Canadian investors haven’t had to think too hard about their dividend stocks over the past decade or so.

For the bulk of the 2010s, income-oriented funds were more or less interchangeable, rising and falling without much deviation from one another.

The steady decline of interest rates and bond yields over that period worked to the benefit of the entire ecosystem of dividend payers.

Then along came a global interest rate shock, and with it, some important shifts in the way dividend stocks behave.

“This is no longer the old dividend universe where you could cobble together a dozen dividend-paying names, buy them and forget it,” Craig Basinger, chief market strategist at Purpose Investments, wrote in a report.

“We believe dividend-focused allocations should remain a core for Canadians’ portfolios, but the dynamics have changed.”

The first big change is that a high-rate environment is not so universally favourable for stocks that pay dividends.

The popularity of dividend investing in Canada is well-earned – this segment of the market tends to protect investors’ capital fairly well in a market downturn, while capturing most of the upside of a bullish run. Dividend payments are also generally taxed at a lower rate than other forms of income in Canada. And the Toronto Stock Exchange is skewed much more toward income rather than growth, especially when compared with the U.S. market.

This is an income investor’s kind of stock market. Over the past 18 months, however, dividend strategies have been tested.

Long-term bond yields started inching higher in August, 2021, before heading sharply upward last year as the Bank of Canada resorted to aggressive rate hikes in the fight against inflation.

The S&P/TSX Composite Index has been roughly flat over that period, which has seen a global bear market erupt around a powerful downturn in U.S. tech stocks. But it has not been dividend stocks propping up the TSX over that time. That credit goes to the energy sector, by virtue of the run-up in global oil prices. To a lesser extent, materials and industrials stocks also mitigated the losses in Canadian equities.

The Dow Jones Canada Select Dividend Index, meanwhile, is down by about 9 per cent over that time. In the current selloff, the average Canadian dividend fund has been an additional burden rather than a relief from the volatility.

The second important change to the Canadian dividend landscape identified in the Purpose report is how much funds in this space diverge on a performance basis.

For many years, variability from one large Canadian dividend exchange-traded fund to the next was minimal. The last year and a half, however, has seen much more divergence “as the finer intricacies of each mandate’s holdings have become more impactful,” Mr. Basinger wrote.

There are most likely a couple of key forces at work. The years between the global financial crisis and the COVID-19 pandemic were characterized by persistently low interest rates, which made it difficult to put together a portfolio with a decent level of income.

Faced with miserly yields on savings vehicles and high-quality bonds, investors were forced into dividend stocks. It is now suddenly much easier to get a 5-per-cent yield through the traditional fixed-income market.

“Because income was so hard to find outside of dividend-paying stocks, you didn’t necessarily have to be a good business to still do well, because your dividend sustained you,” said Matthew Barasch, a senior portfolio manager at RBC Dominion Securities.

Many companies borrowed heavily to cater to a seemingly endless appetite for dividends, in some instances at the expense of their fundamentals. “Now all those other things matter just as much as checking the high dividend box,” Mr. Barasch said, citing debt levels and return on capital as key examples.

Another factor starting to drive performance within the dividend space is economic sensitivity. As the potential for a recession comes into focus, dividend payers in the defensive sectors, such as utilities, telecoms, and consumer staples, may be better positioned.

But many of the big dividend-focused funds in Canada use fixed rules determining what stocks qualify for inclusion.

“This worked when the companies were all being lifted by falling yields,” Mr. Basinger said. Looking ahead, “such a static approach may prove challenged.”

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