider. We care far more about what we call “total shareholder return.”
Total Shareholder Yield = Dividend Yield + Change in Share Count
If a business pays a 2% dividend and buys back 4% of shares outstanding, it implies a 6% total yield to shareholders. This is much preferred approach to a business paying a 5% dividend and issuing 4% more shares, implying a 1% total yield or return of capital to shareholders.
Across the three Cambridge dividend funds the yield is in the 2% range, payout ratios stand at a conservative level (40% on average) and the businesses have been buying back shares and investing significant capital into the business. This underlying growth has helped fuel average dividend increases of over 20% per year over the past three years.
By owning high quality businesses which can not only pay a dividend today, but more importantly grow their dividend stream over time, one is less exposed under a rising rate scenario. We believe this is how one can more effectively strike a balance between earning a fair income stream from their investments, while reducing their exposure to interest rates.