Finding yield in the era of lower-for-longer interest rates

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- Hello, and welcome to the Moneytalk COVID-19 Daily Bulletin for Tuesday, May 12. I'm Anthony Okolie. In a few minutes, Kim Parlee will be speaking with Ben Gossack, Portfolio Manager of TD Asset Management, about finding dividend growers, as well as the use of option strategies to enhance returns. But first, a quick wrap of today's headlines.

Saudi Aramco, the world's most valuable company, reported a 25% drop in profits during the first three months of 2020, which was before crude prices completed their spectacular crash. The US Fed is starting its historic making program to buy corporate bonds and the ETFs that track them, in an effort to stabilize the debt market and help corporations to continue operations.

In the latest economic news, US inflation saw the largest drop ever in April. That drop comes even as grocery prices jumped the most in 46 years, as people stocked up on food amid government lockdowns. Finally, Tesla CEO Elon Musk escalated his standoff with county officials in California after restarting production today against county rules.

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And that's a wrap of today's headlines. Next, Kim's conversation with Ben Gossack.

- So Ben, you manage a global dividend ETF. When we have central banks around the world lowering rates, doing everything they can to get rates low, it looks like lower rates are here to stay. If I'm an investor looking for income, that's hard.

- Hi, Kim, good to see you. Yes, in a low-interest rate world, very hard to generate income. I would argue it was already hard to generate income before the virus. But with interest rates near zero and none of us knowing when the economy will reopen, it does create that added pressure for strategies and for investors that are seeking out income.

- If we take a look at the S&P, and we look at the TSX, I think we're seeing yields at around-- and it's subject to change-- around, say, 2% and 3.5%, respectively. How sustainable do you think those are?

- Right. So on an absolute basis, yeah, you're getting about 2% on the S&P, 3.5% on the TSX. On an absolute basis, they seem OK relative to those treasury rates, around 60 basis points in US and Canada. It's quite a wide spread, and there's some suspicion, a doubt in the investment community that some of those dividends are sustainable.

And in fact, the year to date just in the S&P alone, we've had 15 companies reduce their dividend, and about 30 companies suspend their dividend. So yes, you might get a 2% yield today. Now, that might not be sustainable going forward.

- So I guess, again, we're back to square one then if you're an investor looking for income. Again, that makes it hard.

- Right. And so for us, it always goes back to being active and being fundamental. There are companies-- actually there are four companies that we own that actually raised their dividend within the past two weeks around 6% to 7%. So it doesn't mean that companies will never raise their dividend. But for us, it always goes back to companies having a competitive advantage, having an ability to grow, but more importantly-- and we're reminded about this every time and every cycle-- having a really good balance sheet.

- Yeah. That is certainly-- we're seeing the difference in terms of, I'll say, the valuations of those that have that and those that don't. Let me ask you, though, as someone who is very focused on producing income as part of the ETF strategy, you have some additional things you're doing to try and help with that, some options strategies. Maybe you can just walk us through at a high level, if you could, the calls and puts and how that works.

- Right. So we call our ETF an Enhanced Dividend ETF. And so, yes, you're getting yields and income from dividends. But that might not be enough. And so we feel that using call options and put options is one way for you to further enhance that dividend and effectively unlock really interesting areas of your portfolio. So it all starts with a core group of stocks. And so far, ETF, that's looking around for about 2.5% dividend yield.

But then we can do some more exciting things. So I like to invest in secular growth areas. A lot of times those areas don't pay you a dividend, and that's obviously a drag from an income perspective. But when you add a call to a company like Amazon or Google, you give up some of your upside for the duration of that contract. But you're able to create income today and effectively turn Amazon into a synthetic dividend payer, which is exciting, because you can obviously participate in trends, but it doesn't come at a sacrifice on your income.

The other area that we look at is on the put side. Lots of investors will set aside cash. Cash is there because you're looking for an opportunity to buy companies at lower prices. But again, it will be a drag on your income potential.

But when you're writing puts, you're effectively acting as an insurance company. And you're willing to provide investors with downside protection. I'll buy a stock that they're worried about, that will fall. They'll pay me an option premium. And you can create really interesting mid-teen type yields from writing those contracts.

- What would you say are the risks that people need to think about when they're looking to invest in dividend growers-- not specific to the options, but just when you back in the dividend space, and if they don't have access to something like that?

- Right. So in any economy, when you're Investing in dividend growers, or equities in general, these are never set-and-forget strategies. A company might have a competitive advantage today, and that will erode over time. So it's very important that you're on top of all of your companies, understand their payout ratios, understand their balance sheets.

At the same time, same thing in the options market. When you're writing puts, you're going to get assigned these stocks if they fall below your price that you're going to buy it. For us, we always want to own those stocks, because we believe that those stocks will appreciate over time. But if you're just writing puts because you see yield, you might get assigned stocks that are falling because they have fundamental issues.

- Got it. It's an active strategy, and one that needs to be done with the folks that know how to do it. Let me ask you a last question, Ben. Just when you take a look out over the next month, two, three, six, what are you seeing in terms of signs that you're going to be listening to for dividend-paying companies? I mean, we are in the thick of it right now.

- Yeah, so one thing that that's been really interesting to us in this cycle is that we've done the work on companies. They have a war chest, and in some cases they've chosen not to pay out a dividend. We've seen this in the luxury stocks. We've seen in some of these European companies.

So it's very important for us to be on top of our companies, understand that they may be able to pay a dividend, but they've chosen for certain societal reasons to suspend dividends. So that's something that I'm watching and trying to stay on top of.

- Ben, always a pleasure. You take care. We'll talk to you again soon, OK?

- You too, Kim. Thank you.

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