Yield is a broad sector which covers not only common dividend yield equities but also fixed income. In terms of our selection process for equities, we are looking at investment opportunities with a great economic moat and competitive advantage in their respective industry. We seek to invest in companies whose fundamentals are trading at an attractive valuation, or discount to what we believe is their fair price.
With regards to fixed income, the Yield team has historically looked into municipal bonds and bond ETF’s, while 2016 will be an exploratory year, delving into the high-yield and long-term treasury bonds sectors. In our fixed income choices, we are looking for risk-adverse bonds that act as an assured return for YUSIF’s portfolio.
Previous picks: Blueknight Energy Partners (BKEP), Invesco Build America Bond ETF (BAB), Medical Properties Trust (MPW), Algonquin Power & Utilities Company (AQN)
The Senior Analyst covering this sector is Alexandre Rheault with Junior Analysts, Mitchell Branov and Steven Roberts, and Research Analyst Sam Arami.
Some key drivers for the yield sector include the competitive devaluation observed in the Western world amidst raising interest rates in South America and Russia to match inflation. The US interest rate hike on the horizon has already been priced in to the forward-looking market at this point. However, a U.S interest rate hike will be truly beneficial to Canadian exports as well as fuelling domestic Canadian growth. Other areas such as Asia and Europe are in reactive settings to combat economic stagnation, meaning their monetary policies will specifically reflect this issue. There is always potential disruption to the sector, at this stage primarily from Europe. With quantitative easing in effect, the Eurozone is likely to take a larger hit as a whole, which may cause adverse effects for Asian and American monetary policies due to the competitive devaluation present.
The following outlook examines two main segments composing equity yield, utilities and real estate.
The 2016 utilities market will continue to evolve, thanks to the price in commodity prices such as oil. Companies are having to cope with low prices, which have had a huge impact on the margins and revenue of utility companies. As such, to boost earnings, companies will continue to look towards M&A opportunities, especially with the cost of debt being so low. Coupled with strong balance sheets, it is reasonable to expect a splash in the utilities M&A market. Furthermore, because utilities have a high dividend yield, they are viewed as alternatives to bonds. With interest rate cuts on the horizon for powerful markets like China and Japan, yet hikes in the American market, demand for utilities will fluctuate.
Companies in the electric power transmission and natural gas industries distribute either electricity or gas to end users. Industry drivers include:
1) Electric power consumption – 0.9% compound growth anticipated from 2016-2021
2) Price of electric power – 2.5% compound growth anticipated from 2016-2021
3) Number of households – 1.0% compound growth anticipated from 2015-2020
4) Industry production index – 2.0% compound growth anticipated from 2015-2020
All these factors are positive signs for the electric and gas distributors. All in all, the electric power transmission industry expected to grow 3.2% annually in the next five years and the natural gas distribution industry expected to grow 5.7% annually in the next five years.
The real estate market begins 2016 much like it began 2015; with low interest rate and increasing housing prices. This added with the possibility of interest rate hike in March certainly makes it difficult to predict the market swing. Although the strong fundamentals remain, as new homeowners continue to buy house as 2016 commences. There was a 10.8% increase in December of single home buyers in the United States which is expected to be carried over into the new year. The activity in terms of new developments still remains low for most sectors, although accounting for the cyclical nature of the industry this is not completely unusual.
The interest rate hikes will play a big role into how the REITs, and the real estate market performs. Some experts have speculated that an interest rate hike would increase buying, as potential house owners would fear even bigger hikes in the near future. Moreover, the US Federal Reserve seems reluctant to hike rates as the global economy churns out weaker data than expected to begin 2016. The markets themselves have seen increased sell offs to start the year, and it seems quite unlikely that the US FED would want to add to the market volatility. The younger generation of home-buyers have also seemed to buy cheaper houses than the generation of their parents. This also shows more conservative spending habit which will lead better financial health for most individuals and elongated spending lives. We are anticipating a higher interest rate, and higher aggregate spending as a result.