The end of quantitative easing and rising interest rates could affect dividend-paying firms
By the end of 2014, the Federal Reserve will be close to completely drying up its third quantitative easing (QE3) program, having gradually tapered down $75 bn of monthly bond buying to $45 bn per month at time of writing. The Fed’s former chairman Ben Bernanke hoped that QE3 would keep interest rates low and help boost the economy. But shortly after tapering talk began in June 2013, yields on US Treasury bonds and other interest rates crept up. Other yield-focused assets – including real estate investment trusts (REITs) and other dependable, dividend-paying stocks – correspondingly dropped in value in a period of increased market volatility.
John Stewart, Digital Realty
‘There’s no silver bullet for calming jittery nerves in a rising interest rate environment’
As QE3 trickles down to its conclusion and with US interest rates expected to rise again, it remains to be seen just how those investors who moved into yield-focused assets might react. Might some dividend-paying companies’ IR practitioners face an uphill struggle by the end of the year?
Murky waters
For Ipreo’s head of strategy & innovation, Brian Matt, part of the challenge is that this is uncharted territory. ‘The concept of having sovereign rates this consistently low for this long a period is new,’ he explains. ‘We haven’t seen that much of it to be able to look back and compare over time.’
Beyond the confirmation of the end of QE3, Matt says the only other moment of ‘any real turmoil’ in the past decade for dividend-paying companies – including REITs, master limited partnerships (MLPs) and larger corporations that prioritize cash returns, such as large telecoms firms, utilities companies and big pharmaceutical outfits – was the European sovereign debt crisis. At both of these points, there was a perceptible change in interest rates and a recordable impact on stock prices.
The news, however, was not as bad as might have been expected. ‘What we generally found was that while there were some general outflows from those dividend-focused portfolios, it wasn’t anything overwhelming,’ Matt says, referring to data compiled by Ipreo in 2013. ‘It was muted more by the continuing inflows to passive portfolios that also focused on dividends.’ Even if active managers pull back at some level, he adds, passive funds would more than make up the difference. ‘It’s something you see more of in Europe as well, as exchange-traded fund structures and passive investing spread,’ he says.
Indeed, the most prevalent kind of passive investors in dividend-paying stocks have always been pension funds, which need consistently strong returns for their savers. Typically, pension funds review their allocations annually and any redistribution of capital moves pretty slowly, Matt suggests, so reaction to changes in interest rates would happen within an asset class before it occurred between asset classes. In other words, any shock effect on a dividend-paying company would likely be fairly limited.
The role of IR
Investors, however, may not be so easily convinced of their safety. An investigation launched in late 2013 by the National Association of Real Estate Investment Trusts, for example, argued that the sharp decline in REIT pricing wasn’t so much due to rising interest rates as to investors’ misconceptions. Keeping stakeholders abreast of any changes as transparently as possible seems more important than ever.
John Stewart, senior vice president of IR at Digital Realty, worked as a REIT analyst for most of his career, spending 13 years on the sell side predominantly with Citi and Green Street Advisors. Having followed Digital Realty after its IPO in 2004, he joined the company in 2013 to oversee its flourishing IR program in a market made volatile by the Fed’s QE plans.
‘There’s no silver bullet for calming jittery nerves in a rising interest rate environment,’ Stewart admits. ‘But the same principles apply regardless: consistency of execution, results and communication. It’s also important to identify the reason interest rates may be rising, such as inflation or improving economic growth. Companies that have pricing power and the ability to pass along rising costs to consumers may be able to generate cash flow and dividend growth in those scenarios.’
Another useful step, Stewart adds, is tailoring your investment story for your dividend and income-focused shareholders. ‘They are looking for stability of cash flow and ability to cover the dividend, as well as a philosophical commitment to the dividend as sacrosanct,’ he explains. Companies whose example Digital Realty ended up following when it came to communicating with investors include Kimberly-Clark, Procter & Gamble and Realty Income.
Stewart adds that, in his experience, dividend or income investors are ‘pretty loyal shareholders. I think you see more rotation when you cycle from growth to value or vice versa than [when there are] fluctuations in interest rates.’
Sometimes, however, investors will shift their holdings, no matter how good a job IR does. ‘Each company has to look at its fit in a potential portfolio, and some of this is seen in terms of risk and opportunity: if you’re currently a higher-yielding security and there are outflows from yield-focused investments, there’s certainly risk with that,’ Matt explains. ‘Those flows would likely rotate into the fixed income market for lower-risk investments. That’s not something a company’s going to easily take advantage of.’
Maintaining relationships
Matt sees the value in keeping in touch with investors that might have realized their holdings in REIT or MLP-focused portfolios suddenly look a bit riskier. ‘You want to build relationships with both [focused and generalist portfolios], but those REIT or MLP-focused investors might have new allocations a few years into the future,’ he says. Though it’s tough to predict the yield curve two or three years in advance, Matt continues, it is possible to track flows in and out of dividend or yield-focused portfolios and spread investor outreach to diversified funds if need be.
Stewart recalls a comparable situation at Digital Realty, when an activist short-selling campaign meant his team faced a potentially large turnover in the firm’s shareholding. The solution at every turn seemed to be to ramp up investor outreach, and make sure every constituent was as clued up as possible. ‘It was pretty discouraging at first, but we sharpened our game and redoubled our efforts, and that of course pays dividends (no pun intended) in its own right.’
In short, Stewart continues, it can be best to flexibly react to any situation that unfolds. ‘My advice would be to roll with the punches, and remember that some days you’ll be the flavor of the month, and some days you won’t,’ he says. ‘It can also be helpful to expand your comfort zone, and learn how to best communicate with investors that may have very different styles and mandates from your bread-and-butter shareholder base.’
A brief history of QE infinity First introduced in 2008 to boost the US’s anemic economy, quantitative easing (QE) refers to the Federal Reserve’s buying of bonds and mortgage-backed securities once short-term interest rates – historically a vehicle for promoting growth – can not be lowered further. ‘QE3’ is the third round of such measures, first mooted in September 2012, which saw the Fed plan to buy an additional $40 bn of bonds every month until it saw ‘substantial improvement’ in the US labor market. The scheme became known as ‘QE Infinity’ due to its open-ended nature. As former Fed chairman Ben Bernanke said at the time: ‘We haven’t yet come to a set of numbers, but we’re guaranteeing that we won’t tighten [it] too soon.’ |