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Welcome to our most recent Recommended List of Funds. This report contains our best fund ideas, asset mix suggestions and brief commentaries on a number of funds. We hope that you find this report to be helpful.
Additions
TD Monthly Income Fund (TDB 821 –Front End Units, TDB 831 – DSC Units) – There are definitely more than a few things to like about this equity focused balanced fund. The first thing that jumps out at me is the cost. It has one of the lowest MERs for a balanced fund, coming in at 1.47%. Even at this level, there is still a 0.50% trailer that is paid to advisors. It also pays a monthly distribution of $0.0349 per unit, which works out to an annualized yield of just under 2.25%. Where this fund really holds its own is with the risk reward profile. Yes, it was hit hard in 2008 dropping more than 23%. Much of that can be attributed to the fixed income sleeve, which at the time was invested mainly in high yield bonds. Since then, the fixed income sleeve has become more like the TD Canadian Core Plus Bond Fund, which is one of my top bond picks. Should we see another 2008, it should hold up much better than it did last time around. In the past three years, it has only experienced about a quarter of the drops experienced by its benchmark. On the equity side, Doug Warwick and his team use a fundamentally driven, bottom up approach that looks to find well managed companies with strong financials, solid fundamentals, and the ability to pay and grow their dividends. The result is a fairly concentrated portfolio that is overweight in financials and energy. The top five largest holdings are the big five banks, followed by Canadian Oil Sands, Enbridge and Suncor. The overall asset mix is set by the manager, with input from TD’s asset allocation committee. Historically, it has been relatively stable, as they are more focused on security selection, rather than making tactical bets. If I had to list a concern with the fund it is that there is a fairly high level of interest rate sensitivity in it. If we see a big spike in rates, this fund is likely to lag. However, with rates expected to remain relatively low in the near term, I don’t expect it to be a problem for now.
Manulife World Investment Class (MMF 8251 – Front End Units, MMF 8421 – DSC Units) – The Mawer International Equity Fund has been one of the best international equity funds for as long as I’ve been in the investment business and then some. This Manulife offering is virtually identical to it, except it has a higher level of cost, which includes embedded dealer compensation. Like the Mawer offering, it is managed using a “growth at a reasonable price” approach that looks for wealth creating companies that are trading at discounts to their estimate of intrinsic value. A typical company will also generate high returns on equity. Their research process is one of the strongest in the business, with analysts conducting thorough, in-depth analysis on the company’s business model, financial position, and quality of management. Another unique aspect of their process is that analysts put their assumptions on each company through a Monte Carlo type scenario analysis. They test a wide range of their outcomes to get a stronger understanding of what the company’s true worth will be under a range of situations. The result is a portfolio that is made up of between 50 and 60 names, with the top ten making up about a quarter of the fund. Sector and country weights are largely the result of their rigorous stock selection process. At the end of June, the portfolio had nearly 80% invested in Europe. This could result in a nice rally thanks to the European Central Bank’s recent stimulus actions. It is also heavily invested in industrials, which should benefit from an economic rebound. Performance has been stellar, consistently outpacing most of its peers at a level of volatility that is below average. For the past five years, the fund has gained an annualized 11.6%, slightly lagging the MSCI EAFE Index, which gained 11.9%. Except for 2013, it has posted above average returns in every year since its launch in 2006. It offers decent downside protection, and will outperform the index more often than not. It is managed by a great team, using a rock solid process. The biggest drawback to it is its cost, with an MER of 2.71%, it is substantially higher than the 1.49% MER of the Mawer International Equity. If you are using a fee based account, I would use the Mawer offering, otherwise, this is a great substitute. Even with the higher cost, I believe this will continue to be one of the best international equity funds available to Canadian investors.
Deletions
CI Signature Canadian Balanced Fund (CIG 685 – Front End Units, CIG 785 – DSC Units) – It’s not that this is a bad fund. Far from it. It has a great management team at the helm. It is also managed using a disciplined, repeatable process that incorporates a top down analysis to determine the overall asset mix, with fundamentally driven, bottom up security selection. At the end of June, more than 70% was invested equities, making it one of the most aggressively positioned balanced funds. It is this positioning that is the cause of the funds above average volatility. Performance has been more than respectable, and it has been able to outpace other funds when markets are rallying. However, it has done a relatively poor job in protecting capital when markets fall, which is a big concern for me as we move forward. Another area of concern for this fund relates to its cost. With an MER of 2.44% it is the most expensive balanced fund on the list. While cost may not be an issue in a rising market, it will be a drag on performance if we enter a falling or even flat return environment. If you hold this fund, I certainly wouldn’t suggest you run for the exits, unless you are uncomfortable with the potential for continued high volatility. I still think that over the long term investors will earn average to above average returns, however, I believe that there are better options available. As a result, I am removing it from the Recommended List.
Funds of Note
Manulife Strategic Income Fund(MMF 559 – Front End Units, MMF 459 – DSC Units) – I really hate that this is categorized as a high yield bond fund, because it really understates the quality of the fund, its management, and its risk reward profile. In reality, it is more of an opportunistic go anywhere bond fund that invests across multiple fixed income sectors such as global government bonds, investment grade bonds, high yield, and emerging market debt. In addition, the managers will tactically manage the currency exposure and try to generate additional return from that. Their investment process starts with at top down macro analysis that is used to set the sector mix. Once set, they then use a more fundamental approach to security selection. The average credit quality of the fund must be at least investment grade, however, the high yield exposure will typically be in the 30% to 50% range. At the end of June, 37% was invested in non-investment grade debt. Performance has been decent, gaining an annualized 5.3% for the past three years, handily outpacing the average global bond fund. Volatility, even with the currency trading has been well below average. What is particularly attractive is that it has shown very low levels of correlation to the traditional asset classes, including Canadian fixed income. This makes it a great way to help reduce the overall volatility of your portfolio by including it as a portion of your fixed income allocation. It is a touch pricey with its 2.07% MER. It also has the potential to be more volatile than a more traditional bond fund. Still, it is my view that over the long-term, the benefits outweigh the risks.
Fidelity Canadian Large Cap Fund (FID 231 – Front End Units, FID 531 – DSC Units) – For the longest time, this has been one of the strongest Canadian focused equity funds around. However, so far this year it has lagged considerably, gaining 6.5% which is about half what the S&P/TSX Composite Index earned. The reason for this is the fund’s positioning, which includes no exposure to materials, a significant underweight in energy, and no banks. Unfortunately these were the best performing sectors over the quarter, resulting in the fund’s underperformance. Despite a lackluster six months, I’m not ready to pull the fund from the list. The manager continues to stick with his disciplined value focused process. This discipline will result in periods where return is much different than the broader markets, and I believe that this has been one of those periods. Still, I will continue to monitor the fund for any erosion in the risk reward characteristics.
Franklin U.S. Rising Dividends Fund (TML 201 – Front End Units, TML 301 – DSC Units) – What I like most about this fund is its ability to protect capital in down markets. While most other U.S. equity funds tend to fall more than the S&P 500 does, this gem has only fallen between 60% and 70% of the broader market. The reason is its focus on companies that have a history of consistent and substantial dividend increases over time. Because they tend to offer a relatively high dividend yield, they also tend to hold up better when markets fall. Even in 2008 when the S&P was off by nearly 30%, this fund was only down 11%. A drawback to this strategy is these are also the types of companies that will lag when markets are rising. Still, this is a great core holding for investors who are more risk averse, yet still want or need exposure to U.S. equities.
Fidelity Small Cap America (FID 261 – Front End Units, FID 561 – DSC Units) – Manager Steve MacMillan has been at the helm of this fund for just over three years and the results have so far been great. For the three years ending June 30, it has gained an annualized 24.3%, handily outpacing the 18.5% generated by the Russell 2000. While this is certainly impressive, he has also done a stellar job managing the volatility, keeping it well below the average for the peer group. When it comes to protecting capital in falling markets, this fund leads the category with a down capture ratio of 34% for the past three years. The portfolio is much different than its benchmark and is significantly overweight in consumer names, and industrials. It holds no materials and is underweight financials and energy. That may help explain why it has struggled to keep pace during the quarter. I am monitoring the fund closely, watching for any meaningful erosion in its risk reward characteristics.
CI Signature High Income (CIG 686 – Front End Units, CIG 786 – DSC Units) – When I think of best in class balanced funds, this fund is usually at the top of my list. Managed by the Signature team at CI, it has consistently been one of the strongest performers in the category, yet at the same time has tended to be one of the least volatile. For the three years ending June 30, it gained an annualized 9.3%, handily outpacing its benchmark and peer group. The portfolio is a mix of high yielding equities and high yield bonds. About 40% is invested in bonds, 11% in cash, and the balance in equities. Historically, it could only invest up to 49% outside of Canada, but that was recently changed to 70%, allowing the managers even more flexibility. This flexibility may come in handy once we see interest rates start to trend higher, allowing the managers the ability to find more opportunities abroad. This should also help to reduce the overall interest rate sensitivity of the equity portfolio which is now highly concentrated in REITs and energy income plays. Looking at the management team, the investment process and their track record at both growing and protecting capital, this is one of the best balanced funds available.
Sentry Canadian Income Fund (NCE 717 – Front End Units, NCE 317 – DSC Units) – It’s pretty tough not to be impressed by a fund that has outpaced the broader equity markets by delivering an annualized five year return of more than 17%, and doing so with two thirds the volatility of the index. Managers Michael Simpson and Aubrey Hearn look for well-managed, high yielding equity names that have the ability to deliver strong and growing cash flows. The portfolio will typically hold around 60 names, and tends to look much different than its benchmark. It can invest up to 49% of the fund in the U.S., and it can also hold preferreds, corporate bonds and low risk options to help boost the internal yield. At the end of June, it held about 6% in cash, 5% in bond, and a modest 0.3% in prefs. Unlike a lot of yield focused funds, it has a minimal exposure to financials and does not hold any banks. Even its REIT exposure is rather modest coming in at just over 7%. There is little doubt the longer term numbers are impressive, however it has struggled to keep pace so far this year. Some of that is likely due to the U.S. holdings, which currently sit at 34%. Even still, it is pretty tough to find a fund that has done as good a job at both growing and protecting investors’ capital. While I doubt that the historic level of return can be repeated, it is expected to continue to outperform on a risk adjusted basis over the long-term.