RBC Canadian Equity Income Fund

Analysis: The Globe and Mail ranks this fund as one of the funds offering the best “bang for your buck.” In reviewing it, it’s not hard to see why. It has consistently offered above average returns at a below average cost. It has also consistently ranked very high based on our proprietary fund valuation model for the past few years.

Before July 2009, this fund was known as the RBC Canadian Diversified Income Trust Fund, but with the changes to the taxation around income trusts, the fund’s mandate was broadened to include other equity securities. Today, the management team of Jennifer McClelland and Brahm Spilfogel scour and rank the universe of investible securities using RBC’s “3D” model which scores and ranks stocks based on fundamental, technical and qualitative factors. For this fund, they are looking for stocks that have exhibited positive rates of change on their ranking scores.

The process that is used is very active, with portfolio turnover averaging 370% in the past five years. They are also not afraid to be very active during periods of increased market volatility. In 2008 and 2009 turnover spiked to more than 500%, as they bought and sold a number of positions to take advantage of the volatility. They view volatility as an opportunity to buy attractive names at good valuations. The fund will also look nothing like its benchmark. It is well diversified, holding around 115 names, with the top ten making up about one quarter of the fund.

There is little doubt that the process has worked. Performance has been strong, posting an annualized five year return of 13% while the broader S&P/TSX Composite lost a 0.6% per year during the same period. Volatility has been comparable to the benchmark, but where this fund has really shined is with its downside protection. In 2008, while the broader market was down 33%, this fund lost 19%.

Despite this impressive track record, we do have some concerns about the fund. The assets in the fund have grown substantially. As of July 31, the fund had assets under management of nearly $1.8 billion. In 2009, assets in the fund were only $70 million. This will likely have an effect on the fund in a couple of ways. First, historically they would invest in a number of small and mid cap names. With the higher asset base, they will likely have to move into some larger names if they want to continue to trade as actively as they have previously. Second, they may have to curtail their trading activity given the liquidity that may be available with some of the names in the fund.

We like the fund. But we don’t believe that the past levels of outperformance can be repeated. Still, we do believe that it will do better than the average Dividend & Income Equity Fund for the near to medium term and can be considered a good core holding for most investors.