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Funds of Note
Manulife Strategic Income Fund (MMF 559– Front End Units, MMF 759 – Low Load Units) – The Fund lagged its peers in the first quarter, posting a modest 1% rise. The portfolio remains conservatively positioned, with an effective duration of 2.4 years, which is well below the broader Canadian bond market. In an environment where yields remain near historic lows, the Fund offers a yield to maturity of more than 3.3%.
In this environment, the managers remain cautiously optimistic, but note the global economy is at somewhat of an inflection point. There are many signs showing the global economy is on the mend, including improving economic growth numbers, and rising inflation. On the other hand, there are several external events that could create periods of extreme uncertainty and volatility in the global equity and fixed income markets including the Brexit negotiations, several European elections, and the potential policies coming out of the Trump administration, like the fiscal stimulus plan, tax reform, and of course, trade policy.
It is this potential for volatility, combined with the managers’ focus on mitigating risk that is keeping them somewhat defensive. They have built a reasonably high quality, very liquidity portfolio that they believe will not only protect them in a downdraft, but also allow them to take advantage of potential opportunities in periods of volatility and market dislocations. They remain focused in developed markets, which at the end of March made up more than 90% of the Fund. The U.S. is the largest country allocation, with nearly two-thirds invested there. Credit quality is also rather high, with 64% invested in investment grade issues. 25% is invested in high yield opportunities.
The managers continue to be defensive but selective with their security selection. With valuations looking rich in several areas, they are careful to ensure they are being adequately compensated for the risk they accept with each position. This is particularly true with their investment grade corporate bonds, and emerging market debt sleeves.
Most of their currency exposure is to the U.S. dollar. Currently, they believe the U.S. dollar is likely to remain rangebound to the Canadian dollar, with the lows being in the $0.72 – $0.74 range, and the highs being in the $0.78 – $0.80 range. Their bias is to remain fully hedged, but will tactically adjust their currency exposure based on the outlook, looking to add incremental gains where possible, without accepting too much additional risk.
Looking ahead, this remains one of my favourite global bond funds. It is run by a very disciplined management team, using a very repeatable process that focuses on managing risk. They are dynamic in their approach and will adjust the portfolio based on their view of the risk reward tradeoffs. I see this as a solid addition to the fixed income sleeve of a well-diversified portfolio, as a way to reduce the interest rate sensitivity, and reduce the overall volatility profile.
CI Cambridge Canadian Equity Corporate Class (CIG 2321 – Front End Units, CIG 1521 – Low Load Units) – This benchmark agnostic, actively managed, all-cap, Canadian focused equity fund remains one of my favourites. Using a disciplined investment process, the management team, headed by Brandon Snow, looks for companies that offer strong long-term growth potential, that are trading at attractive valuation levels. The portfolio is typically structured into two segments, a core, which invests longer-term, quality focused investments they are likely to hold for several months to several years, and a more opportunistic segment, that invests in shorter term, more tactical plays. These could be more macro driven, or company specific.
The Fund has had a great year, gaining nearly 18% for the year ending March 31. In the first quarter however, it lagged both the index and peer group, with a modest 1.3% return. Coming into the year, the fund was conservatively positioned, carrying approximately 18% in cash. By a rough estimate, the cash may have cost the fund approximately 25 basis points in performance.
Throughout the quarter, they took profits in many names that had rallied higher in the past year, including several U.S. banks and industrial companies. Valuation levels had reached the point where the risk reward outlook for the companies were no longer attractive. With the proceeds, they added exposure to more attractively valued companies in the grocery, and energy sectors.
They remain defensive, with 16% in cash. They are significantly overweight consumer names, with a healthy exposure to technology names. One area where they have zero exposure is in the Canadian banks. Despite their heft and perceived quality profile in the Canadian market place, the managers believe the big five carry significantly higher levels of risk than many would expect. While there is little question the historic performance has been strong, management believes it may be difficult to repeat going forward based on several factors including, the potential for slower loan growth, higher loan defaults, higher capital requirements, and of course, the high debt levels carried by many Canadians, and the worries over a meaningful slowdown in the Canadian housing market. Combined, these factors lead the team to believe there are better opportunities elsewhere.
Their process works, posting long-term return numbers well above the index and peer group, with less volatility and better downside protection. Considering the management team in place, and the investment process they use, I expect this fund to continue to deliver average or better returns with less volatility.
RBC North American Value Fund (RBF 766 – Front End Units, RBF 130 – Low Load Units) – In contrast to the CI Cambridge Canadian Equity Corporate Class, which holds no Canadian banks, this value tilted, Canadian focused RBC offering sees three of its top five holdings as banks. At the end of March, it had 8% in cash, 52% in Canadian equity, and 38% in U.S. equity. As a result, Morningstar lists its average market capitalization as significantly higher than any of the other Canadian equity funds on the Recommended List.
To start the year, the Fund had a respectable start, gaining 2.6%, outpacing both the S&P/TSX Composite, and the category average. It is reasonably defensive, carrying a higher level of cash, combined with an overweight in reasonably valued consumer names, and healthcare. It is also overweight technology, with exposure to many industry heavyweights including Alphabet, Apple, and Microsoft. Q1 saw growth names outpace value, which helps explain some of the headwinds the fund faced in the quarter.
Longer term return numbers look decent, with an annualized five-year return of 11.4%, while the S&P/TSX Composite gained 7.8%. The U.S. holdings would have contributed to the positively to this return, as the S&P 500 gained 20% in Canadian dollar terms. While the returns have been strong, what impresses me more is the lower volatility and stronger downside protection. Volatility has been less than both the index and peer group over both a three and five-year period. Capital protection has been excellent, participating in nearly 90% of the upside of the index, while realizing less than half of the market drawdowns.
Portfolio valuation remains attractive compared to its peers, offering a modest margin of safety. Looking ahead, I expect this Fund to continue to deliver average or better returns, with lower volatility and stronger capital protection in down markets. Given the value focus, it may lag in the near term, as the markets have largely continued to reward more richly valued, higher beta names. As the markets return to a more normalized environment, this Fund is expected to be a benefactor.
CI Cambridge Pure Canadian Equity Fund (CIG 11109 – Front End Units, CIG 11359 – Low Load Units) – It was a tough start for this Canadian small cap offering, which lost more than 2% in the first quarter. It is particularly disappointing given the significant cash balance, which was roughly 20% at the start of the year. Much of the underperformance was the result of its energy holdings, which sold off on a milder than normal winter, and worries over potential trade barriers, now that Mr. Trump is in the White House.
Throughout the quarter, they took profits in the financial names that rallied after the Trump victory. With the proceeds, they added exposure to more defensive, yet attractively valued consumer staples names.
Despite the underperformance, the managers reiterated their view that the investment thesis of the names they hold in the portfolio remain intact. They believe the companies are creating wealth and in time, the markets will recognize this, pushing their stock prices higher. Valuations remain a concern, which is why they remain defensive, keeping their cash balance at around 20%. From a sector perspective, they are overweight consumer names, energy, and technology, while being underweight materials, financials, and utilities.
Despite the more muted short-term performance, the longer-term numbers have been excellent. For the five years ending March 31, it has gained an annualized 18.6%, handily outpacing the index and peer group. Even more impressive, volatility has been well below average, and the downside protection has been excellent. For the past five years, the downside capture rate has been less than 20%.
Looking ahead, given the portfolio’s slightly extended valuations, I would expect to see a more muted return. However, given the disciplined, proven investment process used, I would reckon volatility to remain well below average, making this a good way for an investor to gain access to Canadian small caps.
TD U.S. Blue Chip Fund (TDB 310 – Front End Units, TDB 370 – Low Load Units) – By far, the “growthiest” U.S. equity fund on our Recommended List, it was also one of the strongest performers in the first quarter, posting an impressive 9.0% return. In comparison, the S&P 500 rose by just over 5% in Canadian dollar terms.
The Fund is diversified, yet concentrated. It holds more than 135 names, while the top ten make up just under 40% of the portfolio. Further highlighting the concentration is the sector breakdown, where more than 70% is invested in just three sectors; technology, consumer cyclical, and healthcare.
The manager looks for dominant players in their respective fields that have above-average, sustainable growth prospects, and the ability to deliver and grow free cash flow. The top holdings are littered with many household names including Amazon.com, Facebook, Alphabet, Microsoft, and credit card processors MasterCard, and Visa. It invests in very large companies, most of which have market capitalizations in the upper quintile of the market. It’s average market cap is more than 60% higher than that of the S&P 500.
Performance over the long-term has been excellent compared with its peer group. For the five years ending April 30, it gained an annualized 19.8%. While this may have slightly trailed the S&P 500, it outpaced its peers. Looking out over ten years, the Fund gained a very respectful 9.3%, lagging the annualized 9.5% posted by the index.
While the returns have been solid, this is not a fund for those with an aversion to risk. It has been significantly more volatile than both the market and peer group over all periods, and experienced higher highs and lower lows. Because of its concentrated sector exposure, there is the potential that there will be periods where it either leads or lags the index, in some cases by a significant margin.
One concern I have about the fund in the near term is its level of valuation. It is currently trading at multiples well above the index. While some of this can be justified by its better than average, forward looking growth rates, it is still a bit rich compared to some of the alternatives. If you have held this for a while, you may want to consider taking some profits, and reducing your exposure to bring it more in line with your target level.
For those looking for a quality, growth focused U.S. equity fund, this is one that should be considered. It has a strong management team, using a disciplined process, and a strong track record. However, you must be comfortable with higher than average volatility.
Trimark U.S. Small Companies Fund (AIM 5523 – Front End Units, AIM 5525 – Low Load Units) – Historically, it has been very difficult for managers to beat the S&P 500 index, given the market efficiency it has. There are countless analysts and managers monitoring every move by every company in the index. The index is constantly highlighted in the financial media, and is a never-ending discussion topic on CNBC and BNN. The same cannot be said in the U.S. small cap space, where those managers who are willing to do the legwork can often find those underappreciated gems that can provide solid risk-adjusted returns over the long term. I believe this is one of those funds.
Managed by a team headed by Rob Mikalachki, they look to build a concentrated portfolio of high quality, well managed companies that are largely ignored by the rest of the investment world. They look for good management teams that are typically the number one or number two ranked company in their industry, and a history of delivering high levels of free cash flow, and strong balance sheets.
The investment process is bottom up, meaning the sector weights are the by-product of the stock selection process. So too is the Fund’s cash weighting, which the team will let rise in situations where they are not able to find suitable investment opportunities that meet their criteria, including a reasonable valuation level. Now is one of those times, as the cash in the Fund ended the quarter at more than 18%, up from 14% at the end of the year. This rise can be attributed to their selling of Alere Inc., a U.S. based healthcare company involved in diagnostics and information solutions. They sold it because they believed the outlook had weakened, making it less attractive on a risk reward basis.
Small cap valuations are a concern, and they remain patient as they continue to look for companies that meet their investment criteria, while offering a reasonable margin of safety. If they cannot find suitable opportunities, they will continue to hold cash.
Over the long-term, the team has done a good job of delivering strong returns, with below average volatility. For the five years ending April 30, it gained an annualized 15.4%, which is right in line with its peers. However, the volatility of the Fund has been significantly lower than the peer group, resulting in considerably stronger risk adjusted returns. Capital preservation has also been excellent, participating in less than 60% of the market’s downside over the past five years, while still delivering 70% of the upside.
While I like the fund, there are a couple things to note. First, it is concentrated, so there are likely to be periods where the returns of the Fund are dramatically different than the index or peer group. This could result in periods of outperformance or underperformance. Another drawback is the cost. The MER for the advisor sold units is 2.93%. However, those accessing the Fund in fee based accounts can access it at 1.47%, and those investing in the “do-it-yourself” units will see a 1.68% MER, making it a more appealing option.
Trimark Fund (AIM 1513 – Front End Units, AIM 1515 – Low Load 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. The companies trade at a discount to what they believe the stock is worth. The result is a concentrated portfolio that holds between 30 and 50 names.
At the end of April, it held less than 40 names, and was decidedly overweight industrials, technology, and consumer staples. This sector mix was not the result of a macro call, but a function of their disciplined, stock selection process.
The process works, with the Fund outpacing its rivals often. In the past five calendar years, it has only posted below average gains in one year – 2014, when it finished in the 51st percentile of global equity funds, still a respectable middle of the pack showing. Looking at the returns over a one, three, five, ten, and 15-year period, at April 30, it has been above average over each of those time frames.
The managers also take a long-term, patient view, and will sell a stock for a few reasons including it reaches full valuation, a better idea is found, or they were wrong. Over the past four years, turnover has averaged in the 20% range. In the first quarter, they sold a financial services company because they believed it had reached full value. Even in the current environment, management have not had a lot of difficulty finding suitable investment candidates, as cash sat at a very modest 3.95% at the end of March.
Looking ahead, the managers see there are signs that the economic fundamentals are getting better. However, there are many risks on the horizon, including the unknown that is President Trump and his potential protectionist policies, which may dampen economic activity. They believe we are still in a “low growth” environment for the next little while. They will continue to look for companies that meet their criteria, and will use periods of market weakness to pick up new holdings, and add to existing names. This remains a great core global equity fund.
Brandes Global Small Cap Equity Fund (BIP 152 – Front End Units, BIP 211 – Low Load Units) – This deep value offering from Brandes had a slow start to the year, gaining nearly 3% in the first quarter, trailing the index and peers. Longer-term however, this has been one of the standouts in the category, outpacing the index and peers over a one, three, and five-year period.
It is managed using a value focused process that looks to buy companies that are trading a significant discount to their true value. On the surface, it appears to be more volatile than its peers with a standard deviation that is 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.
Even with an annualized five-year gain of nearly 20% the portfolio’s underlying valuation metrics remain attractive when compared to the index and its competition. According to Morningstar, there are only four other global small and mid-cap equity funds that have P/E ratios that are lower. Factoring in forward looking growth rates, and it looks even more appealing, offering modest growth with low valuation, representing a solid margin of safety.
Because of the disciplined investment process, there may be periods where the performance of the Fund looks nothing like the index and the peer group. This can make it difficult for those who may be uncomfortable with such a dislocation in the short-term. However, for those willing to take a longer-term view, there is the potential for above average returns as the market realizes the true worth of the oversold companies that make up the portfolio. While not for everybody, this can be a great global small cap fund for those comfortable with the risk.