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2013 Starts out Strong for Equity Markets
S&P 500 shows best monthly gain since October 2011. All equity markets in the black. Bonds post losses.
2013 started out very well with all major equity markets in positive territory. The S&P/TSX Composite Index gained 2.25% during the month, but lagged its global brethren. The S&P 500 gained 5.73% in Canadian dollar terms, while the MSCI EAFE Index rose by 5.74%. In fact, the S&P 500 had its best month since October 2011 and it was its biggest January gain since 1997.
In the U.S., much of the rise was justified after lawmakers reached an agreement to avoid the fiscal cliff and agreed to push back the debt ceiling talks until at least May. This buoyed investor sentiment and allowed them to focus more on the fundamentals, which showed that the economy is continuing on its slow growth trajectory.
Globally, it was again Europe leading the charge as signs of life are slowly returning to the region’s moribund economy. Manufacturing activity was moderately higher, inflation moderated and the jobless rate remained stable. These factors combined to give investors reason to cheer.
In China, all economic news appears to be pointing to a sustained recovery. Real estate prices, industrial purchasing activity, and commodity prices painted an increasingly positive picture. Add to that growing import export activity and modest inflation, it appears that there may be reason for cautious optimism in the region.
In Canada, it was technology, healthcare, and industrials leading the way higher, while gold companies muted the overall gains.
With bond yields pushing higher, Canadian bond prices fell during the month. The DEX Bond Universe was down by 0.7% with long bonds and real return bonds bearing the brunt of the losses. This is not surprising when the yield on the benchmark 10 year Government of Canada bond rose from 2.36% to 2.57% during the month. Real return bonds were hit hard after recent inflation numbers were better than expected.
Despite the great start to the year, there are still many macro issues that need to be addressed. The U.S. may have averted the fiscal cliff, but they basically kicked the debt ceiling can down the road. This will eventually have to be dealt with and should either side dig in their heels, it could result in extreme uncertainty and very rocky markets. We don’t expect too much activity on that front for at least the next few weeks until, the deadline for talks approaches in mid May.
Europe, while showing signs of life is still a long way from full recovery and many countries are still dealing with crippling debt and growth stifling austerity measures. Until these can be addressed, we don’t expect significant growth out of the region. We are cautiously optimistic on the news coming out of China. If the recent trends remain in place, that will bode well for the emerging markets, and should be modestly positive for the Canadian economy.
Please send your comments to feedback@paterson-associates.ca.
Funds You Asked For
This month, we take a look at Fidelity Northstar, CI Harbour, Cundill Canadian Security and more…
Fidelity Northstar Fund – Despite two very strong, experienced and respected managers now at the helm, this “go anywhere” fund has largely been a disappointment for investors. Part of the reason for the underperformance may be the seemingly never ending revolving door on the manager’s office of the fund. Initially it was run by Alan Radlo. After he left, Cecilia Mo stepped into the chair before defecting to rival Dynamic in the fall of 2011. Since then, the team of Daniel Dupont and Joel Tillinghast has been managing the fund. Without consistency in the manager, it will be very difficult for the fund to gain any sort of sustainable momentum.
The team scours the globe looking for companies of any size, operating in any industry that is located anywhere in the world. Taking a medium to long term outlook, they are trying to find high quality, attractively valued stocks that offer what they consider to be an attractive risk reward profile. Historically the portfolio turnover in the fund has been very high, averaging above 100% per year, But with the new managers in place, we expect that we will see that decline over time.
As of December 31, the portfolio is very well diversified, holding more than 300 names across a number of different countries, sectors, and market capitalization. Approximately 36% is invested a large caps, with about half the fund is split equally between small and mid cap names. The fund also has a modest 15% exposure to micro cap companies. From a country standpoint, the US represents the largest exposure, making up about 32% fund, followed by Japan which makes up 20% of the fund.
Performance of the fund has struggled over the long term, however the past two years it appears to have improved. For the two years ended December 31, 2012, the fund posted an annualized loss of -0.9%, compared with the benchmark loss of -2.2% during the same period.
Despite the significant exposure to small and mid cap stocks, the managers have done a very good job in keeping volatility in check. It has exhibited a level of volatility that is in line with both the broader market, as well as the peer group.
While we have been encouraged by the improvement under the new management team, we would be reluctant to recommend this fund at this time. We believe that there are other global equity funds which offer a more compelling risk reward profile for investors.
CI Harbour Fund – With more than $6 billion invested in the mandate, the CI Harbour Fund is easily considered the flagship fund for the Harbour Advisors Group. Since its 1997 launch, the fund has been managed by respected industry veteran, Gerry Coleman. However in December, at Mr. Coleman’s request, portfolio duties were reassigned to Stephen Jenkins who will take on the lead manager role. He was also promoted to Co Chief Investment Officer of the firm.
With these changes, there is not expected to be any meaningful change to the investment process that is used on the fund. It will remain a patient, bottom up and research intensive approach that invests in concentrated portfolios of approximately 40 names. They will continue to look for industry leading companies with strong balance sheets and sustainable competitive advantages that can generate significant free cash flows. They will look for good management teams who have proven that they are good allocators of capital with an eye for creating shareholder value. Once they find these opportunities, they must be trading at an attractive discount to their estimate of intrinsic value, so there is a margin of safety for investors. Ideally, they are looking for a discount of at least 50%. Cash will still be used tactically when no investment opportunities that meet the manager’s criteria are available.
Having served as Mr. Coleman’s back up manager on the fund, Mr. Jenkins is well versed on all the names in the fund. It is not expected that there will be much in the way of significant turnover. There may be some changes around the periphery of the fund, but the core holdings are expected to remain intact. Any changes are expected to be implemented gradually.
One comment that the managers made in a recent conference call is that there is a chance that the fund may become a touch more value focused under Mr. Jenkins’ management. It was noted that historically that Mr. Jenkins has been more value driven in his approach than Mr. Coleman, who may sometimes pay up for a name that has good growth prospects.
Considering our analysis, we believe that this move will be neutral to investors. Mr. Jenkins is a respected manager and is well versed in the Harbour team’s approach and process. However, we will continue to monitor the fund closely to see if there is any material change to the fund or its risk reward characteristics.
Cundill Canadian Security – The Cundill Funds have long had a reputation as being contrarian, concentrated deep value funds, and this Canadian focused offering is no different. Using a bottom up, team driven approach, they conduct extensive fundamental analysis, looking for high quality, well managed companies that are trading at a significant discount to their estimate of its true value. Typically, this will result in companies that have experienced some negative event that has caused it to fall out of favour with investors.
While Canadian in focus, it can invest up to 49% of the fund globally. The portfolio tends to be concentrated, typically holding less than 30 names, with the top ten making up about two-thirds of the fund.
Historically, Cundill funds have tended to be some of the least volatile in their respective categories. This changed after 2008, when volatility spiked substantially to the point where it caused us great concern. In speaking with members of the Cundill team, this increase in volatility is attributed to their deep value style. Seeing opportunity, they invested in a number of companies going through some turbulent times such as U.S. banks and some timber companies like Canfor and West Fraser. They were a bit early in buying these names as they continued to experience extreme volatility.
Fast forward a couple of years and the very stocks that were causing this uptick in volatility are now largely responsible for the sharp increase in return that the fund has been experiencing. In 2012 the fund gained 20%, easily outpacing the index and its peer group. Longer term results have also been strong, with a five year annualized return of 5.5% as of January 31, again, handily outpacing the benchmark.
In a recent commentary, they noted that it has become increasingly difficult to find suitable investment opportunities in Canada. As a result, cash levels have risen, and as of December 31, it held about 19% in cash. They expect to deploy this as suitable investments are found. The fund currently holds 49% in Canadian equity, 31% in U.S. equities and 19% in cash.
Over the longer term, we believe that investors will be rewarded with above average gains with this fund. However, as shown since 2008, it may be prone to periods of extreme volatility. While we don’t expect to see a return to the recent volatility levels, higher than average risk is possible. Because of this, we believe that this is a good core holding for only those investors with an above average risk tolerance.
Dynamic Power Global Growth Class – Despite posting a more than respectable gain of 7.2% in 2012, the Dynamic Power Global Growth Class lagged both the index and the peer group, finishing in the bottom quartile for the year. In fact, the fund has struggled since early 2011 and has been on a roller coaster ride since late 2007.
Through it all, manager Noah Blackstein has stayed true to his style, running a very concentrated portfolio of 20 to 30 companies that he believes to have the best growth prospects. He continues to look for those companies that have strong earnings momentum and a history of upside earnings surprises. Based on this approach, the portfolio is very heavily weighted in technology, consumer discretionary and healthcare stocks.
Unfortunately, these were not the sectors that drove the rally in 2012. Instead, it was those that are historically considered to be lower growth sectors, namely financials, drug companies and utilities that rewarded investors substantially last year. Looking ahead, Mr. Blackstein noted in a recent commentary that he believes that the stage is set for a rebound in the fund. Many of the high growth names are trading at valuations that are at multiyear lows compared with the index.
While have not been overly impressed with the fund’s recent performance, we are encouraged that they have remained committed to their style. Anytime you have a manager that has a distinct style, there will be periods of time where it underperforms. We believe the recent past has been one of those times for this fund and that those with the stomach to hang in there for the long term will be rewarded with above average gains.
As we have always stated with the Power funds, they are not for the faint of heart given their above average volatility. This fund is no exception. It should not be considered a core fund. Instead, it is only suited to those investors who can accept significant swings in the value of the fund, both to the upside and more importantly to the downside. But for those investors who can, this can be a good way to add a little bit of kick to their portfolio.
Invesco International Growth Class – This non-north American equity fund is managed by Clas Olsson and his Austin, Texas based team using a bottom up stock selection process that they refer to as “earnings, quality and valuation”, or EQV. Essentially, they are looking for companies that are likely to experience above average earnings growth, have high quality and sustainable earnings, and are trading at a reasonable valuation. They tend to favour companies that are able to generate solid organic revenue growth, have pricing power in their markets, strong balance sheets and offer a more defensive growth profile.
They have the flexibility to invest in both large and mid cap stocks that are located in Western Europe and the Pacific basin, but the focus tends to be more on the larger cap names. It is a very well diversified, holding approximately 80 names, with the top ten making up just over 20% of the fund.
Performance, particularly the longer term numbers are very strong compared with other international funds, posting first quartile returns more often than not. Shorter term however, while performance has been positive, it has lagged both the MSCI EAFE Index and its peer group. A big reason for this underperformance has been the fund’s European holdings. First, they were underweight the region, and second, their holdings simply did not deliver the returns expected.
Looking ahead, they remain cautious on the market. Much of the market growth in the second half of last year was the result of central bank activity. Economic activity is only now starting to show some signs of improvement. Despite this macro headwind, their bottom up process allows them to continue to find interesting investment opportunities that meet their EQV criteria.
On balance, we like this fund for investors who are looking for actively managed exposure to international equities. There are other high quality international products available that offer comparable risk reward profiles including Mawer International Equity, Renaissance International Equity, and Omega Consensus International Equity. Cost conscious investors may want to consider the Mawer offering over this one because of its lower MER.
Is there a fund you would like us to review?? Please send any requests for fund reviews to feedback@paterson-associates.ca.
February’s Top Funds
Steadyhand Income Fund
| Fund Company | Steadyhand Investment Funds Inc. |
| Fund Type | Canadian Fixed Income Balanced |
| Rating | A |
| Style | Blend |
| Risk Level | Low – Medium |
| Load Status | No Load |
| RRSP/RRIF Suitability | Excellent |
| TFSA Suitability | Excellent |
| Manager | Connor, Clark & Lunn |
| MER | 1.04% |
| Code | SIF 120 – No Load Units |
| Minimum Investment | $10,000 |
Analysis: Let’s just cut right to the chase. We like this fund – a lot! Looking under the hood, it is not hard to see why. It offers investors a good alternative to a traditional bond fund with its target asset mix of 75% bonds and 25% high yielding dividend paying stocks and REITs. As of December 31, it was 69% in bonds, 23% in equity and 8% in REITs.
Within the bond component of the fund, the focus is on corporate and provincial bonds, which make up the lion’s share of the exposure. While the emphasis is on corporates, the credit quality is very high, with only 7.3% of the bond component invested in bonds that are BB or lower. Bond exposure is focused on the short and midterm with only 19% of the fund having a maturity of more than ten years.
For the equity portion, the emphasis is on high yielding equities. Given that, it is not surprising to see that the majority is in financials and real estate and includes such names as the big banks, TELUS, and the Brookfield Infrastructure Partners LP.
Performance has been stellar, with a five year annualized return of 7.4%, outpacing the DEX Bond Universe, its benchmark, and its peer group by an impressive margin. Volatility has been higher than what you would get with a traditional bond fund, but is significantly lower than what you would experience with a typical balanced fund.
While the historic return has been great, we do not expect that it will be repeated with the current and expected interest rate environment. A good gauge of the expected return of a bond portfolio is its yield to maturity. The current yield to maturity of the DEX All Corporate Bond Index is approximately 2.9%. Assuming that 75% of the fund is invested in corporates, you can see how difficult it will be for the fund to deliver a 7% or better return, without seeing big gains from the equity sleeve. Given the names, that is unlikely on a sustainable basis. Instead, we expect more modest gains going forward
It is our opinion that investors could consider this as a great fixed income replacement in their portfolios. We expect returns to be mid single digits at best. With the emphasis on corporates and equity exposure, it may experience periods of higher volatility when compared to a traditional bond fund. Still, we believe that the current positioning will allow it to outperform in both a flat and rising rate environment.
CI American Value Fund
| Fund Company | CI Investments Inc. |
| Fund Type | U.S. Equity |
| Rating | F |
| Style | Large Cap Blend |
| Risk Level | Medium |
| Load Status | Optional |
| RRSP/RRIF Suitability | Fair |
| TFSA Suitability | Fair |
| Manager | William Priest since August 2002 David Pearl since August 2002 |
| MER | 2.42% |
| Code | CIG 7500 – Front End Units CIB 7505 – DSC Units |
| Minimum Investment | $500 |
Analysis: If you were to only judge this fund by its 2012 performance, it would be very difficult to make a case for including it in any portfolio. For the year, it gained 7.3% compared with the S&P 500, which gained 13.2%. But despite this underperformance, we believe that the managers are following a very sound investment process that will reward investors over the long term.
While the fund may be called the CI American Value Fund, the managers follow a more blended approach. Rather than focusing on valuation relative to growth prospects, they focus on companies that can maximize shareholder yield. This includes dividends, share buybacks and debt repayment. They look for companies with management teams that have a history of generating consistent free cash flow, and have shown that they can use that cash flow for the benefit of the shareholders.
With this emphasis on cash flow and shareholder yield, it is not surprising to see the portfolio made up of such well known blue chips such as Apple, Microsoft and Abbott Labs. In looking at the current environment, they believe that those companies that can maximize shareholder yield will outperform in the future. They don’t believe that the current environment is conducive to multiple expansion, which means that any share returns must be driven by strong company fundamentals.
While the short term performance has been disappointing, the longer term numbers are considerably more encouraging. For the ten years ending January 31, the fund has gained 4.1%, outpacing not only the majority of its peer group, but also the S&P 500. The firm’s investment approach has resulted in a portfolio that has exhibited significantly lower volatility than the peer group, and is comparable to that of the index.
Epoch Investment Partners, the management group running the fund was recently acquired by rival TD Bank. While both CI and TD have said that it is business as usual, it is possible that the CI may make a manager change in the future. Should this occur, we will reevaluate our opinion of the fund. In the interim, we do believe that this can be a solid core US equity fund for most investors. However, more cost conscious investors may want to look at a lower cost index fund or ETF, which will provide comparable exposure at a lower cost.
Mawer Global Small Cap Fund
| Fund Company | Mawer Investment Management Ltd. |
| Fund Type | Global Small / Mid Cap Equity |
| Rating | A |
| Style | Small Cap Growth |
| Risk Level | Medium High |
| Load Status | No Load |
| RRSP/RRIF Suitability | Good |
| TFSA Suitability | Good |
| Manager | Paul Moroz since October 2007 |
| MER | 1.92% |
| Code | MAW 150 – No Load Units |
| Minimum Investment | $5,000 |
Analysis: Like other Mawer funds, this go anywhere small cap fund looks to build a well diversified portfolio of well managed companies that are trading at a discount to the firm’s estimate of its true worth. They use a very disciplined, bottom up approach that helps them find companies that have sustainable competitive advantages that will allow them to earn a return for shareholders that is above their cost of capital. They are patient and long term focused in their approach, which is reflected in the fund’s portfolio turnover that has averaged less than 20% in the past five years.
It is quite a diversified portfolio holding 69 companies across 21 different countries. As of December 31, the largest allocation was to the United Kingdom, which made up nearly 30% of the fund. It is also quite diversified across sectors, with technology, financials, consumer discretionary and industrials making up the lions share. Cash is currently at 13%, which can be a double-edged sword. Obviously it is a great buffer against potential market volatility, and provides the manager with “dry powder” if any attractive investment opportunities are found. However, it can be a drag on performance, should markets rally sharply higher.
2012 was a good year for the fund, gaining 29.5%, outpacing the Dow Jones Global Small Cap Index that rose by nearly 17%. The longer-term numbers are equally impressive, with an annualized five-year return of 8.1%, more than four times the 1.9% gain posted by the index. Volatility has been reasonable, in line with both the index and the category average.
In isolation, the MER appears low at 1.85%, which is lower than the category average of 2.70%. However, this does not include any advisor compensation, which typically can add up to 1% to the total cost of owning a fund. Considering this, we believe that the cost is a touch on the high side, but is still a cheaper option for a do it yourself investor.
On balance, we believe that this is a very solid offering for investors who are looking for global small cap exposure. It offers a good management team, a disciplined repeatable process, and a very compelling risk reward profile. However, given its focus on small caps, it does have the potential to be very volatile and could experience sharp drops in value. Considering this, those with less appetite for risk may want to limit their exposure to this fund within their portfolios.
Brandes Emerging Markets Equity Fund
| Fund Company | Brandes Investment Partners |
| Fund Type | Emerging Markets Equity |
| Rating | B |
| Style | Large Cap Value |
| Risk Level | High |
| Load Status | Optional |
| RRSP/RRIF Suitability | Fair |
| TFSA Suitability | Fair |
| Manager | Brandes Management Team |
| MER | 2.70% |
| Code | BIP 171 – Front End Units BIP 271 – DSC Units |
| Minimum Investment | $1,000 |
Analysis: For the past several years, the AGF Emerging Markets Fund had been the category leader, with a risk adjusted return profile that was head and shoulders above the rest. That all changed last year when their manager, Patricia Perez-Coutts resigned, taking her team with her to a competitor.
After that, we began looking at other emerging markets funds, and one that stood out was the Brandes Emerging Markets Fund. It is managed using a value driven process that looks for companies that are out of favour with investors and whose share price has been beaten down by the markets. It is built on a stock by stock basis which results in a portfolio that has country and sector exposures that look nothing like that of the benchmark. There are various restrictions in place to ensure that the fund does not take on too much risk by becoming too concentrated in any one sector or country.
It is managed by an investment committee using a longer term investment horizon. This patience is reflected in the fund’s lower than average portfolio turnover. It is well diversified holding just under 70 names with the top ten making up just over 30% of the fund. They do not hedge the currency exposure.
Performance on a relative basis has been very strong, particularly over the long term, handily outpacing both the index and peer group. For the five years ending December 31, the fund gained an annualized 2.4% per year, compared with a loss of 0.7% for the index.
Shorter term numbers have been stronger on an absolute basis, but have lagged the index. Much of the recent underperformance can be attributed to its holdings in Brazil’s Eletrobras, which lost nearly 50% in value on a surprise rate cut announcement. They have reevaluated their position and still believe it is undervalued, even with the lower revenue forecast. In fact, they remain committed to all of the names currently in the portfolio and have used the selloff in a number of their favourites as an opportunity to add to them.
Costs are on the high side with an MER of 2.70%. We should point out that this is still below the category average. The volatility of the fund is comparable to other emerging markets funds.
All in, we believe that this is a good option for investors seeking emerging market exposure. However, it is a volatile fund in a volatile sector and investors must be comfortable with this before making any investment in t