What’s not to love about dividend-focused investing? Over the past thirty years, the dividend factor has outperformed the broader index (DJ Canada Select Dividend index versus TSX), with less volatility, not as much up-market capture, but much less down-market capture. Add in steady cash flow in the form of dividends, which enjoy some preferential tax treatment (a.k.a. less tax) than many other income sources. Or add in the fact that dividends, paid from nominal earnings, have a VERY long history of outpacing inflation, enabling dividend-focused investing to help financial plans reduce the risk of inflation on purchasing power.
Oh right, what’s not to love is that dividends underperformed the broader market by a decent amount in 2022 and 2023, and just by a sliver in 2024 before roughly pulling even in 2025. The reason for this underperformance, even in the down market of 2022, was largely the result of rising yields. In contrast with the falling yields of the past three decades, higher yields of the past few years have created a market where you can find yield just about anywhere: cash, GICs, government bonds, credit, lots of yield-enhancing strategies, etc. There’s simply lots more on the yield menu than in years past, so dividends have not enjoyed the relentless inflows compared to the past decades.
There is good news, though. Bond yields have become rangebound, which we believe will persist (see our Debt Sustainability edition of the Ethos or our WHY report) given the higher elasticity of yield demand. And perhaps the biggest factor is that short-term rates are falling, which may start to entice the hordes of money that were diverted into cash vehicles back to other yield destinations such as the dividend factor.
The chart above tracks assets in the 30 largest money market funds/ETFs in Canada, so it’s not an all-encompassing picture, as it excludes so many other near-cash options. However, it can provide insights into the trend, and since short-term T-bill yields dropped below 3%, it seems the money has stopped flowing into cash (flat aqua line in the past few months). It’s a leap of logic to imply cash is going to be reallocated to dividend-paying equities, as equities certainly have a much different risk profile. However, even if cash just stops hoovering up new capital from people’s savings, that money may start to show up in dividend strategies again.
This trend appears to have started and accelerated in 2025, and money is flowing into the dividend factor. Tracking five of the largest ETFs available in Canada, trailing 12-month flows dried to a trickle in 2023 as yields rose and cash was the go-to asset class. But inflows improved a bit in 2024, and then have really accelerated in 2025. Dividends are back!!!
Here comes the challenge, though; the dividend space has become harder to navigate. The inconvenient truth for anyone managing or investing in dividend-focused strategies is that all those years of falling yields and steady or relentless inflows were the golden age. It helped support dividend payers in times of trouble, made capital for these companies relatively cheap and easy to access. As a result, it lifted all boats. It didn’t matter how your portfolio was constructed or managed, just as long as you were capturing the dividend factor.
Now, other things appear to be driving performance more and more. With higher costs of capital, debt – or financial leverage – has become a factor of greater importance. Operational leverage, too, as well as geographic exposure, economic cyclicality of the business, and, of course, interest rate sensitivity. These factors have always mattered, but their influence on performance appears to be rising in importance.
One way this is showing up is in the divergence among dividend strategies. In the 2010s, the performance difference between the top quartile and the bottom quartile was not that wide. Again, it didn’t matter how you were getting exposure to dividends; you just wanted some exposure.
But in the 2020s, divergence in performance among dividend strategies has been increasing. We believe this is because other factors are having a greater impact on performance, and this is revealing the differences across strategies.
The chart below is the standard deviation of three-year rolling performance among 20 of the largest dividend-focused ETFs and funds available in Canada. An important consideration is the Covid market volatility of 2020, as we had a bit less conviction in this trend as long as that year was still in the three-year rolling number. However, it has rolled off the back of the three-year variance among dividend strategies, and it is still rising. It now matters more how you get exposure to dividends.
The challenge is that, if you agree that other factors are increasingly important among dividend strategies, then which factors are good or bad going forward? Do you want higher or lower: beta, dividend yield, valuations, dividend growers, those with higher dividend health, or interest rate sensitivity? The list goes on, and these tend to be more volatile factors. For instance, beta as a factor was very bad in March and April, when markets were falling, but very good in the last few months as markets moved higher. A strategy that leans into simply higher dividend-paying companies, which are typically more interest rate sensitive, will do better if bond yields come back down somewhat. But it would suffer if yields moved higher. It's not just about picking the factor you want more of; it’s about getting the timing right.
Here are considerations we believe investors should look at when selecting new or assessing existing dividend strategies in this more complicated environment for dividend managers:
Diversification – While it sounds pretty basic, many dividend strategies are not well diversified. Chasing yield at the cost of diversification can lead to very high single-sector weights, while many other sectors have no exposure. Some have as much as 50% financials or no health care or consumer exposure. Better diversification helps in an environment that has different factors working at different times.
Balanced cyclical yield/interest rate sensitivity – When bond yields were on their previous secular trend down, it was easy just to have exposure to more interest rate-sensitive dividend payers. But now with higher yields and more volatility around inflation and yields, a more balanced approach is needed. Economically sensitive dividend-paying companies can help balance the impact of interest rate sensitivity in this higher yield environment.
Financial leverage – Many higher dividend-paying companies operate in industries that are more stable, which enables a more optimal capital structure to carry more debt or financial leverage. However, given a higher cost of debt capital in this yield environment, financial leverage has become a rising risk. When the cost of capital is high, financial leverage is negative.
Flexibility – With other factors in addition to changes in bond yields increasingly driving performance, and these additional factors being more volatile, adaptable dividend strategies could have an advantage. Specifically, they could potentially take advantage of valuation extremes in different parts of the market, adjusting the split between cyclical yield and interest rate sensitivity depending on the trend in economic conditions, yields, or other factors. A more flexible or active approach compared to a static allocation may be more ideal. Look for higher active share or turnover, or active shifting exposures as evidence of greater flexibility. Of course, shifts won’t always be the right shifts, but they could be better than a static approach given a changing landscape for dividend companies.
Our Thoughts
The dividend factor appears to have weathered the adjustment in yields and is now back in vogue from a flow perspective. The challenge is that a higher yield environment makes manager or strategy selection in the dividend space more important, as divergence in performance is widening. Gaining exposure to the dividend space is certainly not as easy as it used to be.
— Craig Basinger is the Chief Market Strategist at Purpose Investments
The content of this document is for informational purposes only and does not provide investment, legal, accounting, or tax advice, nor does it constitute a recommendation or an offer to buy, hold, or sell any financial products. The information is not tailored to any investor’s circumstances, is provided “as is,” and may change without notice. Past performance is not guaranteed and values may change frequently.
Harness Investment Management Inc. (“Harness”) makes no warranties and is not liable for any loss or damage arising from use of this document, its information, or third‑party sources. All content is owned by Harness and may not be used or reproduced without prior written consent. This document is for personal, non‑commercial use only and is not intended for jurisdictions where its distribution would be unlawful. This publication is produced by Purpose Investments Inc., an affiliate of Harness Investment Management, registered as a Portfolio Manager and Exempt Market Dealer. For more information, please visit https://www.harnessinvest.ca/disclosure/disclaimer.