Michael Lough, vice-president and director at TD Asset Management Inc., says the case for investing in dividend-paying stocks remains intact, particularly given the expectation that the low-interest environment will persist for some time.
"The dividend yield on the S&P/TSX Composite Index is higher than the yield on both five- and 10-year Government of Canada bonds," says Lough, who specializes in managing income-oriented equities.
Lough considers it unlikely that there will be an increase in Canadian interest rates for two years or so, in the light of all the global economic uncertainty. Given this low-rate climate, "many investors in search of income have been moving up the risk spectrum to buy dividend-paying stocks."
In the context of the equity market, they will likely continue to favour good dividend-paying stocks, he says, rather than those that pay lesser or no dividends -- often associated with more economically sensitive stocks.
This investor preference is likely to continue, Lough says, even though some defensive stocks with high dividend yields "appear to be expensive by historic standards." The reason, he says, is that investors are cautious about taking on the risk attached to the more economically sensitive areas of the equity market.
Given that the total return from equities is expected to be somewhat muted over the next few years, says Lough, "stable dividend-paying stocks are a good place to be."
At TD Asset Management, Lough is a member of the firm's dividend and blue-chip team, which had assets under management of $22.3 billion at the end of September. He is lead manager of TD Diversified Monthly Income 
and co-manager of several other funds including TD Dividend Growth , TD Dividend Income and TD Monthly Income .
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| Michael Lough | |
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At the end of September, TD Diversified Monthly Income (assets $565 million) had roughly 66% in equities. The remainder was in fixed-income securities (32%) and in cash. "This is an overweight in equities relative to our internal benchmark, which is 60% in equities and 40% in fixed income." This equity overweight "underscores my point that fixed-income yields are low relative to those on good dividend-paying stocks."
Lough is responsible for making the asset-mix call for TD Diversified Monthly Income and for managing the equity component. In stock selection for all the equity-income portfolios that he is responsible for, he focuses on solid dividend-paying stocks and trusts, where the businesses enjoy high barriers to entry, generate high returns on equity and where management is capable of expanding the business.
"Our emphasis is on consistent, modest growth over time," says Lough, who favours companies and income trusts that can grow their dividends or distributions. The fund has a low turnover, he says. "Our approach is more buy and hold."
The two biggest sector weightings in the portfolio are financials and energy. "The fund is overweight the financial-services sector, mainly the banks," says Lough. It has only a modest weighting in real estate investment trusts and conventional real-estate companies, which also fall into the financial category.
TD Diversified Monthly Income has significant holdings in the stocks of the five largest Canadian banks: Bank of Montreal BMO, Bank of Nova Scotia BNS, Canadian Imperial Bank of Commerce CM, Royal Bank of Canada RY and Toronto-Dominion Bank TD.
"Even though their growth rates are slowing, the Canadian banks are still an excellent place to be," Lough says. "They are steadily increasing their earnings and their dividends."
Lough notes that the Canadian banks are experiencing a slowing in both their domestic commercial and retail-lending businesses, "though the former is holding up better than the latter."
| Bank of Montreal |
Bank of Nova Scotia |
CIBC | Royal Bank of Canada |
Toronto-Dominion Bank |
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| Nov. 6 close | $59.15 | $54.39 | $79.24 | $57.14 | $81.84 | |
| 52-week high/low | $61.29-$53.15 | $57.17-$47.54 | $79.43-$68.15 | $59.13-$43.30 | $85.85-$68.13 | |
| Market cap | $38.5 billion | $64.2 billion | $$32.2 billion | $82.6 billion | $74.3 billion | |
| Total % return 1Y* | 6.7 | 8.3 | 12.1 | 29.6 | 16.2 | |
| Total % return 3Y* | 10.5 | 9.0 | 12.0 | 4.8 | 11.6 | |
| Total % return 5Y* | 3.4 | 4.4 | -0.6 | 4.8 | 6.5 | |
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| *As of Nov 6, 2012 Source: Morningstar |
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The Canadian real-estate market has weakened, he says, and the mortgage growth rate has declined. "This is in keeping with Ottawa's policy to cool down the Canadian housing market and reduce consumer debt."
Still, says Lough, the Canadian banks are delivering returns on equity in the high teens. Also, bank stocks are trading at an average price-earnings multiple of about 11 times, which "is in line with historic valuations."
TD Diversified Monthly Income is overweight in energy, says Lough. "Within this sector, we are mostly overweight pipelines and midstream companies." The Canadian pipeline companies offer "the stability of a utility and have a reasonably good growth profile."
In fact, Lough says these companies have "a much better growth profile going forward than has been the case over the past five years." This, he adds, should be taken into account in assessing the present valuations on these stocks.
Two significant pipeline holdings in the fund are Enbridge Inc. ENB and TransCanada Corp. TRP. The two companies have "good growth prospects," notwithstanding the opposition in Enbridge's case to its Northern Gateways Pipelines Project and, in TransCanada's case, to its Keystone XL Pipeline Project.
Of the energy producers, two big holdings in TD Diversified Monthly Income are Canadian Oil Sands Ltd. COS and Suncor Energy Inc. SU. Canadian Oil Sands has a 36.74% stake in Syncrude Canada Ltd., a joint-venture oil-sands project north of Fort McMurray, Alta.
Canadian Oil Sands is embarking on some major capital projects, says Lough, which could reduce its cash flow significantly. "This is a short-term challenge and the company is expected to have sufficient cash flow to cover its dividends and fund its growth."
Suncor Energy is also a major player in the Canadian oil-sands industry. "The company has a number of projects on the go and is producing good earnings per share growth," says Lough.
TD Diversified Monthly Income has a substantial underweight to the materials sector. "The stocks in this sector do not generally have stable and growing dividends," Lough says.
From his "modest" holding in this sector, Lough has sold his "small position" in Alcoa Inc. AA, a major global integrated aluminum producer. "There has been a slowdown in the demand for industrial metals from China, with the resultant pressure on commodity prices. I do not expect this situation to improve over the short or medium term."
