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Additions
Franklin Bissett Core Plus Bond Fund (TML 200 – Front End Units, TML 515 – Low Load Units) – Over the past few years, Franklin Bissett has quietly grown out its fixed-income team and the results are now starting to show. This was one of the strongest-performing bond funds in 2016, gaining 3.3%, placing it in the first quartile for performance and outpacing its peers. In 2017, the fund gained 2.9%, while the broader Canadian market was rose by 2.5%.
The fund’s goal is to provide strong risk-adjusted returns and a steady income stream over a full market cycle. To do this, the management team, headed by Tom O’Gorman, uses a process of top-down macro analysis and bottom-up sector and security analysis.
The team’s top down analysis looks at global economic trends, interest rate outlooks, growth and inflation expectations, central bank policies, and sector fundamentals. Using the macro view, the analysis helps the team determine the most attractive areas of the fixed-income universe, taking into consideration duration positioning, yield curve positioning, sector, country, and currency allocations.
The more granular bottom-up security analysis looks at individual issues, weighing relative value, duration, company financials, as well as fundamentals, management, and liquidity
The fund aims to deliver returns in excess of 50 to 150 basis points over the benchmark, with a Canadian-focused mandate that allows the managers to invest across the Canadian fixed-income universe. Up to 25% of the portfolio can be held in high-yield issues. While the fund has a primarily Canadian focus, it can invest up to 30% outside of Canada, of which 10% of currency exposure can be unhedged.
At December 31, the portfolio held 57% to corporate bonds, 36% to government issues, and 6% to municipal bonds with the balance in cash. Given the flexibility of the fund’s mandate, its active management style, and its well-diversified portfolio, this fund has the potential to outperform in a volatile bond market. It is for those reasons I am adding it to the Recommended List of Funds.
Leith Wheeler Corporate Advantage Fund (LWF 032 – Fee Based Units, LWF 021 – No Load Units) – Vancouver-based Leith Wheeler uses the slogan “Quiet Money,” which is pretty apt, given they are not exactly a household name. The employee-owned firm focuses on one thing: managing money for investors.
The Leith Wheeler Corporate Advantage Fund is an actively-managed Canadian- bond fund that invests mainly in investment-grade corporate bonds. Managers can be very flexible in their approach and have many tools at their disposal. The fund can invest up to 20% in non-investment-grade bonds and up to 30% in preferred shares, which provides additional yield. It can also invest in convertible bonds, bank loans, and mortgages. The managers can also use derivatives to hedge against interest rate and credit risk.
The investment process starts with a top-down analysis that sets the economic and interest rate outlook. This helps the managers establish targets for duration, sector, and credit quality factors. Security selection is bottom-up and uses fundamental credit analysis that looks for credits trading at reasonable levels, offering attractive yields for the risk.
In positioning the portfolio, the managers are careful not to take on too much risk for the conditions. At the end of December, for example, the fund was about 78% invested in corporate bonds, 11% in preferred shares, 10% in Leith Wheeler Multi Credit Fund, and the balance in cash. Credit quality was high, averaging A, and the duration was 4.3 years, well below the 7.5 years of the benchmark
The process has paid off, with the F-Class units of the fund gaining 3.3% in the past 12 months, nearly doubling the category average, and outpacing the benchmark. Volatility has been well below the index and peer group. The fund pays a variable monthly distribution, which over the past year has yielded investors approximately 4%.
With its defense-first approach, the fund has lagged in rising markets, but has done an excellent job protecting capital in falling markets. As we head into a potentially tricky bond market, the depth of the team, combined with the focus on capital preservation, disciplined process, and the availability to use some non-core strategies, gives this fund the potential to continue delivering above-average returns for investors, on both an absolute and risk-adjusted basis. It is for that reason I am adding it to the Recommended List of Funds.
EdgePoint Global Growth & Income Portfolio Fund (EDG 180 583 – Front End Units, EDG 380 – Low Load Units) – As a company, Edgepoint likes to keep things simple. They have a very simple lineup, offering four funds, and each is managed using the same, simple, disciplined investment process. This Fund is their global balanced offering that invests in equity and fixed income securities of companies located anywhere in the world.
The asset mix of the Fund is set on where the managers see the most attractive opportunities, and they are afforded a high degree of flexibility. The fixed income weight can range from a high of 60% to a low of 25%. At the end of December, it sat in the 40% range, reflecting a more defensive positioning.
When making an equity investment, the Managers approach it not as though they are buying stocks, but rather like they are taking an ownership interest in a company. They take a very long-term and patient approach and look to acquire this ownership interest at a price that is well below what they believe it to be worth, based on the company’s prospects. It is this patience that affords them the ability to build a concentrated portfolio on companies they have thoroughly reviewed, which allows them to develop what they refer to as a “proprietary insight” on the company. This proprietary insight covers the company, the management, the industry, and its prospects.
To develop this proprietary insight, the Managers use a fundamentally driven, bottom up investment process that looks to find high quality, undervalued businesses. They seek well-managed companies with strong competitive positions, defendable barriers to entry, and solid long-term growth prospects. Because they are not traditional value investors, their view of a business is likely to differ from the market consensus. They are not afraid to pay up for what they believe is a quality company with excellent long-term prospects. It is this independent view which helps explain why their valuation metrics appear to be higher than the index. However, in many cases, these higher valuation levels are justified by above average forecasted growth rates.
This approach also results in a portfolio that tends to look much different than its benchmark or peer group. From a sector perspective, they are meaningfully overweight industrials, and underweight financials, telcom, energy and utilities.
On the fixed income side, they can invest in both investment grade and high yield issues, and at the end of December, the average credit quality was listed as BBB on Morningstar.
Their approach is very patient, which is reflected by the portfolio turnover numbers, which are very low, averaging less than 50% per year.
Performance has been excellent with an annualized five-year gain of 15.1% to the end of January, and a one-year gain of 14.3%. Volatility numbers have been higher than the index and peer group, but the excess return has more than offset this.
This is a great core holding, managed by an excellent, deep team, using a disciplined repeatable process that has the potential to continue to de-liver solid risk adjusted returns for investors.
Manulife Monthly High Income Fund (MMF 583 – Front End Units, MMF 783 – Low Load Units) – Co-managed by Alan Wicks and Jonathan Popper, this fund has long been a favourite of mine, and was on the Recommended List before it was closed to investors in August 2015. However, Manulife recently reopened it to new investors in January, as management believes they can effectively implement their process at the current $9.4 billion in assets under management (AUM). As a result, I am reinstating it on my Recommended List.
For the equity sleeve, the managers use a bottom-up, fundamentally-driven process that seeks out businesses of any size with high returns on invested capital. Each investment candidate is scored on a number of fundamental factors.
A deeper due diligence review includes meetings with management and generating an estimate of fair value. Buy and sell prices are also determined, and position sizes are actively managed based on real-time valuation levels. Surprisingly, turnover levels have averaged a modest 70% for the past three years.
The fixed-income sleeve is managed using a combination top-down economic review and bottom-up credit analysis. The fund aims to generate returns by focusing on sector allocation, credit quality, and individual credit selection. Managers aim to mitigate risk with active management of the portfolio’s yield curve and duration exposure.
At the end of November, roughly 28% of the portfolio was in bonds, 15% in cash, 25% in Canadian equity, and 30% in U.S. names.
Performance has been excellent, with the fund delivering an impressive 5-year average annual compounded rate of return of 9.6% to December 31, handily beating both its index and peer group. Shorter-term, the fund gained 10.6% in 2016, making it one of the strongest performers in the category. Volatility numbers have been lower than the index and peers, and the managers have done an excellent job protecting capital in down markets. Still, the way the portfolio is built, there will be periods when it lags, which is what happened in 2016, when it trailed the index and peer group.
This is a strong balanced offering and remains one of my favourites. While the managers believe they have sufficient runway to implement their strategy with the current AUM, I will continue to monitor the fund closely for any erosion in the risk-reward profile, particularly if inflows are robust.
Deletions
PH&N Total Return Bond Fund (RBF 6340 – Front End Units, RBF 4340 – Low Load Units) – For the longest time, PH&N has had one of the strongest fixed income teams on the street. They follow a disciplined and repeatable process that has led to above average returns over the long-term. This fund is very similar to the highly respected PH&N Bond Fund, with additional flexibility that allows the Managers to invest in “non-core” strategies such as derivatives and high yield bonds as a way to enhance return and protect capital in volatile markets.
The reason I am removing the Advisor Class units of the Fund from the Recommended List is I believe the other Funds on the list are better positioned for a more challenging fixed income environment. With volatility expected to return in the rates market, the other Funds with a greater emphasis on active management, corporate bonds, and duration management are expected to hold up better.
TD Canadian Core Plus Bond Fund (TDB 695 – Front End Units, TDB 697 – Low Load Units) – Like PH&N, TD has a very solid reputation as one of the stronger fixed income managers on the street. This Fund invests predominately in investment grade fixed income from Canadian issues but has some flexibility to invest in non-core fixed income strategies including high yield and foreign bonds.
Like PH&N, the team follows a disciplined and repeatable process, with an emphasis on credit analysis. Unfortunately, the performance numbers have failed to keep pace with the peer group. The thesis on the Fund was that as rates began moving higher and volatility increased, the non-core holdings would allow it to hold up better with above average returns. This did not unfold as expected and has resulted in the Fund being removed from the Recommended List of Funds.
Sentry Conservative Balanced Income Fund (NCE 734 – Front End Units, NCE 234 – Low Load Units) – The goal of this conservatively positioned Canadian balanced fund is to provide investors with consistent income with some capital growth by investing in a relatively balanced portfolio of equities and fixed income securities. It pays out a regular monthly distribution of $0.0375 per unit, which works out to an annualized yield of approximately 3.8%, which is certainly reasonable.
Unfortunately, the Fund failed to keep pace with its benchmark and peer group. For the three years ending January 31, it has gained an annualized 0.81%, dramatically underperforming the peer group. Further, the volatility profile of the Fund was higher than expected, which likely came from its overweight exposure to energy, industrials, and healthcare. Further, it tends to focus more on small and mid-cap names. When I look at the valuation metrics of the equity sleeve of the Fund, they are above the index, and the forward-looking growth metrics are in line. This creates the potential for a more significant drawdown if the companies fail to meet expectations on earnings. This brings far too much uncertainty for a fund that is deemed to be “conservative”.
Another concern is with CI Investments having recently acquired Sentry, there may be some changes to the portfolio management team, which creates additional uncertainty around the Fund.
Combined, these factors lead me to remove the Fund from the Recommended List of Funds.
Funds of Note
Fidelity Canadian Large Cap Fund (FID 231 – Front End Units, FID 031 – Low Load Units) – To understand the recent performance, we need to revisit the fund’s investment process. Manager Daniel Dupont uses a bottom-up, value-focused approach, with a very defensive philosophy. Capital preservation is the first and foremost objective of the fund.
Dupont looks to build a portfolio of high-quality companies that are trading at very attractive discounts to what he believes they are worth. While valuation is important, so too is quality, with management being key. He looks for management teams that have a strong consistent track record of effective execution.
The portfolio is concentrated, typically holding between 35 and 50 names. At the end of December, the fund held roughly 60 stocks. About half the fund was weighted to Canadian equities, and 30% to foreign equities. About 15% was dedicated to short-term bonds as a cash substitute, with the balance in cash. The sector mix is a by-product of the stock selection process.
The long-term performance numbers, particularly the risk-adjusted returns, are stellar. The defense-first focus of the manager has resulted in volatility numbers that are well below the index and peer group, and excellent downside protection. For example, over the past five years, the fund has experienced less than 10% of the downside of the broader market.
Recently, the fund has struggled because the market has generally been rewarding higher growth, higher beta, and in many cases, lesser-quality companies at the expense of higher-quality, value-focused names. Another headwind for the fund has been its high cash balance, which has dragged overall gains when markets have rallied.
Despite its recent underperformance, I still believe in this fund. It is managed using a very disciplined process and has a focus on protecting capital. I am comfortable in foregoing some upside for protection of my capital during periods of market turbulence.
Market volatility has been at its lowest level in more than 40 years, and periods of low volatility are always followed by periods of high volatility. While low-volatility periods can last for many quarters or even years, the fact is they do come to an end. It is for that eventuality that I favour this fund.
Of note, during the period between January 26 to February 8 20118, the S&P/TSX Composite dropped by 7.5%. During this same period, the Fidelity Canadian Large Cap dropped approximately 2.4%, highlighting the defensive nature of the Fund. Further, manager Dan Dupont used the market volatility to deploy some cash, initiating a new position and adding to existing holdings.
RBC O’Shaughnessy U.S. Value Fund (RBF 766 – Front Units, RBF 130 – Low Load Units) – The fourth quarter was very strong for the Fund, gaining 8.4%, handily outpacing the benchmark and peer group.
The Fund is managed using a very systematic approach that scores the U.S. stock universe on several factors including sufficient trading size, trading volume, growing sales and cash flows. Another metric considered is what O’Shaughnessy calls “shareholder yield” which is a combination of dividend payouts and stock repurchase programs. The result of this process is a portfolio that is much different than the S&P 500. According to RBC, the Active Share, which measures the similarity of a fund with the benchmark was 89%. The higher the Active Share, the more different the holdings of the fund are from the benchmark, making this a very distinct U.S. equity offering.
In the fourth quarter, it was the yield and value factors that were the strongest contributors to the overall return. Any currency exposure is fully hedged, which was a modest drag in Q4, but a big driver of returns over the year adding more than 800 basis points of return. This helped boost relative returns, as most of the peer group tends to run with unhedged currency exposure.
The Fund’s volatility tends to skew a bit higher than the index or peers, with the unhedged currency position being a key contributor to that. Despite the higher volatility, it remains an interesting U.S. equity pick for the long-term.
Trimark U.S. Companies Fund (AIM 1743 – Front Units, AIM 1745 – Low Load Units) – After a rough 2016, 2017 was a very strong year for this U.S. equity fund. For the year, it gained 21.8%, while the S&P 500 gained 13.8% in Canadian dollar terms. The Fund finished the year nicely gaining 9.7%, again, handily outpacing both the index and the peer group.
A key reason for this outperformance is the Fund’s growth tilt, with overweight positions in technology, industrials and healthcare. These “growthier” sectors were strong, while the fund’s underweight exposures of real estate, telecos, and utilities were weaker performers. While the Fund carries the Trimark banner, manager Jim Young tends use a more growth focused process in managing the Fund than the other, more traditional Trimark Funds. As part of his investment process, he looks for companies that have distinct proprietary advantages, invest significantly to obtain a competitive advantage and demonstrate consistently strong management and industry leadership.
The portfolio is concentrated, holding just over 40 names, with the top ten making up 40% of the Fund. The top holdings include PNC Financial Services, biotech firm, Celgene Corp, and semiconductor maker Analog Devices. At the end of December, the manager believed the market was fairly valued relative to interest rates, and inexpensive compared to bonds. Within the Fund specifically, valuations are rich, but in line with the broader market.
Over the long-term, performance has been above average. If you have held this fund for some time, you may want to consider taking some profits off the table, particularly in light of its above average level of volatility. It tends to fluctuate more than the broader market and has historically sold off more in down markets.
Despite the strong long-term performance numbers and excellent 2017, I am concerned that when the markets begin focusing on fundamentals, it will trail because of its emphasis on higher growth names, and elevated valuation levels.
The Fund remains UNDER REVIEW and I continue to monitor it closely.
Mackenzie Ivy Foreign Equity Fund (MFC 081 – Front Units, MFC 7107 – Low Load Units) – The fourth quarter was another tough one for this defensively positioned global equity offering. The Fund gained 2.8%, trailing the MSCI World Index, which rose by more than 6.2%. The Fund’s high cash balance was again a key reason for its underperformance. At the end of December, the Fund held more than 25% in cash. Taking a very rough estimate, this level of cash would translate to approximately 1.3% in potential performance given up during Q4.
Another contributor to the underperformance was stock selection in the consumer discretionary sector, particularly in retail names. Clothing retailer H&M struggled in the quarter and over the year, as many retailers faced headwinds. Bankruptcies of other traditional retailers (Sears, Toys R Us) combined with the continued rapid growth of Amazon hurt most retailers and dragged down H&M. Ivy management believes that H&M is uniquely positioned and their investment thesis on the company remains intact. An underweight allocation to technology also hurt the Fund.
Heading into 2018, the manager remains very defensive with heavy emphasis on consumer names, industrials and healthcare. Cash remains high, sitting at 27.6% of the Fund at the end of January.
Its focus on defense is a key reason why I like this Fund. To highlight this, between January 25 and February 8, the MSCI World was off by 6.6% in Canadian dollar terms. During the same period, the Fund was down 3.4%. With more volatility expected on the horizon, I expect this Fund will really start to shine. Further, as volatility increases, it will give the Manager the opportunity to put some of his cash to work as high-quality companies become more attractively valued.
I continue to monitor this Fund closely.
BMO Asian Growth and Income Fund (GGF 620 – Front Units, GGF 942 – Low Load Units) – Despite a very respectable gain of 5.5%, the Fund trailed its index and peer group in the final quarter of 2017. Unlike its peers, which are typically all equity plays on the Asian market, this BMO offering is more conservatively positioned holding not only equities, but also convertible bonds and preferred shares. At the end of January, it held approximately 85% in equities, 9% in convertible bonds, and 3% in preferred shares.
The Fund’s holdings in Hong Kong and China were strong contributors over the quarter with big gains coming from AIA Group, a pan-Asian life insurance company that saw strong growth in new business, and continued liberalization in the China market is expected to see it expand further in the country.
There are many reasons to like Asia, and this Fund in particular. Looking ahead, the managers expect the current synchronized global growth cycle will continue into 2018. Valuations in Asian markets are attractive compared with the U.S. providing significant runway for growth. While the outlook is favourable, there are risks on the horizon including central bank tightening, China, and increased trade barriers could all create potential headwinds. It is also expected that volatility will be on the upswing.
Considering the above, this Fund, with its more conservative positioning, is an excellent way to access Asia in a more risk measured way.