Top Funds Report – March 2014

While markets were strong in February, the near term outlook does not look quite as favourable. There are a number of troubling situations that have been capturing investor attention of late. They include:

Russian Annexation of Crimea

In February, an uprising in the Ukraine resulted in Russian forces seizing control of the Crimea region. In March, a referendum was held on whether Crimea should join the Russian Federation or remain part of the Ukraine. The results widely favoured rejoining Russia, however there is much dispute over the results, with both the U.S. and the European Union considering the vote to be illegal. Still, this did not stop Russian parliament from overwhelmingly approving the annexation of the disputed region.

In response, the U.S. has announced tough sanctions, freezing any U.S. based assets held by individuals connected to the uprising. It is expected that more sanctions and travel bans will be forthcoming.

Despite the political uncertainty this has caused, the direct economic impact is expected to be relatively minor in developed economies. Emerging markets however, are likely to be more affected, particularly those with exposure to Russian and Eastern Europe.

Developed markets may see some indirect impact. One area would be gold. With gold being viewed as a safe haven in periods of uncertainty, it may see further gains if the political situation between Russia and the west deteriorates further. Energy may also be a benefactor. Russia is a large natural gas producer, and with sanctions cutting off that flow, gas producers may see their share prices rise. My top energy pick would be the Franklin Bissett Energy Fund.

With approximately 40% of the S&P/TSX Composite exposed to energy and materials, there may be a rally in the broader Canadian equity markets. I would expect that the broader markets will outperform my picks the category, given their general underweight to materials. You are likely better off investing in a lower cost index fund in the near term.

Central Bank Comments

Recently, newly appointed Federal Reserve Chair Janet Yellen said that she expected that the Fed’s massive bond buying program would be wound down by late fall 2014. She went on to say that they could begin actual tightening as soon as six months after that, much sooner than many market participants had been expecting.

Compare that to Canada, where Bank of Canada governor Stephen Poloz said that slower than normal growth may be the new norm and the next rate move may be a cut. This sent the loonie tumbling, with some predicting that the dollar will be trading in the $0.85 range by the end of next year.

While this makes for interesting headlines, it really is just noise. While the next rate move in Canada may be lower, there is only so much lower that bond yields can go, making any capital gain potential quite limited. In Canada, while the short term risks may be lessened, the medium to long term trend is that yields will move higher, pushing the value of bonds lower.

I continue to suggest that investors focus on actively managed bond funds that are defensively positioned with an emphasis on corporate bonds. Two of my picks would be the Dynamic Advantage Bond Fund and the PH&N Total Return Bond Fund.

Please send your comments to feedback@paterson-associates.ca.

Funds You Asked For

This month, I take a look at some funds from CI, O’Leary, and Beutel Goodman. 

 Front Street Special Opportunities Fund (FSC 451)

Managed by respected veteran manager Norm Lamarche, this fund focuses on small and mid-sized resource companies, with a current concentration in small and microcap companies. Technically, the fund can invest in any sector, but historically, it has been heavily focused on energy.

In managing the fund, Mr. Lamarche uses a top down / bottom up approach. He looks for macro factors to identify potentially profitable sectors and bottom up analysis to find the companies he believes are best positioned to benefit. Recently, he has become excited about the lower cost shale gas and oil plays that are expected to change U.S. manufacturing.

This enthusiasm is reflected in the fund’s positioning. At the end of February, more than 70% was invested in oil & gas exploration companies, 11% invested in energy services companies, and 6% invested in drilling. The rest was invested in gold and mining related companies. Despite holding more than 100 names, it is fairly concentrated, with the top ten names making up 55% of the fund.

It has been on a tear of late, gaining nearly 18% so far in 2014. These gains have been propelled by a few names in the fund, particularly Augusta Resources that has more than doubled in the past three months, and Parex Resources and Birchcliff Energy, both of which have gained more than 40%. The long term performance has also been relatively decent, managing to outpace many of its competitors.

Not surprisingly, with its focus on the resource sector, volatility has been significantly higher than the broader equity markets, and has been above its peer group.

This is not a cheap fund. The base management fee is 2.50%, plus operating expenses. In addition, it has a 20% performance fee on performance of the fund over and above the performance of the S&P/TSX Composite Index. The most recent MER is 3.05%, but with the recent gains I would expect that to be much higher in the next year or two.

Investors will want to be sure that they are very comfortable of the very high level of risk that they can continue to expect for this fund. This is particularly true with its small and microcap focus.

In the energy space, I prefer the Franklin Bissett Energy Fund (TML 3021), because it is more diversified, with more of the fund invested in large, and mid cap names. You may miss out on some of the pop of this fund, but longer term, I believe that the risk adjusted returns will be better. Still, it’s a highly focused fund, and any exposure within a portfolio should be limited.

Franklin Bissett Energy Fund (TML 3021)

Focusing on the energy sector, managers Gary Aitken and Les Stelmach use the Bissett approach of fundamentally driven, bottom up research that looks for companies with sustainable, repeatable growth that are trading at reasonable valuations.

Despite the narrow focus, the fund is fairly diversified holding more than 50 stocks with the top ten making up just over 30%. It can invest in companies of any size, but the focus is currently more on small and mid-cap names. At the end of the year, it was overweight in the oilfield service industry, which made up a third of the fund.

Portfolio turnover has been relatively modest, averaging 37% for the past five years. Recently, it has been on the increase as the managers took advantage of volatility in the sector, allowing them to take profits in some longstanding positions, as well as make new investments in attractive energy names. As long as volatility remains high, the managers expect that they will continue to trade more frequently to better position the portfolio.

Performance has been strong. For the five years ending February 28, it has been the top performing fund in the category, both on an absolute and risk adjusted basis. Overall volatility has been roughly in line with the category average. Compared to its peer group, it has posted stronger performance in rising markets, and held up much better when markets fall.

Because this fund invests only in energy related companies, it is not a fund that should be considered by everybody. Only those with a very high risk tolerance looking for specific exposure to energy stocks should think about this fund. But for those looking for that type of a fund, it is my top pick. I expect that it will continue to deliver above average risk adjusted returns over the long term.

CI Cambridge Global Equity Corporate Class (CIG 2323)

Managed by industry heavyweight Alan Radlo and his Cambridge team, this global equity offering serves as the flagship fund for Cambridge Advisors. CI describes Cambridge’s investment style as “core with a growth tilt.” They look for companies that have a demonstrated history of growing their earnings, sales and cash flows and that are trading at a discount to what Cambridge believes they are worth. They also look for strong management teams who have their interests firmly aligned with shareholders.

The fund has an all cap mandate, with no restrictions on geography or sector mix. Currently, the majority of the holdings are focused in large and mid-cap names. Geographically, about half the equity holdings are invested in the U.S. From a sector standpoint the portfolio is positioned for a growing economy with an overweight in healthcare, technology, and industrials. It is underweight in financials and has no exposure to real estate, communications or utilities.

It is well diversified, holding more than 100 names, with the top ten making up just under 20% of the fund. The management approach is very active, with portfolio turnover averaging more than 200% for the past five years.

The process appears to be working, having outperformed the benchmark and finishing in the top quartile in every year since its launch, except for 2011. Much of the underperformance in 2011 can be attributed to the fund’s currency position being hedged in the latter half of the year, when the Canadian dollar fell as investors fled to the safe haven U.S. greenback. This blip has negatively skewed the fund’s longer term performance slightly.

Volatility has been roughly in line with both the index and the category average. Costs are reasonable for a global equity fund, with an MER of 2.52%.

Looking ahead, I expect that performance will continue to be above average, while volatility will be in line with its peer group. All things considered, this is a very solid global equity offering and could be used as a core holding for most investors.

CI Signature Global Income & Growth Fund (CIG 2111)

This is a tactically managed balanced fund run by Eric Bushell and his team at Signature Global Advisors. The fund’s asset mix is actively positioned across investment grade bonds, high yield, equities, and resources, based on the team’s macro view.

The managers have a great deal of flexibility around the asset mix. For example, the equity weight can range between 30% and 75% and fixed income can range between 25% and 70%, with high yield making up at least 15% and no more than 40% of the fund. They also have the ability to take the cash weighting of the fund as high as 30% if they feel the environment warrants it. Foreign currency exposure is actively managed.

The team has definitely taken advantage of this ability. For example, the fund held nearly 40% cash in December 2008, yet by September 2009, it was fully invested. At the end of February, it held just under 20%. They are equally as active in their approach to the other asset classes, all of which have fluctuated significantly since the fund’s launch.

As important as actively managing the asset mix is, security selection is equally important. The underlying investments are selected by the Signature team, using their holistic approach to research, not only analyzing the fundamental quality and managerial talent of the company, but also studying the various segments of its capital structure, looking for the most attractive area to be invested. The team has analysts for each global sector and asset class who is focused purely on security selection.

The approach seems to have worked. For the five years ending February 28, it has generated an annualized return of 13.82%, handily outpacing the benchmark and its peer group. While performance has been decent, volatility has been higher than average. It was hit particularly hard in 2008, when it lost 22%, and finished firmly in the bottom quartile.

Looking ahead, I expect more of the same. The Signature team has a very strong process in place that should continue to deliver above average risk adjusted returns over the long term. However, given their flexibility, I expect we will see periods of higher volatility, where performance is dramatically different than both the index and its peer group.

Dynamic Blue Chip Balanced Fund (DYN 202)

This Dynamic offering is a pretty standard balanced fund that invests in a mix of stocks and bonds. Adam Donsky is responsible for the equity sleeve, while Domenic Bellissimo looks after the bond exposure. At the end of December, it held about 5% in cash, 30% in fixed income and the rest in equities. The overwhelming majority of the equity exposure is outside of Canada.

The manager is somewhat benchmark agnostic and will focus on finding what he believes to be the best in class opportunities available. Equities are selected using a value focused approach that looks for companies with proven track records, sustainable competitive advantages, and strong management.

The equity exposure is heavily weighted towards consumer focused and industrial sectors. It had no exposure to real estate, communications, healthcare or utilities. The fixed income sleeve is focused on corporate bonds.
Looking at the fund’s performance, both returns and volatility have been middle of the pack. I expect you will get benchmark like returns with benchmark like risk in most market types. With an MER of 2.43%, its cost is slightly above average.

Overall, this isn’t a bad fund, but there is nothing spectacular about it. I don’t think it will hurt you too badly, but I also don’t expect it do surprise to the upside. In my opinion, there are better balanced funds available. A couple that immediately come to mind are the CI Signature High Income Fund and the Fidelity Canadian Balanced Fund.

Mawer Global Equity Fund (MAW 120)

Managed by the team of Jim Hall and Paul Moroz, this go anywhere equity fund invests in companies of any size that meet the Mawer investment criteria. In very simple terms, they are looking for wealth-creating businesses with competent management and long-term competitive advantages. Once they find these companies, they buy them at a reasonable price and look to hold them for the long term. To find these opportunities, the managers follow a highly disciplined, research-driven, bottom-up process

It can invest in companies of any size, but has recently focused on larger names, with more than three quarters currently invested in large companies.

The portfolio is much different than its benchmark. It holds approximately 70 stocks, with the top ten making up about 30%. It is overweight in industrials and financials, and significantly underweight in consumer focused names.

They tend to take a longer term outlook when looking at a company. This is reflected in the fund’s very low level of portfolio turnover. It has averaged less than 20% per year since its launch.

Performance has been very strong, gaining 17.8% a year for the past three, besting both the index and most of the peer group. Perhaps even more impressive is this has been done with a rather low level of volatility, resulting in very strong risk adjusted returns.

With its go anywhere mandate and bottom up portfolio construction approach, there may be periods of time where performance lags the peer group and benchmark. However, given the strength, reputation and process in place at Mawer, I would expect that this fund will continue to deliver above average returns with below average risk for investors over the long term.

If there is a fund that you would like reviewed, please email it to me at feedback@paterson-associates.ca.

March’s Top Funds

GBC Canadian Bond Fund