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Additions
Guardian Global Dividend Growth Fund (GCG 570 –Front End Units) – This go anywhere, global dividend fund is managed by Sri Iyer and his team at Guardian Capital, using a proprietary, multi factor quantitative model that screens the global equity universe looking for positive rates of change in the fundamentals of companies. The model looks at 31 key factors including growth, payout ratios, efficiency, valuation and investor sentiment. Each of the factors is weighted, with growth, payout and sustainability factors being the most important for this strategy. The model is run on a daily basis, with the highest ranked stocks receiving a “buy” rating, and lower ranked securities rated as “sell”. The team will conduct a fundamental review to validate any of the potential buy candidates to ensure the rating is appropriate.
The result is a well-diversified portfolio that will typically hold between 70 and 100 names. At the end of December, it held just under 90 stocks. The sector and country mix is the byproduct of the bottom up stock selection process. To ensure sufficient diversification, it must have exposure to at least seven of the ten GIC sectors at all times. The maximum sector weight is capped at 25% of the fund, and emerging market exposure is limited to 15%.
At the end of December, nearly 55% was invested in U.S. equities, with European names making up most of the rest. Some of the top holdings included Apple, Johnson & Johnson, and JPMorgan Chase. The fund is conservatively positioned – overweight the more defensive sectors such as consumer defensives, communications, and utilities. It is underweight financials, consumer cyclicals, and material. This would be expected to hold up well in periods of higher volatility.
The process is quite active, with portfolio turnover that has been well above 100% since the fund’s inception. A stock is sold when its rating falls into the bottom 30% of the universe.
I really like the investment process used by the managers. It is disciplined and repeatable. It focuses more on rates of change rather than the value. I also like that it takes a lot of the potential emotion out of the process, yet has the fundamental oversight of the investment team. In other words, it’s not simply a black box strategy.
I would expect this fund to deliver average to above average returns, with lower than average volatility. It is also quite different than its benchmark. This of course can be a double edged sword, and could potentially result in periods where it underperforms for an extended period of time. Still, I believe it can be a great core global equity holding for most investors.
If you are unable to purchase this fund through your advisor, you could invest in the BMO Global Dividend Fund (GGF 70725), which is virtually identical, except for a slightly higher MER – 2.48% vs. 2.32%. If you prefer an ETF, you could look at the Horizons Active Global Dividend ETF (TSX: HAZ).
IA Clarington Global Equity Fund (CCM 3071 – Front End Units, CCM 3072 – DSC Units) – Last July, Joe Jugovic of Calgary based QV Investors took over the management duties of this fund. QV is a shop known for their focus on finding high quality companies trading at attractive valuations.
While the track record on this fund is very short, QV has been running this mandate as a pooled fund since January 2007 with great success. This fund is identical to the pooled fund, except that it carries an MER of 2.86%. Yes, this is high, but even with the additional cost, it would have still able to outpace most of its peers over the past five years on a risk adjusted basis. Adjusting for the higher cost, this would have been the number 3 ranked global equity fund in my coverage universe at the end of the year.
The fund is managed using the same disciplined, bottom up process that is used with other QV funds. It looks for high quality, invested management that has delivered strong growth in equity, earnings, sales and cash flows. The company must be generating a level of free cash flow that will allow it to increase dividends over time, and the balance sheet cannot be over levered. Finally, it must be trading at a level of valuation that is well below current market levels, while providing return on equity that is above average.
The portfolio is fairly concentrated, holding roughly 35 names. The sector mix and geographic allocation is a byproduct of the stock selection process. At the end of December, it was overweight communication services, financials and consumer defensive, and underweight utilities and real estate. The fund also has exposure to companies of all sizes, although more than 60% is invested in larger firms.
Looking at the historic track record of the pooled fund, combined with the other QV mandates I follow, I expect this fund to deliver above average returns over the long term. With their focus on higher quality names, it is expected to lag in a sharply rising market, however, it will more than hold its own when markets sell off. The emphasis on yield and cash flow will also help to mitigate overall volatility. The biggest drawback is its higher MER. Still, I see this as a great core global equity fund for most investors.
Manulife Monthly High Income Fund (MMF 583 – Front End Units, MMF 483 – DSC Units) – The fund is managed by the team of Alan Wicks and Jonathan Popper. The equity approach is rooted in a value philosophy that looks for businesses that generate high and sustainable profits that are trading at attractive valuations. The fixed income sleeve is managed using a combination top down economic review combined with a bottom up credit analysis. The process looks to generate returns by focusing on sector allocation, credit quality and individual credit selection. They also emphasize risk management by actively managing the portfolios yield curve and duration exposure.
At the end of December the fund held 15% in cash, 35% in Canadian equities, 30% in U.S. equities and 20% in bonds. The equity sleeve is defensively positioned with consumer names making up 30%. It is dramatically underweight energy, materials, and financials which results in a portfolio that is dramatically different than the index.
Performance, particularly since 2011, has been excellent, posting an annualized three year return of 13.2% to the end of December. Perhaps even more impressive has been the volatility profile, which has been below both the benchmark and the category average. It has also done a great job at protecting capital in down markets.
Going into 2015, if my investment thesis plays out, this fund should do an excellent job for investors. The lack of exposure to Europe and Asia is expected to help keep volatility in check, however, if a rally does take hold in Europe, this fund may lag some of its peers. The fixed income portion of the fund is defensively positioned and expected to hold up relatively well when rates do start to move higher.
Deletions
PH&N High Yield Bond Fund (RBF 6280 –Front End Units, RBF 4280 – Low Load Units) – When I added this fund to the Recommended List last time around, I fully expected it to be closed fairly quickly. Sure enough, it was, with RBC once again shuttering the fund to new investors effective November 26. As a result of this closing, I am removing the fund from the Recommended List.
The only reason I am removing it from the list is because the Recommended List only has funds that are currently open for new investment.
If you hold this fund, assuming it is in line with your investment objectives and risk tolerance, I would suggest you continue to do so. It has consistently been one of the top high yield bond funds in Canada. What I like most about this offering is that it tends to be one of the more conservative offerings in the space, offering excellent risk adjusted returns, thanks to a level of volatility that is significantly lower than its peers. It also offers one of the best down capture ratios in the category. The drawback however is that it tends to lag its peers in a rising market. Another bonus is that it carries one of the lowest MERs in the category, even for the advisor sold units.
If you hold it, consider yourself lucky. If you don’t, I wouldn’t hold your breath waiting for RBC to reopen it any time soon.
Trimark Canadian Small Companies Fund (AIM 1683 – Front End Units, AIM 1681 – DSC Units) – This is another fund that I am removing from the list because it has been closed to new investors, effective October 8. It is a “soft cap”, meaning that if you hold the fund, you can add to your holdings, but if you don’t own it, you’re out of luck.
Despite removing it from the Recommended List, this remains one of my favourite Canadian small cap equity funds. Managers Rob Mikalachki and Virginia Au run a very concentrated, high conviction portfolio that is made up of their best 25 to 40 ideas. They are disciplined in their approach and will not make any investment that does not meet their strict quality and valuation criteria. This can result in significant cash balances, which averaged 29% in the fourth quarter of the year.
In a recent commentary, the managers highlighted the fact that at this point in the market cycle, they are having difficulty finding new ideas, which is a key reason behind both the high cash balance and the fund’s closing. Their investment process can often be contrarian, and that is the case today, as they are starting to find a number of ideas in the energy sector, many of which have become even more compelling given the haircut that oil has had recently. They expect to be using this as an opportunity to pick up high quality, well managed, profitable businesses at very attractive valuations. A potential drawback to this move is it may cause an uptick in the fund’s volatility profile. That said, if you are a long-term investor and are comfortable with the risks, this remains one of the better small cap funds available.
I will continue to follow the fund, and will revisit its place on the Recommended List if it is reopened.
Franklin Mutual Global Discovery Fund (TML 180 – Front End Units, TML 182 – DSC Units) – Over the past few quarters, I have noticed a material erosion in the risk reward metrics of the fund, combined with underperformance relative to its peers. I still believe that this is a solid fund, however, there are funds that appear to be better positioned than this offering. Looking at the portfolio metrics, the valuation appears to be reasonably attractive, however, the expected growth rates are lower than the peer group, which dampens my return expectations for the near term. Considering the above, I removed it from the Recommended List. It will however remain on my watch list, and should I notice an improvement in the portfolio’s metrics, I will reconsider the fund to be added back to the rec list.
Funds of Note
Dynamic Advantage Bond Fund (DYN 258 – Front End Units, DYN 688 – DSC Units) – When it had appeared that interest rates in Canada were likely going to rise, the defensive positioning of this fund resulted in it being my top bond fund pick. With a shorter duration and more conservative asset mix, it was well positioned to withstand the increased volatility in the bond market, and was expected to hold up better when yields started to rise. That all changed a few weeks ago when the Bank of Canada surprised everyone and cut its overnight lending rate by 25 basis points to 0.75%, with many expecting more cuts to follow. In an environment where it is more likely that yields will fall or remain flat, this fund will likely lag those funds that have a more neutral positioning. I still believe this is a great bond fund for the long term, and expect it to hold up well when yields are moving higher. Until then, my focus will shift to funds that have a higher duration exposure such as the PH&N Total Return Bond Fund, or the TD Canadian Core Plus Bond Fund.
PH&N Total Return Bond Fund (RBF 6340 – Front End Units, RBF 4340 – DSC Units) – With more cuts to interest rates expected from the Bank of Canada, this high quality bond fund becomes my top pick. At the end of December, it had a duration of 7.3 years, which is slightly less than the 7.6 years of the FTSE TMX Canadian Universe Bond Index. The fund itself is very much like the stalwart PH&N Bond Fund, except the managers have a little more flexibility which allows them to invest a modest portion of the fund in non-traditional strategies such as high yield, mortgages and derivatives. A little more than half is invested in government bonds, the majority of which are higher yielding provincial bonds. Approximately 40% is invested in corporate bonds. Within the corporate sleeve, they have focused more on higher quality issues, and have remained underweight bonds in more cyclical sectors, namely energy. Looking ahead, I expect the management team to continue to do what it has done since the fund’s launch in 2000 – use its rigorous, highly disciplined investment process to opportunistically position the portfolio in a way they believe will best benefit the portfolio, while paying particular attention to managing risk.
AGF Monthly High Income Fund (AGF 766 – Front End Units, AGF 689 – DSC Units) – With two thirds of the fund invested in equities, combined with an overweight allocation to energy and materials, it is not hard to see why this was the worst performing balanced fund on our list in the fourth quarter. It lost 5%, while each of the other picks on the list were in positive territory. While the equity sleeve was aggressively positioned with a cyclical bent, the fixed income sleeve was somewhat defensive, with a duration slightly lower than the index, and a yield that was higher. Approximately 50% of the U.S. dollar currency exposure was hedged against currency movements, which dampened gains in the quarter. In December, they increased the hedge from 50% to 75%, which may be a further headwind in the face of the prospect of a falling Canadian dollar. With the benefit of hindsight, we can see that they got the positioning wrong for the short term. Understandably, I will continue to monitor this fund, and it’s positioning closely. I expect it to remain the most volatile of the balanced picks, but anticipate it will do well over the long term.
CI Signature High Income Fund (CIG 686 – Front End Units, CIG 786 – DSC Units) – Despite a modest 0.6% gain in the final quarter, the fund still posted a respectable 8.6% rise for the year. Over the year, the managers had taken profits in many of their energy names, and built up a significant cash reserve. At the end of December, it had about 20% of the fund’s assets in cash and cash like investments. They have done this for two reasons. The first is to help boost the defensive positioning of the fund, helping it to better withstand any near term volatility. The second reason is for some “dry powder”, which will allow the managers to step in and pick up some high quality names trading at very attractive valuations. I continue to like this fund and believe it to be one of the best balanced funds out there. I expect it to continue to deliver very strong levels of risk adjusted returns, with volatility levels that are well below average.
IA Clarington Conservative Canadian Equity Fund (CCM 1300 – Front End Units, CCM 1400 – DSC Units) – For me, the big appeal of this fund is its conservative profile, which has allowed it to post decent returns over the long term, with significantly less downside than the market, and its peers. Historically, it has delivered about 70% of the upside of the market, yet only experienced between half to two thirds of the downside. This helps to explain why I was so disappointed with its recent performance when it dropped lockstep with the market.
I had the chance to speak with Ryan Bushell, one of the managers of the fund recently, and the main reason for this underperformance was the indiscriminate selloff of any stock that was related to energy. If you look at the fund, it has about a third invested in energy. Yet digging deeper, we see that many of these energy names are high quality, cash flow generating, conservative plays, such as pipelines and companies more focused on natural gas. This includes names such as Enbridge, TransCanada, and AltaGas. Historically, when oil sold off, these names held up much better. Unfortunately this time around, that didn’t happen, and these stocks were punished with the same veracity as their oil focused brethren.
As we move forward, Mr. Bushell believes that much of the selloff in many of the fund’s holdings was unwarranted, leaving a significant amount of upside in the portfolio. They will continue to build the portfolio on a bottom up, fundamentally driven approach that looks for companies with strong management teams and excellent balance sheets that will allow them to withstand any market cycle. They will not deviate from the same process that has worked for them since 1950. I will continue to follow the fund closely.
RBC O’Shaughnessy U.S. Value Fund (RBF 776 Front End Units, RBF 134 – Low Load Units) – If you look at the quarterly performance of this fund compared to the other U.S. equity funds, you might be wondering what happened with it, posting a very modest 2.1% rise, while the others were all significantly higher. Well since you asked, I’ll tell you what happened -currency happened. Over the quarter, the Canadian dollar dropped by nearly 4%. The RBC O’Shaughnessy U.S. Value Fund hedges its currency exposure, while the other U.S. equity funds on the list are largely unhedged. When a fund is unhedged and the Canadian dollar drops in value, the U.S. dollar assets will see a rise in value because of the falling currency. For example, the TD U.S. Blue Chip Fund rose by 3.7% in U.S. dollar terms. When the returns were converted into Canadian dollars, the gain was nearly double, coming in at 7.3%. With the U.S. Federal Reserve likely to start moving rates higher in the U.S. and the Bank of Canada expected to cut rates at home, it is highly likely we will see a further drop in the value of the Canadian dollar. At the very least, I would expect that currency volatility will be on the upswing in the near term. For this fund, or any other that hedges a significant portion of its U.S. dollar exposure, it may result in underperformance when compared with funds that do not hedge their currency. That said, I still believe this to be an excellent U.S. equity fund for those who can stomach a bit higher level of volatility in their portfolio.
Trimark Global Endeavour Fund (AIM 1593 – Front End Units, AIM 1591 – DSC Units) – While I have this fund in the Global Small and Mid-Cap Equity category on the Recommended List, it is really much more of an all cap mandate. Managers Jeff Hyrich and Erin Greenfield have built a concentrated portfolio of high quality names, with sustainable competitive advantages that trade at a discount to their estimate of intrinsic value. Their fundamentally driven, bottom up approach has resulted in a portfolio that looks nothing like its benchmark. They are very disciplined when it comes to valuation, and as a result, cash balances can run quite high. For example, at the end of September, cash was sitting at 14%. Over the course of the quarter, they used market weakness as an opportunity to chip away at a few opportunities, adding a couple of new names to the portfolio, and adding to existing names. This brought the cash down to around 11% at the end of the year. They continue to be patient, waiting for high quality names to trade at values they like. They are also starting to find some ideas in the emerging markets. This remains a great global mid cap pick for those investors who can be comfortable with a performance stream that is much different than the index.
Brandes Emerging Markets (BIP 171 – Front End Units, BIP 271 – DSC Units) – The fourth quarter was a tough one for the fund, amid a precipitous drop in the price of oil, major currency devaluations (especially the Russian Ruble), and political instability in Brazil, Argentina and other EM nations. With its overweight position in both Russia and Brazil, the fund was hit particularly hard, dropping 9.3% in Canadian dollar terms. It was even worse in U.S. dollar terms, with the fund dropping 12.6%. In a recent commentary, the managers stated they remain committed to their thesis on Russia. They believe “…it can offer some of the most potentially undervalued businesses in the world right now. On a macro level, valuations in that nation are about half those of the next closest country, China.”
At the end of December, the fund had 8.4% invested in Russia. It also had 18% in Brazil. It is important to note that the portfolio is constructed using a bottom up process, meaning the country allocations are a byproduct of their stock selection process. Emerging markets have historically been more volatile than more developed markets, and that has certainly been the case of late. I don’t see anything near term that will change that. If you are uncomfortable with high levels of volatility, you should not be invested in an emerging market fund. Over the long term, I believe Brandes will reward investors with solid gains. However, you need to be comfortable with potential underperformance. If not, you should look elsewhere. I am monitoring both the fund and sector closely.