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This episode, Stu Kedwell, Co-Head of North American Equities, discusses the positive and negative impacts higher interest rates can have on high yielding dividend stocks. Stu also explains dividend growth, and why it can be a powerful tool for long-term investors. [6 minutes, 12 seconds] (Recorded March 23 2021)

Transcript

Hello and welcome to The Download. I'm your host, Dave Richardson, and it is (S)Tuesday! So, we're joined by Stu Kedwell, Co-Head of North American Equities at RBC Global Asset Management. Stu, welcome to (S)Tuesdays.

Thanks very much, Dave. How are you doing?

I'm good, thanks. I never really asked - do you like the term (S)Tuesdays?

I do like (S)Tuesdays. It's a good name for me. When I was in university, I got “Stu-pid”. So I prefer (S)Tuesdays.

So this is an upgrade. Does the family celebrate (S)Tuesdays at home?

Not to the same way that you do.

OK. All right. Well, there's a reason why we celebrate it and particularly with today's topic, because we're going to talk about dividend stocks and probably nobody knows more about dividend stocks in Canada than you, Stu. And what I wanted to ask you is, we've been talking with several of the guests on the podcast about the recent rise in Treasury yields, interest rates moving higher. So Stu, what is the impact, from your point of view on the recent move in interest rates, on high yielding dividend stocks?

It's a good question, something that we think a lot about. You know, the early stages of interest rates increasing normally mean things that are good for many of the companies that we own. So, there's a number of different phases to think about on interest rates increasing. But in the early phases, the central banks are still quite accommodative. You have a rise in longer-term interest rates because the bond investors are worried that the economy might be stronger than they otherwise thought. A strengthening economy then kind of plays through to a bunch of the stocks that would be in the dividend fund, so, you take a financial stock like a bank where you have this big mass of deposits sitting inside the bank. As the economy starts to improve, people start to borrow money. And you start to do it at slightly higher interest rates, so it can be very good for earnings. You’re taking an insurance company where you have all these future liabilities and when interest rates start to rise, that can actually be a positive for the businesses themselves. In other areas, whether it's auto parts manufacturers or things that are a little bit economically sensitive, a rising economy normally means more units, a little bit easier way to make money. So, the early phases of interest rates increasing are normally quite positive for not just the earnings that we're owning through our investments in these businesses, but funnily enough, it actually can be a little bit supportive for valuation as well, which might seem a little bit strange. But rising interest rates can be a modest positive for valuation in some of these sectors as well. Where you worry about it is when a company's cash flow is highly contracted, which means there's really no way for it to outgrow what you otherwise thought possible. Then it functions a little bit more like a bond so that when rates rise, the price of that security can sometimes be pressured a little bit. A couple come to mind there, and so far this year, we've seen modest underperformance from some of the renewable and utilities companies. The renewables companies, you think, well, trends are extremely strong and there's going to be a lot of renewable energy. But when you sign a contract for a certain amount of power, that contract is normally quite fixed. And so, when you have higher interest rates, you have to reflect that in the valuation. Utilities are a little bit better prepared because while they have an ROE, or a return on equity, that the regulator gives them. As rates rise, eventually they get to put that through to the rate base and to the ultimate rate payers, the people who are buying electricity and gas and what have you. So, they'll get to recover some of that as rates rise. They are not quite as interest sensitive, but still fall on that end of the spectrum. But all things considering, when we look across our portfolios, we would much prefer to see a better economy, rising interest rates reflective of that fact, because it means there's good things going on in our earnings of the businesses we own. That normally is a good period for performance.

And as we've seen over a number of years, dividend payers and in particular dividend growers have tended to do better than the market overall. Is that something that persists during periods of higher interest rates or is that more pronounced during periods of low interest rates?

Well, the make-up can be a little bit different, but in both scenarios, a dividend and dividend growth is a very powerful cocktail for a long-term way to participate in the stock market. We like to think about our collection of businesses yielding somewhere in the neighborhood of, as a collection, maybe 3.5 to 4%, and the dividends of those stocks growing mid-single digits over long periods of time. So sometimes it's the businesses that are yielding 2 or 2.5%, but their dividends might grow at 7 or 8%, doing the heavy lifting. And sometimes it's the ones with slightly higher yields, but maybe less growth, doing the heavy lifting. And when we combine it all, as I say, it's a pretty good way to have long-term equity exposure and to compound your capital mid-to-high-single digits over a long period of time.

And so, as you say, it's a powerful cocktail and powerful cocktails are always welcome on Stu’s Days.

A hundred percent, Dave.

Not that we're recommending that. A nice glass of water is also a good thing to sip on Stu’s Days. But Stu, a great overview of why dividends are such a powerful force for so many investors and something they should take a look at. And some of the ways that interest rates influence those dividends certainly as we're seeing things move around in the markets right now. So Stu, always a pleasure. We'll look forward to seeing you next week.

Thanks, Dave. Take care.

Disclosure

Recorded: March 23, 2021

RBC Global Asset Management is the asset management division of Royal Bank of Canada (RBC) which includes RBC Global Asset Management Inc., RBC Global Asset Management (U.S.) Inc., RBC Global Asset Management (UK) Limited, RBC Global Asset Management (Asia) Limited, and BlueBay Asset Management LLP, which are separate, but affiliated subsidiaries of RBC.

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