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List Changes
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Additions
There were no funds added to the list this month.
Deletions
Franklin U.S. Rising Dividends Fund (TML 201 – Front End Units, TML 301 – DSC Units) –When I first added this fund to the Recommended List I really liked its risk adjusted return profile. While it often lagged the broader market on an absolute basis, it’s lower than average volatility and excellent downside protection more than made up for it. This time however, it sold off more severely than the market and the overall volatility profile was also increasing. Looking deeper into the portfolio, valuations, according to Morningstar, look rather extended when compared to the broader market. This leads me to believe that more volatility is likely, which is in direct contrast to the main reason I liked the fund. Considering the above, I have decided to remove the fund from my Recommended List effective immediately. Instead, in most cases, I believe an investor is likely better served using a low cost index fund or ETF to gain U.S. equity exposure.
Funds of Note
PH&N Total Return Bond Fund (RBF 1340 – No Load Units, RBF 6340 – Front End Units, RBF 4340 – Low Load Units) – This remains my top Canadian bond fund pick for a couple of reasons. The first is the excellent management team and investment process used by PH&N. Second, with interest rates in Canada more likely to stay flat or move lower, this fund, with its duration of 7.3 years and yield to maturity of 2.4% is more likely to generate stronger returns than either the TD Canadian Core Plus Bond Fund, or the ultra-conservatively positioned Dynamic Advantage Bond Fund in the near term.
The management team are quite active in the fund, and were again active in the fourth quarter trading into the heightened bond market volatility. They have slightly reduced the corporate bond exposure on liquidity concerns, and are focused on less cyclical industries and higher quality issuers. They are maintaining a meaningful allocation to provincial bonds for their liquidity and marginally higher yields. From a valuation perspective, they find real return bonds compelling, and have added some exposure within the fund.
As we move forward, I would expect the bond market to remain challenging, with volatility higher than normal. Also, until we see some level of stabilization in the price of oil and improvements to the Canadian economy, I would expect there to be more downward pressure on yields.
Given the challenging environment, I would expect that volatility within the bond market to remain high, but with there being more downward pressure on yields. This leads me to favour the higher duration position of this fund over the TD or Dynamic offerings. As the economy improves and there is upward pressure on yields, I’ll likely begin to favour Dynamic, given their very short duration positioning.
RBC Global Corporate Bond Fund (RBF 1009 – No Load Units, RBF 753 – Front End Units, RBF 853 – DSC Units) – This actively managed global bond fund invests mainly in investment grade corporate bonds from issues anywhere in the world, as well as high yield and emerging market bonds. At the end of December, it held about 15% in high yield issues, and about 10% in emerging market bonds.
The fund was down 0.1% while its index was up by 0.1%. It was a tough quarter for global bonds with the U.S. Federal Reserve looking to boost rates, while most other central banks looking to do the opposite. Adding to the uncertainty was the continuing selloff in the energy market, which has had a significant impact in the high yield market. One consequence of that has been the market pricing in significant levels of defaults that has resulted in lower bond prices. Spreads have widened considerably and now look fairly attractive, but not without risks. Still, in this environment, the managers have taken an overweight position in high yield, which may result in some shorter term volatility, but is likely to generate stronger long term gains.
In addition, they are also overweight investment grade credits in the U.S. Emerging markets, Canada and Europe are all a neutral weight. The fund’s duration is 5.89 years, with a yield to maturity of 3.8%, both of which are roughly in line with its benchmark.
Longer term, the management team has done an excellent job delivering above average returns with lower volatility. I would expect that to continue over the medium to long term, although the higher weight in high yield may result in some shorter term volatility. This remains a great pick for those looking for global fixed income exposure.
Cambridge Canadian Equity Class (CIG 2321 – Front End Units, CIG 3321 – DSC Units) – With a gain of 1.5% the fund managed to outperform the S&P/TSX Composite Index, but trailed its peer group. The managers have kept the sector positioning mostly unchanged over the quarter, adding slightly to consumer staples and financials, while reducing consumer discretionary names. At the end of the year, it looked much different than the broader Canadian equity market, with overweight positions in technology and consumer names, while underweight financials and energy. It also held nearly 20% in cash. Historically, the managers have been more active in periods of high volatility, taking advantage of opportunities as they arise. I expect this to continue. While there may be a bit more volatility in the short term, this remains an excellent long-term pick. There is an excellent management team at the helm, using a disciplined and repeatable process.
IA Clarington Canadian Conservative Equity Fund (CCM 1300 – Front End Units, CCM 1400 – DSC Units) – This is a fund that I continue to struggle with. There is no denying that recent performance has been abysmal, and there was a definite uptick in the volatility, and an erosion in the downside protection offered in the most recent selloff. But unlike the Franklin U.S. Rising Dividends Fund, which I removed from the Recommended List, I am more comfortable with the reasons for the decline and the investment process used.
In very simple terms, it was largely the pipeline holdings that were responsible for the fund’s significant underperformance. Yet, when I look at the underlying fundamentals of the sector, but more specifically the stocks in the portfolio, things are not nearly as dire as one would surmise from the stock price annihilation. According to the manager in a recent commentary, “…pipeline shares are still the 4th best performing sector in Canada over the past 10 years, with a 9.75% annualized return and representing the highest dividend yield and dividend growth in our portfolios.” Further, pipelines, while technically energy stocks, are not directly affected by oil and gas prices, as much of their revenue is driven by fixed contracts, meaning they get paid regardless of the price of energy. When you factor in the increasing demand for energy in North American and elsewhere, the picture begins to brighten.
Understandably, the managers believe that 2016 will be better than 2015, as the benefit of cheaper dollar will help offset some of the impact of the lower oil price. They are also expecting to see some firming in the oil price in the latter part of the year.
The managers remain true to their process, which focuses on high quality businesses that are trading at attractive yields. This explains why the fund is underweight technology, consumer and healthcare names. While these sectors were responsible for a significant portion of the market gains, they also tend to pay very little in the way of dividends – a key requirement for this fund.
While I am more positive on this fund than I have been in the past few quarters, it remains Under Review, and I continue to monitor it closely.
Mackenzie U.S. Large Cap Class (MFC 1022 – Front End Units, MFC 1172 – DSC Units) – Using a mix of top down thematic investing and bottom up security selection, this fund managed by Erik Becker and Gus Zinn, posted a very strong 10.6% gain in the final quarter of the year. It was largely the technology and consumer names that propelled it higher, while the unhedged currency position bolstered gains further, as the Canadian dollar continued its slide against the U.S. dollar.
The portfolio holds approximately 45 names, with the top ten making up about a third of the fund. It is overweight in healthcare, consumer, and communication names – sectors, and companies that are expected to benefit from the current themes of the portfolio – the mobile internet, consolidation, and the North American manufacturing renaissance.
The fund has had a great run, gaining nearly 25% per year over the past three years, and more than 17% annualized over the past five, both of which were well above average. Looking at the portfolio now however, it has a definite growth tilt to it, with valuation levels that are higher than the broader market. According to Morningstar, the P/E on prospective earnings is nearly 23 times, compared with just over 17 for the S&P 500. Further, the expected earnings growth rates of the companies within the portfolio are lower than some of the other U.S. equity funds on the Recommended List, causing me some concern around the overall valuation picture.
Considering the above, I am placing the fund Under Review. I would expect that we will continue to see higher than normal levels of volatility within the portfolio, and expect to see performance lag should the market leadership shift towards more value focused names. If you have held this fund for any length of time, you will want to consider taking some of your gains off the table to protect against any major drawdown. I will continue to watch the fund closely for any material erosion in the risk reward metrics of the fund.
RBC O’Shaughnessy U.S. Value Fund (RBF 776 – Front End Units, RBF 134 – Low Load Units) – With a modest 2.3% gain in the final quarter of the year, and an 8.9% loss for 2015, this quantitatively managed U.S. equity offering was the worst performing funds on the Recommended List. There were a couple of key factors contributing to the underperformance. The first is the fund’s currency exposure, which is fully hedged back to Canadian dollars. Because of this, it missed out on currency gains of more than 19%. Another reason for the underperformance was its value biased stock selection process. Value names have struggled compared to more growth focused companies in the healthcare and technology sectors. A number of key holdings lost nearly half their value over the year including such names as Bed Bath & Beyond, Hess Corp., and Mosaic. A nearly 10% weight in energy was also a headwind for the fund.
Looking ahead, the currency position is not expected to be as large a detractor from performance as it has been of late. While some further erosion in the Canadian dollar is expected, particularly if the Bank of Canada cuts rates, or the U.S. Federal Reserve moves higher again, but I wouldn’t expect to see another 20% fall. If anything, once we see a stabilization in the price of oil, the Canadian should dollar start to move higher.
Also, as the market leadership returns to the more value focused names, I would expect to see performance improve. While there is no way to effectively forecast when that will happen, the valuations of the growth names, even after the recent selloffs still remain elevated. Regardless, I would expect to see more volatility in all areas of the equity markets.
Still, this remains an excellent long-term pick for those looking for U.S. equity exposure. It offers a disciplined, transparent investment process that has an excellent long-term track record, and it carries an MER of 1.49%, which is well below the category average. With a longer term time horizon, now may be an opportune time to add some exposure to this fund in your portfolio.
TD U.S. Equity Index Fund (TDB 661 – No Load Units) – The fund had a decent year, gaining 20.5% compared with the S&P 500, which was up by 20.8%. This underperformance is not surprising, given it is designed to track the Canadian dollar return of the S&P 500, net of fees. I should emphasize that nearly 19% of the gain was the result of the falling Canadian dollar, something that is not likely to be repeated in the coming year. If you are looking to protect against an increase in the value of the Canadian dollar, there is a currency neutral version available. It tracks the U.S. dollar returns of the fund, net of fees, taking currency movement out of the equation. The fund code for that is TDB 655. I am expecting there to be more near term volatility in the currency, but expect it to stabilize once we see the price of oil gain a stronger footing.
Brandes Global Small Cap Fund (BIP 152 – Front End Units, BIP 252 – DSC Units) – This deep value offering from Brandes had a very strong quarter, gaining 5.5%, matching the peer group, but lagging the index. It ended the year with a gain of more than 22%, putting it firmly in the upper quartile of all global small and mid-cap funds.
It is managed using a value focused process that looks to buy companies that are trading a significant discounts to their true value. On the surface it appears to be more volatile than its peers, with a standard deviation that is considerably higher than both the index and its competition. However, looking at upside and downside capture ratios, the fund still manages to do a good job at protecting investors’ capital.
It has had a heck of a run since the start of 2012, more than doubling, and delivering an annualized gain of more than 24% per year. Despite this, the portfolio’s underlying valuation metrics remain attractive when compared to the index and its competition. According to Morningstar, only the Mackenzie Cundill Recovery Fund, and the Vertex Value Fund have P/E ratios that are lower.
Given the strong run, I would expect to see the fund take a breather at some point, still, with the more compelling valuation, it should hold up better than its peers. That has been the case so far in 2016, with the fund falling by 6.7% while the category average is down nearly 10%. Longer term, I believe this fund, with its excellent management team, repeatable, disciplined investment process, and focus on valuation will continue to deliver above average returns for investors. However, with its very high active share, there may also be periods where the performance is out of step with the index and its peers. If you are comfortable with this, the fund remains a great option for those looking for global small and mid-cap equity exposure.
Trimark Fund (AIM 1513 – Front End Units, AIM 1511 – DSC Units) – This bottom up managed global equity fund has been one of my favourites for a long time now. The managers look for companies that are industry leaders, have strong barriers to entry, high levels of free cash flow, and excellent management teams that have a history of generating high returns on invested capital. Further, the companies must be trading at a discount to what the managers believe the stock is worth. The result is a concentrated portfolio that holds between 30 and 50 names.
Performance has been excellent of late, with a five year annualized gain of 14.6%, handily outpacing most of the competition. Because the portfolio tends to be fairly concentrated, it can be a bit more volatile at times, however over the longer term, because of the higher emphasis on quality, it has been of lower than average volatility.
The managers are expecting that the recent volatility is likely to continue, as a lot of uncertainty remains. If this happens, I see it as a positive for the fund for a couple of reasons. Historically, it has outperformed in volatile markets, which is a byproduct of the quality bias. Second, the managers tend to be more active in volatile periods, using market weakness as an opportunity to pick up attractive companies at compelling valuation levels. Currently, they are finding a number of interesting ideas in the energy space and in the emerging markets. There is a risk to this in that they may be early in the space, which could have a negative impact on shorter term performance numbers. However, given their longer term outlook, they are comfortable being wrong in the short term to be right in the long-term.
I expect to see more volatility in the near term with this offering, but believe it is a great pick for those who can be patient. I also prefer the “SC” Units over the “A” series units because of the much lower cost structure.
CI Signature High Income Fund (CIG 686 – Front End Units, CIG 786 – DSC Units) – Despite gaining 1.2% in the quarter, the fund underperformed its peers. There were a couple of reasons for this underperformance.
The fund has about half of its bond exposure invested in high yield issues, which were hit hard in the final quarter of the year. It also has an overweight position in REITs, which have struggled and had a tough Q4. Finally, financials, particularly U.S. financials faced some headwinds on economic worries. The result was a lackluster quarter where most of the gains were the result of the unhedged currency position.
Still, this has been one of the stronger balanced funds around over the long term It has an excellent management team at the helm, using a disciplined, holistic approach that has generates superior risk adjusted returns over the long term. Given the positioning, I would expect to see some more volatility in the near term, but longer term, it should return to its former glory, delivering above average returns with below average volatility.