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Additions
PowerShares 1-5 Year Laddered Corporate Bond Fund (AIM 53203 – Front End Units) – This fund invests in a laddered portfolio of the most liquid short term corporate bonds with maturities between one and five years. It is fairly concentrated, holding only 25 bonds, all of which are investment grade.
I like this fund for a couple of reasons, with the biggest being that it offers a higher yield to maturity than either the TD Short Term Bond or the PH&N Short Term Bond and Mortgage Fund. At the end of April, its yield to maturity was 1.74%, compared with 1.1% for TD and 1.5% for PH&N. The other thing I like about it is its low MER of 0.99%, compared with 1.34% for TD and 1.16% for PH&N in the advisor series. Another feature is it pays a variable distribution, which has generated an annualized yield of more than 3% for investors.
Barring a major dislocation in the credit markets, I would expect this fund to hold up better than the other short term bond funds on the list, making it a great addition to the Recommended List.
Sentry Conservative Balanced Income (NCE 734 – Front End Units, NCE 334 – DSC Units) –This conservatively managed balanced fund is managed by the team of Michael Simpson, who runs the equity sleeve, James Dutckiewicz, who is responsible for the fixed income and broader asset mix.
The equity portion is managed in a similar way to the highly regarded Sentry Canadian Income Fund, although this fund’s smaller size allows it to take more of an all cap approach. It has companies that range from the very small to the very large. Like other Sentry managed funds, it has been increasing its exposure to the U.S. in recent quarters. At the end of March, more than 25% of the fund was invested in the U.S.
The fixed income sleeve is very heavily weighted towards corporate bonds, which make up more than three quarters of the bond exposure. While the focus is on investment grade bonds, about one quarter is invested in high yield bonds. On a whole, the bond sleeve offers investors a higher yield than the FTSE/TMX Bond Universe, with a lower duration. This positioning will lessen the overall sensitivity to rising interest rates, while providing better returns in a flat or falling yield environment.
They have a fair amount of flexibility with the asset mix, which can range between 40% and 60% in stocks or bonds. At the end of March, it held approximately 44% in equity, 44% in bonds, and the balance in cash.
The fund’s performance has been very strong, particularly on a risk adjusted basis. For the five years ending March 31, it generated an annualized return of 9.7%, finishing well ahead of the pack. Most of this outperformance can be attributed to the fund’s ability to hold its value in falling markets. I certainly don’t expect that it will continue to outperform as strongly as it has going forward, but I do expect it to be well above average on a risk adjusted basis.
It is also a decent option for those looking for cash flow. It pays a monthly distribution of $0.0375 per unit, which works out to an annualized yield of 3.6 %.
The MER is 2.25%, which is above the average Canadian Neutral Balanced Fund. The biggest drawback to the fund is that the management team has only been at the helm for a little more than two years. Still, when all things are considered, this looks to be a decent balanced fund for those with a modest appetite for risk.
CI Cambridge Pure Canadian Equity Fund (CIG 11109 – Front End Units, CIG 11159 – DSC Units) – This offering is managed by the team of Stephen Groff and Greg Dean, using the same investment process used on other Cambridge managed funds. Their process is driven by a few key beliefs, including a strong commitment to active management, a focus on absolute return and downside protection, and they eat what they cook, meaning each of the managers at Cambridge has a significant portion of their own net worth invested in the funds they manage.
The portfolio is a combination of longer term, higher quality holdings, and more opportunistic names where there is a near term catalyst the managers believe can unlock shareholder value, such as companies that are expected to benefit from a cyclical recovery or an entrenched macro theme.
The investment process uses top down macro analysis as a consideration when determining the sector, geographic, and cap mixture of the fund. Security selection is done on a fundamental, bottom up basis that looks for companies that have a demonstrated history of strong capital allocation, a sustainable competitive advantage, and a management team that is strongly aligned with shareholders. Another interesting aspect of the Cambridge process is they pay attention to the correlation between holdings, which helps to provide better diversification, and helps protect the downside.
This results is a high conviction portfolio, holding around 35 names. Their approach is active, with portfolio turnover averaging well above 100%.
Performance has been excellent, gaining more than 31% for the three years ending March 31, handily outpacing the index and peer group. Their focus on capital preservation has really paid off, with the fund having a negative down capture ratio, meaning that in general, it gained when other small caps were down.
This is a great small and mid-cap focused fund, but don’t look for it to continue to deliver double digit returns going forward. Returns are expected to moderate to more normalized levels. Still, I would expect that over a longer term period, it will be well above average with volatility that is in line or lower than average
Manulife Global Infrastructure Fund (MMF 4569 – Front End Units, MMF 4469 – DSC Units) – Infrastructure makes a fairly compelling investment because it offers long term stable cash flows that are often adjusted to inflation, low risk of loss of capital, and potentially attractive risk adjusted returns.
My pick in the space is the Manulife Global Infrastructure Fund, managed by a team headed up by Craig Noble at Brookfield Investment Management. Brookfield is one of the recognized leaders in the infrastructure investing space.
The investment process is a mix of top down macro analysis and bottom up company selection. The top down process is used to identify potential investment themes and starts with a detailed economic outlook that is used to provide an understanding of which industries, countries and themes are expected to do well. This helps the team narrow down the companies on which they will do a more detailed fundamental analysis that evaluates the quality of the balance sheet, free cash flow generation, and valuation.
The portfolio tends to be well diversified, holding about 50 names from around the world. Given the nature of infrastructure holdings, the portfolio is concentrated in utilities, energy, and industrials, which combined make up nearly 85% of the fund.
Performance has been decent. For the three years ending March 31, it gained an annualized 17.8%. In comparison, the more broadly focused MSCI World Index gained more than 23%. Volatility has been lower than both the index and many other global equity funds. But what really makes this an attractive piece of a well-diversified portfolio is the downside protection it offers. For the past three and five years, it has participated in approximately two-thirds of the upside of the global equity markets. However, it has been flat to positive when markets are falling.
Given the management team behind it, this is a great option for investors looking for infrastructure exposure in their portfolios.
Deletions
PH&N Short Term Bond and Mortgage Fund (RBF 6250 –Front End Units, RBF 4250 – Low Load Units) – This has long been one of my favourite short term funds available. It is run by a strong management team, and it has delivered decent risk adjusted returns over the long term. At the end of March, its duration was 2.7 years, and it offered a 1.5% yield to maturity. However, with an MER of 1.16% for the advisor sold units, the cost was making the fund uncompetitive, particularly if there are no further rate cuts coming from the Bank of Canada. If you can buy the Series D or Series F units, this is still a great pick, but if you are using the advisor class units, I believe the PowerShares 1-5 Year Laddered Corporate Bond Fund is a better choice offering a higher yield and a lower cost.
TD Short Term Bond Fund (TDB 814 – Front End Units, TDB 870 – DSC Units) – It’s not that there is necessarily anything wrong with this fund, it is just that in the current rate environment, combined with its 1.34% MER, I believe it will be tough for it to generate any level of meaningful return. As a replacement, I would suggest the PowerShares 1-5 Year Laddered Bond Fund or the PH&N Short Term Bond & Mortgage Fund, if you can access the low cost D or F series. If you have to invest in the higher cost advisor series, you’re better off with the PowerShares offering.
AGF Monthly High Income Fund (AGF 766 – Front End Units, AGF 689 – DSC Units) – I have had some concerns about this fund in the past few quarters, and have decided to remove it from my Recommended List immediately.
I believe it has struggled against other balanced funds for a couple of reasons – first, it has been one of the more aggressively positioned balanced funds and has been underweight fixed income. That has hurt relative performance. The other reason is its equity exposure is pretty concentrated in energy and financials, which have struggled of late. Another reason is they have about 75% of their USD exposure hedged, which has dragged the CAD performance of their foreign holdings while the dollar fell against the USD.
The bond sleeve is very focused on investment grade, with an average credit quality of A. There is a small weight in BB and B rated bonds, but it likely won’t make much of a difference. Duration is slightly less than the FTSE/TMX Bond Universe, and the yield is significantly higher at 4.7%. This positioning will hold up a little better than the broader market, but will still be hit if we see any upward pressure on yields.
The managers have recently pulled the equity weight in the fund back a bit, but it’s still sitting at around 62%, with a third in bonds and the rest in cash. A little less than half the equity exposure is in foreign names. They have also repositioned their energy names into higher quality companies that are expected to withstand the lower oil price.
Considering the above, I believe there are more attractive balanced funds available.
Funds of Note
Dynamic Advantage Bond Fund (DYN 258 – Front End Units, DYN 688 – DSC Units) – In an environment where interest rates are moving higher, I believe this is a bond fund you will want to own.
The management places an extraordinary focus on preserving capital, and actively manage the portfolio’s duration, yield curve positioning, sector exposure and credit quality to help do so. At the end of March, it held 39% in investment grade corporate bonds, 37% in government bonds, 11% in real return bonds and floating rate notes, 8% in high yield and the rest in cash. This resulted in a yield to maturity of more than 4% and a duration of 3 years, which is less than half the FTSE/TMX Bond Universe Index. It is also about half of the duration of the PH&N Total Return Bond Fund.
With it no longer being a sure thing that the next move from the Bank of Canada will be a cut in rates, management believes this conservative positioning is warranted. They intend to keep their duration lower until there is a sustained move in ten year bond yields, at which point they will look at increasing duration. They are also using interest rate swaps to better manage risk.
This strategy is likely to result in underperformance in a flat or falling rate environment, compared with the PH&N Total Return Bond and the TD Canadian Core Plus Bond Fund. Given that rates in Canada are extremely unlikely to rise significantly in the near term, I am favouring the longer duration funds. However, as we start to see an improvement in the economic numbers, the possibility of a rate increase will become more likely. As that happens, I will once again be favouring this offering.
PH&N Short Term Bond and Mortgage Fund (RBF 6250 –Front End Units, RBF 4250 – Low Load Units) – This has long been one of my favourite short term bond funds. It is run by a strong management team, and it has delivered decent risk adjusted returns over the long term. At the end of March, its duration was 2.7 years, and it offered a 1.5% yield to maturity. However, with an MER of 1.16% for the advisor sold units, the cost is making the fund uncompetitive, particularly if there are no further rate cuts coming from the Bank of Canada. If you can buy the Series D or Series F units, this is still a great pick, but if you are using the advisor class units, I believe the PowerShares 1-5 Year Laddered Corporate Bond Fund is a better choice, offering a higher yield and a lower cost.
Fidelity Canadian Balanced Fund (FID 282 – Front End Units, FID 582 – DSC Units) – With a targeted asset mix of 50% equities, and 50% bonds, this is about as basic a balanced fund as you will find, at least on the surface. But dig deeper and the underlying managers are extremely active, keeping the various asset classes well positioned.
For example, in the first quarter, the fund managed to outperform its benchmark by a substantial margin, thanks to some great stock picks in the healthcare and industrial sectors. It was also helped by its underweight in energy and financials, two dominant sectors which have struggled of late.
On the fixed income side, the target mix is 40% traditional bonds, with 10% in high yield names. They have overweighted corporate bonds, because of their higher yield potential compared to governments. Even within their government holdings, they had overweight exposure to provincial bonds, again, because of the higher yield potential, without sacrificing the overall credit quality.
Barring a surprise jump in bond yields, I would expect that this fund will continue to deliver strong relative risk adjusted returns. The biggest risk that I see is the high interest rate sensitivity, given the relatively static 50% allocation to bonds. Granted, the managers can be active within that sleeve, but once rates do start to move higher, the fund is likely to face some potentially strong headwinds. I will continue to monitor the macro picture and will reevaluate as things develop.
IA Clarington Canadian Conservative Equity Fund (CCM 1300 – Front End Units, CCM 1400 – DSC Units) – Low volatility and excellent downside protection have been why this has been one of my favourite Canadian equity funds. However, the recent uptick volatility has me a bit concerned. The big reason for this has been the fund’s significant weighting in the energy sector. Because of this, it has been uncharacteristically dragged lower in lockstep with the market during the recent selloff. The management team believes this was an anomaly and that we should see a return to its previous risk reward profile. They also assure me that there have been no changes to their disciplined stock selection process and they will continue to focus on high quality, dividend paying Canadian companies. I am inclined to believe them, particularly in light of April’s strong showing, but I will continue to monitor the fund very closely.
Sentry Small Mid Cap Income Fund (NCE 721 – Front End Units, NCE 321 – DSC Units) – This fund just keeps delivering, posting an impressive 7% gain in the first quarter, handily outpacing both the benchmark and its peer group. Much of the outperformance was attributed to the fund’s U.S. equity holdings, which now make up about half the fund. I would expect the U.S. holding to remain high for a couple reasons. First, management believes that growth in the U.S. will continue to outpace Canada for the next few months. Another reason is the fund, now with more than $1.5 billion in assets must look beyond Canada to find suitable investment opportunities that meet the manager’s valuation criteria. The size of the fund is definitely something I am monitoring to make sure it does not have a negative effect on the risk reward profile on the fund. So far, I have not noticed any meaningful erosion, but will continue to watch the fund closely.
Fidelity Small Cap America Fund (FID 261 – Front End Units, FID 561 – DSC Units) – Manager Steve MacMillan has done a stellar job with this small cap offering since taking it over in 2011. In the past three years, it has gained more than 33%, outpacing both the index and peer group. This trend continued in the first quarter, gaining an impressive 18.9%, thanks to a strong showing from the fund’s consumer and technology names, combined with the effect of a falling Canadian dollar.
The process used is a fundamental, bottom up approach that looks for companies with strong management, sustainable competitive advantages, and a high degree of earnings visibility and the ability to grow earnings in the future. At the moment, he seems to be finding these opportunities in the technology, consumer discretionary and healthcare sectors.
I know I have said this a few times in the past, but the past performance is not likely to be sustainable going forward. If you have held this fund for a while, it may be a good idea to rebalance and take some money off the table. Still, when I look at the valuation of the underlying portfolio, I believe it is well positioned to outpace the index and its peer group going forward. It remains my top pick in the U.S. small cap space.
Trimark U.S. Small Companies Class (AIM 5523 – Front End Units, AIM 5521 – DSC Units) – Not surprisingly, the fund lagged both the benchmark and its peer group in the first quarter of the year. The main reason for this was the cash drag caused by the nearly 30% of the fund that was invested in cash. This high cash balance is the byproduct of the managers’ inability to find attractive opportunities that are trading at valuations they believe make them strong investment candidates. In a recent commentary, they expressed continued concern over the level of valuation in the U.S. small cap space, which now sees the Russell 2000 index trading at 25 times earnings. The holdings in the fund are trading at a nearly 40% discount to the benchmark, making this an attractively valued portfolio.
Also, it was recently announced that co-lead manager Rob Mikalachki was recently named the Chief Investment Officer of Invesco Canada. Invesco has assured me that this new role will not detract from his ability to continue to manage the fund as he has in the past. He is supported by Virginia Au and Jason Whiting, two very capable managers, which will help as he takes on these additional responsibilities. Another concern I have is Virginia Au has taken a leave for a few months. While I don’t expect there to be a major disruption in the fund, I will continue to watch it closely.
BMO Asian Growth & Income Fund (GGF 620 – Front End Units, GGF 120 – DSC Units) – The outlook for Asia remains very challenging, with the backdrop of slowing economic growth across the region, combined with a rising U.S. dollar. Recently, many governments, from India to China have taken steps to spur growth, and seed up market reforms. Still, it will be a challenging place to invest in the near term. In my view, this fund remains the best way to play the region. By investing in a portfolio of high quality, dividend paying stocks, as well as preferred shares and convertible bonds, it provides an excellent way to gain exposure to Asia, while still having some level of downside protection.