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Funds of Note
IA Clarington Floating Rate Income Fund (CCM 9940 – Front End Units, CCM 9942 – Low Load Units) – Over the past several quarters as interest rates have pressed upward, investor demand for floating rate investments has also been on the upswing. In fact, there is now more money invested in floating rate investments than at any time in history.
There is little question that floating rate investments can be a great way to help reduce the effects of rising rates in a portfolio, but it is important to note that these are not suitable as a core holding for the fixed income portion of a portfolio. While the reduction of interest rate sensitivity is undeniable, the credit risk is very real. It should be noted that the underlying loans are almost always unrated, and while they are secured by assets, the risks for default still exist. With their near zero duration, many investors make the mistake of thinking these investments are much like a cash substitute. Again, this is not the case as these are often non-investment grade loans that can sometimes fluctuate significantly. In the fourth quarter the average floating rate fund fell by more than 2%. A key reason for this decline was equity market volatility led investors towards traditional safe haven investments such as government bonds which lowered the demand for riskier investments pushing prices lower.
In this environment, the IA Clarington Floating Rate Income Fund was one of the better performers in the category, with a modest 1.26% loss. A key reason for this outperformance is the defensive approach used by manager Jeff Sujitno. His approach is very simple and is best described as “clipping coupons”. He looks for loans offering an attractive coupon rate, and are trading at a discount to par. The investment process starts with a top down macro analysis, which helps him, and his team understand the market trends, and risks, and helps set up their outlook. Security selection is done using a fundamentally driven, bottom up credit analysis that focuses on cash flow generation, sustainability of revenues, balance sheet strength, and quality of management. The Fund is typically 70% to 80% invested in floating rate debt, with the balance in high yield bonds and other asset backed securities. It is well-diversified, holding between 100 and 125 securities. It invests mainly in U.S. traded issues, and all currency exposure is hedged.
Looking ahead to 2019, the Manager expects loan spreads to widen, but with coupons approaching 6%, total return is expected to remain attractive. Further the Manager does not see a material uptick in default rates in 2019.
One of the mounting concerns in the space is the potential for a reduction in liquidity in the overall market. This is a risk for a few reasons, with the settlement times of loans in the 20 day range compared to 2 days for most ETFs and mutual funds. To help mitigate this risk, the Manager is focused on higher quality, more liquid issues in the loan market, and will typically have up to 20% in more liquid high yield issues that can help to raise cash quickly if necessary.
Given the uptick in volatility and potential spread widening, this remains my top pick in the category for the defense first approach used by the Manager.
RBC Global Corporate Bond Fund (RBF 753 – Front End Units, RBF 118 – Low Load Units) – This Fund invests in a diversified portfolio of predominantly investment grade bonds from issuers around the world. The Management team of Frank Gambino, Marty Balch, and Soo Boo Cheah have a fair bit of flexibility in managing the Fund and can invest up to 30% in the portfolio in non-investment grade issues.
While the Managers have this flexibility, recent market conditions have seen them pull back their high yield exposure, and at the end of December, only 15% was in non-investment grade issues. Credit quality as a whole remains high, with 45% of the Fund rated A or better and 39% rated BBB. It is this higher average credit quality that allowed the Fund to outperform both the index and other corporate bond funds in the final quarter of 2018.
Looking ahead, the Managers remain defensive and have positioned the Fund for a slowing economy with the higher credit quality, and a duration that is slightly shorter than the benchmark. They expect that volatility is likely to remain higher and will be looking to take advantage of further weakness in the corporate bond prices to improve the quality of the portfolio at attractive prices. An example of this active approach saw the Manager increase its exposure to emerging market bonds, as they sold off sharply. At the end of December, more than 10% was in emerging markets, in line with the Fund’s benchmark, but higher than the recent past. Given this defensive positioning, I would expect the Fund to trail its peers in strong bond markets but hold up better in periods of above average volatility. Over the long-term, I expect it to deliver average or better returns with slightly lower levels of volatility.
CI Cambridge Canadian Equity Corporate Class Fund (CIG 2321 – Front End Units, CIG 1521 – Low Load Units) – Despite the recent uptick in volatility, this Canadian focused offering that is managed by the Cambridge team, headed by Brandon Snow remains an excellent long-term pick. The team uses a fundamentally driven, bottom up investment process that looks to find durable, compounding businesses of any size that have a defensive business model, a history of intelligent capital allocation, and a management team whose interests are aligned with the shareholders. Their process is very active and looks to find dislocations within the investment markets. Thanks to above average levels of volatility in the latter half of 2018, equity market valuations have become significantly more attractive as the markets discounted the potential fallout of slowing economic growth and central bank tightening on corporate earnings. In this environment, the Managers have started to find companies that have higher cyclical exposure to be particularly attractive.
The portfolio remains very close to being fully invested, with a small 2% cash weight. At the end of December, it held 49% in Canadian equities, 44% in U.S. names and 5% in the UK. The largest sector exposure is to industrials which make up more than 21% of the fund, followed by energy at 14%. The Manager used the very violent selloff in energy names in Q4 to add significantly to the sector.
Over the long-term, the Fund has delivered very solid performance, gaining 5.2% annualized over the past five years, and 10.1% over the past ten years. Volatility has been in line with the index and the peer group which, when combined with the above average returns, has delivered above average risk adjusted returns for investors. It has also done an excellent job protecting capital, participating in more than 80% of the market’s upside and 67% of the downside.
Looking ahead, I believe the active investment approach and disciplined and experienced team make this a great core equity holding for the long-term.
CI Signature Select Canadian Fund (CIG 677 – Front End Units, CIG 1777 – Low Load Units) – This Canadian focused equity fund is managed by Eric Bushell and the Signature Global Asset Management team using a holistic approach that looks at all parts of a company’s capital stack. Their process is very much a combination of a top down macro analysis combined with bottom up security selection. The first step in the process is to develop a comprehensive global outlook for the markets, which takes such factors as economic growth, interest rates, capital market conditions and geopolitical risks into account. Using this review as a framework, the geographical exposure and sector mix is determined based on the regions and industries that are expected to outperform in the anticipated environment. The stock selection process is completed by the team’s sector specialists who will conduct a holistic review on the company, studying its entire capital structure. This helps them to gain a better understanding of where the best risk adjusted investment opportunities are. A typical company in the portfolio will be financially strong, operate in a business where there are high barriers to entry, have strong brand recognition and be reasonably valued relative to the growth potential.
The result is a very diversified portfolio holding more than 100 names that has a slight value tilt to it. At the end of December, it held just under 10% in cash, 52% in Canadian equity, 22% in U.S. equity and 18% in international equity. The Fund had struggled in the past few quarters as the value tilt had weighed on performance as the market rewarded more growth focused names. Over the past five years, performance has been average, finishing in the middle of the pack.
Historically, a good part of the appeal of the Fund is that it has historically done a good job at managing volatility and protecting capital in down markets. However, in recent quarters, I have noticed the volatility has ticked up and the downside protection is not what it used to be. In the fourth quarter, the Fund was down 15.5% while the S&P/TSX was down 10%. Over the past three years, it has participated in more than 100% of the downside, compared with mid-80% over the past five, ten and 15 years. Overall volatility is also ticking higher.
Looking specifically at the fourth quarter, the Fund’s overweight exposure to energy and financials were the biggest detractors to performance. The manager believes the market selloff in the fourth quarter was overdone and expects the economy to pick up steam in 2019. They have positioned to portfolio to benefit from this but do note that higher volatility is very likely.
Given the erosion in the risk reward metrics, I am putting the Fund UNDER REVIEW and will continue to monitor it closely in the next few quarters.
Manulife Monthly High Income Fund (MMF 583 – Front End Units, MMF 783 – Low Load Units) – This Fund, co-managed by Alan Wicks and Jonathan Popper, has long been a favourite of mine with an investment approach that is rooted in a value philosophy that looks for businesses that generate high and sustainable profits that are trading at attractive valuations. The team puts each investment candidate through a scoring process where each is evaluated on a number of fundamental factors. This helps the team to further focus their efforts on the stocks they believe have the qualities that will allow it to outperform. On these companies, the Managers undertake a deeper due diligence review that includes meetings with management and a fundamental review that results in determining an estimate of fair value. It is at this stage the team determines buy and sell prices for each stock. An interesting feature of this portfolio approach is that position sizes are actively managed based on real-time valuation levels. The further a stock is from their estimate of intrinsic value, the larger the weight it has in the portfolio, and vice versa. Intuitively, this seems to imply a portfolio turnover that is extremely high. However, turnover levels have averaged a modest 62% over the past five years.
The fixed income portion of the Fund is managed using a combination top down economic review combined with a bottom up credit analysis. The Managers look to generate returns by focusing on sector allocation, credit quality and individual credit selection, rather than focusing on duration management. Instead, duration management and yield curve positioning are incorporated into the Fund’s overall risk management process.
Performance, particularly over the long-term has been excellent, posting an annualized five-year return of 6.2% and an annualized ten-year return of 8.8%, both of which handily outpace the category average. However, the Fund struggled in 2018, falling 5.7% for the year finishing in the bottom quartile. The fourth quarter was rough, falling more than 7.5%, again trailing the benchmark and peer group.
There were a couple of factors driving the decline. First, the portfolio is overweight equities compared to the index and the peer group. Equities as a whole sold off much more sharply than bonds in the volatile markets. Second, the equity sleeve of the portfolio has a slight growth tilt to it, and growth stocks were certainly hit harder in the final quarter of the year. Finally, the fixed income sleeve is focused on corporate bond holdings. In the very volatile period, corporate bonds trailed government bonds, which rallied higher on the flight to safety trade. Combined, these factors led to the Fund trailing its peers in both the quarter and for the year.
Despite the short-term blip, the Fund has done an excellent job at delivering returns while protecting capital in down markets. For the past five years, the Fund has participated in roughly 70% of the downside of the market, while delivering more than 100% of the upside.
Looking ahead, the Fund has an excellent management team behind it, using a very disciplined and repeatable investment process which make it an excellent balanced Fund for most investors.
EdgePoint Global Growth & Income Portfolio (EDG 180 – Front End Units, EDG 380 – Low Load Units) – While I’m sure it didn’t feel like it at the time, the timing for the launch of EdgePoint really couldn’t have been much better. In November 2008, the depths of the financial crisis, but also just a couple months shy of the 2009 bottom, the firm went live with four mandates; two equity funds and two balanced funds. Fast forward a decade and EdgePoint has become one of the most respected money managers on the street. In my opinion, the main reason for that is they are a no-nonsense shop. They keep things very simple and what you see is what you get. They continue to offer four very simple mandates, with each 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, the Fund held approximately 31% in bonds.
The managers view equity investing as if they were taking a direct ownership interest in the business. 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. The Management team undertakes extensive due diligence 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. They conduct fundamentally driven, bottom up analysis that looks to find high quality, undervalued businesses. An ideal investment is a well-managed company 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 which helps explain why their valuation metrics appear to be higher than the index. In most 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 materials, energy and utilities. The fixed income sleeve is focused on corporate bonds across the quality spectrum. 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.
Performance has been excellent, posting above average returns in every year except 2010. For the past ten years, the fund has gained an annualized 12.7%, handily outpacing the peer group. For the past five years, it has done an annualized 9.2%, again significantly besting the peers. Even 2018, which was a volatile year by any measure, the Fund ended in the top quartile, with a very modest 1.2% loss.
Volatility is higher than average, but the above average returns more than offset this higher risk. That said, volatility is not something the managers are concerned with. In fact, they embrace volatility as they see it as an opportunity to find significant price dislocations and pick up high-quality stocks at very attractive prices.
Considering the above, I see this as an excellent balanced fund offering for those who have an above average risk appetite. It can be more volatile than the index or peers, but if you’re comfortable with that and have a medium to long-term time horizon, this is a great balanced fund to consider.
Fidelity Canadian Balanced Fund (FID 282 – Front End Units, FID 582 – Low Load Units) – This balanced fund is structured like a fund of funds, with the top-level asset mix managed by Geoff Stein and David Wolf, while the underlying asset class pools managed by dedicated managers. It targets a balanced asset mix of 50% in Canadian equities and 50% in fixed income.
Mr. Stein and Mr. Wolf will make slight adjustments to the asset mix with the goal of delivering strong risk adjusted returns while reducing risk. While the goal is to maintain the asset mix near the target, they do have some flexibility around the asset mix. Equities can range between 40% and 60%, investment grade bonds can range between 30% and 50%, while high yield can range between 0% and 20%. At December 31, the fund was 47% equity, 44% bond, 6% high yield and the remainder in cash.
The equity sleeve is managed by Darren Lekkerkerker who looks for high quality, well managed companies with strong balance sheets that are trading below his estimate of fair value. While Fundamentals are the most important factor, he will also take a macro view when reviewing investment candidates and determining the sector mix. The result is a portfolio of 40 – 50 mid-cap and large cap Canadian companies.
The fixed income sleeve takes a more core focused approach that uses a blend of top down macro analysis combined with fundamentally driven, bottom up security selection. The portfolio’s duration is expected to be roughly in line with the benchmark. High yield is often used as a way to generate extra return while reducing the interest rate sensitivity of the Fund. The high yield portion is managed using a fundamental credit analysis that focuses on balance sheet quality and the company’s ability to generate free cash flow.
Performance, particularly over the long term has been strong with an annualized five-year return of 4.8%, outpacing the peer group. This trend held true in 2018 when despite ending in negative territory, it delivered above average returns. When this above average return is combined with volatility that has been in line with the category, the result is slightly better risk adjusted returns than the peer group.
The Fund has done a decent job at protecting capital in down markets over the long term. For the past five years, the Fund has delivered 100% of the upside of the benchmark and participated in only 86% of the downside.
With interest rates likely on hold, the fund is well positioned to deliver strong risk adjusted returns for investors. If we see an environment where rates are expected to move higher, I would likely look to an alternative balanced fund that employs a more dynamic asset allocation strategy or a more tactical fixed income sleeve to help mitigate the potential headwinds. For now, this remains a very solid balanced fund offering for most investors.