Feeling Fickle about Domestic Options? Go Global.Feb 28, 2018

Searching for high quality franchises paying above-average yields

Why now?

Today’s investors have a lot on their minds. Consider that in January of this year, after nearly a decade of accommodative monetary policy, the Bank of Canada raised interest rates for the third time since last summer. Also consider that, as part of a healthy correction, the Dow Jones index, which soared by 25 percent in 2017, lost 4.6 percent in a single day in February and triggered a global selloff. Needless to say, the benign financial environment of the last few years may be over.

Today’s investors have a lot on their minds. Consider that in January of this year, after nearly a decade of accommodative monetary policy, the Bank of Canada raised interest rates for the third time since last summer. Also consider that, as part of a healthy correction, the Dow Jones index, which soared by 25 percent in 2017, lost 4.6 percent in a single day in February and triggered a global selloff. Needless to say, the benign financial environment of the last few years may be over.

In the midst of still historically low, but rising, interest rates and increasing market volatility, many investors are looking at dividend investment strategies for their performance potential and attractive yields.

But not all dividend strategies are created equal. Let’s look at two dividend-oriented types of investments: high-yield and dividend-growth. A high-yield dividend company is one whose dividend yield is higher than that of its benchmark. Dividend-growers, on the other hand, are companies that have a demonstrated history of increasing their dividend payouts. Investors have appreciated both strategies, but for different reasons. While they like the income produced by high-yield focused strategies, many investors are equally interested in benefitting from the stability and quality associated with dividend growth strategies.

Traditional high-yield stocks have performed strongly in recent years; however, in the current rising rate environment, many have become overvalued and overpriced. In an ultra-low interest rate environment, many of these businesses were able to take on more debt to expand their operations and sustain their high dividend payments to investors and/or increase debt simply to finance yields. Consequently, these highly-leveraged companies may start to encounter financial challenges as the cost of borrowing increases.

In addition, after a stellar 2017, a year during which the Dow Jones closed at an all-time high more than 70 times, the index suffered its worst fall in six years, sparked by higher bond yields, higher U.S. wages and the prospect of higher interest rates. We may be seeing signs that the halcyon days of steady gains could be over.

Stocks that represent high quality franchises paying above-average sustainable yields, however, could present a compelling investment opportunity … especially in the current environment.

Why high quality dividends?

The upward trend in interest rates could signal an improving economy. But how are dividend-paying companies affected by rate hikes? We’ve already mentioned that highly leveraged companies can be sensitive to interest rate changes, as they tend to be more impacted by higher borrowing costs. Dividend-growers, on the other hand, are typically higher-quality companies with relatively strong cash flows and lower debt ratios. With less debt to service, these companies are well positioned to ride out periods of rising interest rates.

In times of market volatility, quality companies with a strong history of dividend growth can help to protect against market downturns because they are usually financially stable, well- established enterprises. These companies are also better able to offer yields on a regular basis, regardless of market moves. As a result, high quality companies can provide greater stability than those that pay high yields.

Companies paying sustainable dividend payments also tend to have strong fundamentals, such as low debt levels and a history of profitability, making them ideal long-term investments. In addition, their history of sustainable dividends indicates an ability to continue to grow and pay higher dividends in the future—a reliable way of positioning an investor’s portfolio for strong returns.

Why global?

A portfolio that holds companies from around the world offers a buffer against country or region-specific downturns. In other words, a portfolio with broad global exposure enhances diversification, which can reduce volatility—an important factor for many investors’ portfolios. Global investing also expands the types of companies a portfolio can choose from, adding broader sector and currency options, which often results in lower correlations across individual holdings.

However, despite the benefits of this asset class, it has been difficult for Canadian ETF investors to access a diversified portfolio with the benefits of both high dividend yields and the characteristics of a dividend growth company, until now.

Introducing the Franklin LibertyQT Global Dividend Index ETF

Franklin LibertyQT Global Divided Index ETF (TSX Ticker: FLGD) is a Smart Beta ETF that fills an important gap in the Canadian ETF landscape. Like all of our Smart Beta offerings, it is designed to deliver better risk-adjusted investment outcomes than traditional market cap- weighted products.

With its global menu of constituents, unique investment approach and competitive management fee of 0.45%, FLGD can easily complement an investment portfolio, without detracting from returns through excessive costs.

To see how FLGD embodies a truly global perspective, take a look at the regions in which the fund invests:


Our unique approach

During periods of market uncertainty, there may be a “flight to quality” as many investors look to reduce risk in their portfolios.

FLGD can help investors achieve these goals by focusing on high-quality, dividend-paying companies from around the world. Let’s explore some of the features of FLGD, and how it filters for quality companies to deliver reduced volatility and stable income.

FLGD offers:

  • A core portfolio building block through exposure to global dividend equities (the ETF’s investment universe is the MSCI ACWI Ex-REITS Index).
  • A Smart Beta, low-cost solution with a management fee of 0.45%.
  • A robust, two-step dividend screen that first narrows the investment universe to a shortlist of high-quality global companies paying above-average yields, and then applies a Smart Beta Quality filter to this shortlist for a final selection of approximately 100 global dividend companies.

STEP 1. General Dividend Filter

This filter screens for companies in the MSCI ACWI (ex-REITS) Index that demonstrate attractive dividend histories. During this screening process, the fund managers look for:

  • Dividend Sustainability— Companies that have a five-year+ track record of consistent or rising dividends.
  • Higher Dividends— Companies that have grown their dividends by at least 1.2 times the benchmark growth rate over the past five years.

STEP 2. Smart Beta/Quality Filter

This second filter focuses only on quality to further screen companies that have passed through the general dividend filter, to:

  • Higher Yields – High-quality companies paying above-average yields.
  • Attractive Risk/Return Characteristics – Companies that can help to reduce portfolio volatility and improve capital appreciation potential.

This second quality filter overlay further reduces the universe down to the portfolio’s final 100 holdings, systematically ruling out “problematic” companies by identifying these outliers through an assessment of balance sheet and general financial statement health. As a result, FLGD is constructed to hold a healthy representation of highly reputable “global titan” companies, such as Zurich Insurance, Novartis and GlaxoSmithKline (as of February 21, 2018).

The table below compares the portfolio characteristics of the holdings in FLGD portfolio with those of the MSCI All Country World (ex-REITS) Index.

Portfolio Characteristics

As of February 21, 2018

CharacteristicFLGDMSCI ACWI (ex-REITS) Index
Return on Equity 24.66% 16.32%
Dividend Yield ~3.22% 2.18%
Price-to-Earnings (12-month trailing) 13.00 15.48
Beta 0.88 1.00

Based on the aforementioned portfolio characteristics, FLGD offers a higher return on equity, higher dividend yield, lower price-to-earnings multiple and lower beta than the index.

Below is a breakdown of FLGD holdings by sector. High-yield companies tend to be concentrated in the Utilities, Consumer Staples and Financials sectors. Dividend-growers, on the other hand, are diversified across sectors, which can help to improve portfolio stability.


Commitment to the ETF market

When Franklin Templeton decided in 2016 to broaden our product platform to include ETFs, we knew that we didn’t just want to jump on the “ETF bandwagon.” By paying close attention to the needs of advisors and investors, we are building a suite of ETFs that provide investors with greater flexibility and choice when making investment decisions. To help make this vision a reality, we assembled a team of experienced ETF experts to help us bring high quality, differentiated and well-priced ETF products to market. We strongly believe that this specialized expertise, combined with of our 70-plus years of investment knowledge and global resources, will enable us to become an innovative leader in the ETF industry.

Is now the time?

For Canadians who are concerned about the effects that market volatility and rising rates could have on their investments, an ETF that focuses on the dual benefits of high yield coupled with the stability and quality of global dividend growth could be a very compelling option.

Call us at 1-800-387-0830, speak to your advisor, or visit libertyshares.ca to find out how Franklin LibertyQT Global Dividend Index ETF can meet your needs in this changing financial landscape.