Page 21 - Newcom

MAY 2020
A strong start marred by crisis
PAGE 21
SECTOR WATCH
colin ramkissoon is vice
president, U.S. and inter- national equities and chair of the balanced fund asset mix committee of Beutel Goodman Investment Counsel, a unit of Beutel Goodman & Co. Ltd., in Toronto. The committee man- ages the $3.37-billion (valuation as of March 31) Beutel Goodman Balanced Fund.
“The enduring discipline of our process is designed to remove emotion from the equation — precisely in market environments such as the one we are currently experiencing,” Ramkissoon says.
Ramkissoon is “focused on investing in businesses with competitive differentiation, sus- tainable free cash, strong bal- ance sheets and management teams that are aligned with shareholders.”
Ramkissoon adds: “The indi- vidual component portfolio weights of the fund are driven by the relative attractiveness of their long-term expected returns. We do not make top-down stra- tegic asset-mix shifts, and capital preservation is paramount.”
Normally, the Beutel Good- man (BG) fund’s target asset mix is 60% equities and 40% fixed-income.
Ramkissoon explains that when returns in equities are attractive, the equity component of the BG fund’s balanced port- folio will approach the higher limit of the investment policy range. As stock prices reach the BG team’s targets, the shares are sold and the proceeds reallo- cated to existing holdings with lower valuations and higher anticipated returns or to new stocks. If market conditions are such that the anticipated returns on equities portfolios are unattractive, the equities alloca- tion is reduced and reallocated to fixed-income and cash.
As of March 31, the BG fund’s asset mix of the portfolio com- prises 66% equities, with 33% exposure to the Canadian mar- ket, 15% to the U.S. market and 18% to the international mar- ket. The fund has a 32% weight in fixed-income securities, com- posed of 4% federal bonds, 11% provincial and municipal bonds, and 17% corporates.
From a sector standpoint, the BG fund portfolio’s greatest exposure is to financials (24.9%), followed by communication ser- vices (12.9%), consumer staples (12.3%), industrials (11.8%), health care (8.3%), information technology (8.2%), materials (7.3%), consumer discretionary (6.3%), energy (4%) and utilities (0.4%), with the balance in cash.
“We are bottom-up stock- pickers and sector allocation in equities is an outcome of that process,” Ramkissoon says. “In fixed-income, we believe certain
sectors in the corporate bond market are attractive — finan- cials and telecoms, specifically.”
One of the BG fund’s major long-term holdings is Rogers Communications Inc. (communi- cations networks and media hold- ings). “We view Rogers as very well positioned, given its substantial spectrum position and network investment, its strong balance sheet and low payout ratio, and its small percentage of legacy business,” Ramkissoon says, add- ing that regulatory intervention remains a risk, but is manageable over the long term.
Another major holding is Toronto-Dominion Bank (TD), which, Ramkissoon says, “has excellent retail-banking assets and a strong risk culture. TD has the best mix of businesses in the Canadian banking sector. [It focuses] on its core Canadian and U.S. retail bank segments and grows them incrementally while managing business risk.”
Even after stress-testing for Covid-19 scenarios, Ramkissoon says, TD continues to hold sig- nificant market share and good businesses outside Canada.
Over the past six months, the BG team conducted partial trims of two holdings as they hit tar- get prices: Roche Holding AG (a pharmaceutical company) and NortonLifeLock Inc. (software). Earlier, the fund sold one-third of its position in NTT Docomo Inc. (mobile phone networks), but upon further review, “the relative attractiveness of other names in the portfolio led us to sell the remainder of our pos- ition,” Ramkissoon says.
In addition, the BG fund sold its position in Cenovus Energy Inc. (integrated oil operations) “due to the significant drop in oil prices following a concerted effort of major market partici- pants to secure market share without regard to any cost.”
Ramkissoon says investors’ short-term focus and increased volatility in equities markets have caused stock prices to be significantly discounted. As a result, he is finding attractive opportunities in new and exist- ing companies that have been indiscriminately sold off. He believes the market will eventu- ally differentiate between com- panies that possess solid balance sheets and strong free cash flow generation, and those that do not.
On the fixed-income front, Ramkissoon believes the econ- omy is likely to experience a deeply negative second quarter, as most businesses are shut down and consumer spending is con- strained. However, with the aid of myriad monetary policy responses as well as fiscal stimulus, he antici- pates “we will likely experience a U-shaped recession.” IE
The Canadian equities market began the year on a strong note before the coronavirus pandemic led to a dramatic decline in stock prices
believes the bank will continue to pay regular dividends.
During the first quarter of 2020, the FB fund added to its existing position in Nutrien Ltd. (fertilizers), the shares of which are attractively valued with a well-supported dividend. Nutrien “offers some defensive character- istics that could prove valuable in the current environment,” Stelmach says. “Being agricul- ture-driven, its performance is not necessarily tied to GDP growth.”
The FB fund also established its initial position in Wheaton Precious Metals Corp. (royalty and streaming assets in the pre- cious metals space). “The busi- ness generates robust cash flow through market cycles and is committed to paying dividends,” Stelmach says. “Its capital-light model and strong balance sheet leave it well positioned to weather
the current economic downturn while positioning it to add accre- tive royalty streams from miners seeking financing.”
Stelmach recently trimmed the FB fund’s position in Brook- field Renewable Properties LP on its strength in January and February of this year. The fund still holds a significant position in the company, but, Stelmach says, it was “garnering a signifi- cant premium valuation, likely in part due to the pre-Covid-19 preoccupation [with] investing in renewable power assets.”
Stelmach also reduced the FB fund’s position in WSP Global Inc. (professional services). “The shares were no longer trading at as significant a discount to our estimate of intrinsic value as they once did,” he says.
Stelmach believes normalized economic and business conditions will eventually resume and a secu- lar growth pattern will be re-es- tablished. Whenever this happens, “we would look to tilt back toward more cyclical equity investments,” he says. “With respect to [corpor- ate] fixed-income, with interest rates currently very low, a dis- cerning eye to creditworthiness will serve us well.”
BY DWARKA LAKHAN
investors seeking diversi-
fied exposure to the equities and fixed-income markets can get such exposure from Canadian equity balanced funds.
These funds invest 60%–90% of their total assets under man- agement (AUM) in equities, includ- ing U.S. securities, and a smaller portion in fixed-income securities. These funds can offer up to 50% greater exposure to equities than fixed-income balanced funds and thus are more suitable for moder- ately aggressive investors.
Canadian equity balanced funds were not left unscathed by unprecedented market vola- tility stemming from the Covid- 19 pandemic and compounded by historically low oil prices.
Les Stelmach, senior vice presi- dent and portfolio manager with Franklin Bissett Investment Management, a unit of Franklin Templeton Investments Corp., in Calgary, is co-lead port- folio manager (along with Ryan Crowther, vice president and port- folio manager) of the $332-mil- lion Franklin Bissett Dividend Income Fund and the $1.5- billion Franklin Bissett Dividend Strategy. (Fund valuations are as of March 31.) Stelmach says the income fund was defensively pos- itioned prior to the market decline.
“Although no sectors were spared from losses, the fund’s defensive tilt, instituted in the latter half of 2019 and into 2020, allowed it to outperform its equity benchmarks,” Stelmach says.
The defensive position was taken in anticipation of poten- tial market risk. The extended bull market that ended in March created “an environment where fundamentals and valuation took a back seat to momentum and potential,” Stelmach says. “The pandemic is reversing this trend, and business fundamen- tals, capital structure and allo- cation are again predominant.”
The Franklin Bissett (FB) divi- dend income fund seeks to gener- ate higher risk-adjusted returns than its benchmark — a blend of 60% S&P/TSX composite index, 20% S&P 500 composite index, 15% FTSE TMX Canada universe bond index and 5% S&P/TSX
preferred share index — while delivering stable to rising cash distributions.
Stelmach says the FB fund employs a “growth at a reasonable price” philosophy with bottom-up security analysis: “Valuations are regularly fine-tuned based on factors such as changing industry dynamics, appraisal of business risk and changes in underlying interest rates.”
The FB fund portfolio’s asset mix as of March 31 is 58.7% Canadian equities, 20.6% U.S. equities, 15.5% bonds and 4.1%
preferred shares, with the bal- ance in cash. The largest expos- ure to Canadian equities is in financials (23.3%), followed by utilities (16.5%), communication services (13.1%), energy (12.3%), consumer staples (12.2%), materials (8.9%), real estate (8.8%) and industrials (4.3%).
The largest exposure to U.S. equities is information technol- ogy (21.6%), followed by health care (19.8%), consumer sta- ples (17.9%), industrials (10%), financials (9.7%), utilities (6.4%), energy (6.3%), consumer discre- tionary (4.9%), and communica- tion services (3.4%).
One of the FB fund’s major holdings is Fortis Inc. (power generation and distribution). Stelmach says the company is “committed to a strong invest- ment-grade credit rating with a manageable payout ratio to sup- port a self-funding growth model.”
Another major holding is Royal Bank of Canada (RBC). Stelmach praises its leading banking-prod- uct market share, strong capital markets franchise and full-service wealth-advisory business, the lar- gest in Canada. He adds that RBC went into the Covid-19 crisis with a strong capital position, and he
The market will differentiate between companies that possess solid balance sheets and strong cash flow, and those that do not