Equity income with southern exposure

Gibbs considers that the U.S. equity market is bottoming. "The knife has stopped falling, as a lot of the bad news has already been factored into the valuations and the all-important U.S. consumer is in better shape."

The recovery in the U.S. economy is a double-edged sword, says Gibbs, as it has been fuelling upward pressure on interest rates south of the border. This, in turn, has caused some of the Canadian real estate investment trusts "to weaken slightly recently." REITs, says Gibbs, generally have high dividend/distribution payout ratios and modest dividend-growth prospects.

Of the concerns about rising U.S. rates, Gibbs points to reassuring words from the head of the U.S. Federal Reserve. Fed chairman Ben Bernanke has made it clear that despite recent signs of U.S. economic growth, the U.S. job market remains weak and the Fed is intent on keeping its low-interest-rate policies in place for some time.

For Gibbs, the case for investing in Canadian REITs remains intact. "They have high-quality, hard assets, which are enjoying strong demand both from a tenant perspective and from institutional investors." There has not been a lot of overbuilding in Canada, other than of condominiums, he notes. "In all, Canadian REITs offer good cash-flow visibility, and Canadian demographics will continue to underpin the demand for equity-income assets."

Jason Gibbs

In other areas of the financial-services sector, the prospect of higher interest rates has helped to boost the performance of Canadian bank stocks in the year to date, Gibbs says. "Banks tend to benefit from modestly rising interest rates and Canadian banks have been raising their dividends."

Gibbs is a senior member of GCIC Ltd.'s equity income team responsible for assets totalling $10.6 billion in Dynamic funds. The team manages a range of funds, including Dynamic Equity Income  , Dynamic Strategic Yield and Dynamic Global Infrastructure.

In stock selection, the team looks for companies with robust cash-flow generation and strong balance sheets. The target must have a dominant market position in an industry with high barriers to entry, and its management must be "best in class." The team's discipline is to buy these businesses at reasonable valuations.

Dynamic Equity Income (assets $1.5 billion), which was started in July 2001, has 62 names. Its largest holding is H&R REIT HR/UN. Foreign content, in the form of U.S. holdings, is around 15%. "We hedge 50% to 100% of our foreign currency exposure across all our funds," Gibbs says.

A recent U.S. purchase by the team is Comcast Corp. CMCSA, a leading telecom services, media and entertainment player. The shares are among Dynamic Equity Income's top 10 holdings.

The company owns Comcast Cable, which has a significant market share in video, high-speed Internet and phone services for businesses and the consumer, says Gibbs. "We know the cable space and Comcast Corp. meets all our investment criteria." There is not a lot of competition in its business, he says. "The company generates a substantial amount of free cash flow, is producing double-digit dividend growth and is attractively valued versus its Canadian peers."

Dynamic Equity Income continues to hold positions in three major Canadian telecom-services providers: Telus Corp. T, Rogers Communications Inc. RCI.B and BCE Inc. BCE. The equity-income team trimmed its holding in BCE at the end of last year "as the stock had risen significantly in a short period of time." In general, these three Canadian telecom services companies are "solid dividend growers," increasing their dividends by 3% to 5% per year.

Turning to pipelines, Gibbs notes that the team added Williams Co. WMB across all funds including Dynamic Equity Income and Dynamic Global Infrastructure. "Williams is one of the largest pipeline companies in the United States," says Gibson, "and fits our criteria like a glove."

It is a "dominant player" in its field with little competition and generates good cash-flow growth. The company has "a foothold in the important Marsellus shale gas play," which extends through Pennsylvania, New York, Ohio and West Virginia." Williams' stock is cheaper than many of the major Canadian pipeline companies, he says.

The equity-income team's favourite Canadian pipeline company is Enbridge Inc. ENB, says Gibbs. It is in the top 10 holdings in Dynamic Equity Income. "This is a great stock to buy on pull-backs."

The team recently trimmed its holding in Keyera Corp. KEY, which operates one of the largest midstream businesses for natural gas and natural-gas liquids in Canada. This includes ownership of pipelines and processing plants. "The stock was ahead of the fundamentals."

Finally, Gibbs points to the team's recent purchase of a holding in the U.S.-based global software giant Microsoft Corp. MSFT as an example of strategic diversification. "We don't traditionally invest in technology stocks," he says. "This stock offers value and the company meets our criteria. Its business model is dominant, it has visible and growing free cash flow and it is increasing its dividend at 10% a year."

There is little to choose from in the Canadian technology sector that meets the team's requirements, says Gibbs. Research in Motion Ltd. RIM, for example, is "not in our universe, as it does not pay a dividend."

		Comcast Corp., Class A	Microsoft Corp.	Williams Co.
	April.3 close	$29.26	$31.94	$31.44
	52-week high/low	$30.41-$19.19	$32.95-$23.65	$32.09-$17.88
	Market cap	$80.3 billion	$268.0 billion	$18.6 billion
	Total % return 1Y*	20.1	28.2	26.2
	Total % return 3Y*	28.8	21.7	47.9
	Total % return 5Y*	3.5	4.5	7.7
	*As of April. 3,2011 Source: Morningstar