Volatility - This is wild

Fri, 08 Dec 2017 10:01:56 PST

by Tom Bradley

Back in October, Scott posted a blog on the lack of volatility in the stock market.

Below is a chart that Connor, Clark & Lunn Investment Management, the manager of our Income Fund, came up with. It shows just how unusual this period has been. The market (as measured by the MSCI ACWI, or world index) has had a move of 1% or more on only 3 days so far this year. And no days where the market’s rise or fall was over 2%.

As you see from the history, this is remarkable and to echo Scott’s comments, shouldn’t be expected to continue.

Equity Fund Update

Thu, 07 Dec 2017 14:51:06 PST

by Scott Ronalds

CGOV’s Ted Ecclestone was in Vancouver this week and gave an update on the Steadyhand Equity Fund to a group of our clients (CGOV Asset Management is the manager of the fund). Below is a review of some of the topics Ted touched on.

What CGOV looks for in a company

When assessing a company, CGOV narrows in on three attributes: people, business and price. Put simply, they look for well run companies that have either built substantial brand equity or offer a valuable product or service that can’t be easily replicated. As for price, they assess a stock’s valuation in relation to its peers, growth outlook and its own historic levels to determine suitable buy and sell points.

A prototypical CGOV stock is CN Rail. The company is well run by a respected and proven team, it has valuable, irreplaceable assets (CN operates the largest rail network in Canada and the only transcontinental network in North America), and it trades at a reasonable valuation.

25 stocks only

CGOV will own a maximum of 25 stocks in the fund. This allows for ample diversification and enables the firm to know its holdings and their competitors well. This concentration of stocks also creates a unique “competition for capital” within the portfolio. If the team finds a stock it likes, it must like it more than something already in the portfolio before it’s added. This forces the firm to always look at their current holdings with a critical, objective eye.

With this as background, Ted addressed some of the current factors that are playing a role in how CGOV is thinking about the portfolio.

Trump

The U.S. stock market has performed well since Trump’s victory. Investors’ enthusiasm for stocks is attributable in part to the President’s proposed tax cuts, which would be good for businesses. The U.S. market, however, is also one of the most expensive in the world and CGOV is cognizant of this. The manager sold one holding earlier in the year, Lincoln Electric, which is an infrastructure-related company that benefited significantly from the “Trump bump”, and has trimmed the fund’s position in Visa and CBOE Holdings.

The U.S. President’s desired trade policies are protectionist in nature and detrimental to companies that rely on the free movement of goods and services. This could impact certain companies, although it’s still unclear how far his proposed policies will go. The holding in the fund that could be impacted the most is Magna International (a Canadian producer of auto parts), although CGOV isn’t inclined to act on the stock until the trade picture becomes clearer.

Trump’s victory also led to greater volatility in some currencies, including the Mexican Peso, and uncertainty around America’s relationship with many countries. This led to a sell-off in FEMSA, a Mexican beverage and retail company with operations throughout Latin America. CGOV saw this as an opportunity to buy more shares in a high-quality business. These shares have since had a still-bumpy recovery.

Energy

Some observers think the writing is on the wall for the oil & gas industry with the emergence of cleaner sources of energy and new technologies. This may be the case, but it’s a ways off. The world still has a big thirst for oil, and CGOV feels it’s wise to have some exposure to the sector. Diversification, however, is paramount.

Energy companies make up about 13% of the fund (this is considerably less than the sector’s representation in the Canadian index - 20%). The fund’s holdings are diverse and include Suncor Energy (a producer in the oil sands), PrairieSky Royalty (a pure royalty business with no exploration risk), Pason Systems (more of a technology company in the sense that it develops technologies to monitor rigs) and Enbridge (a pipeline company). These businesses are more stable and predictable than those focused strictly on exploration and development.

Downside protection

While CGOV wants to keep pace in good markets (which they’ve done well), they also put a lot of thinking into downside protection. This is done through security selection rather than hedging or derivative strategies, which can be expensive and complex.

Two portfolio holdings provide a good example of this thinking: CBOE Holdings and Franco-Nevada. CBOE is the world’s largest options exchange (Chicago Board Options Exchange) and home to the VIX, the leading barometer for equity market volatility. When market volatility picks up, CBOE generates more revenue, which should provide good downside protection. Franco-Nevada is a royalty company with a focus on the gold sector. Franco is essentially a finance company (with no debt) that provides investors with exposure to gold without much of the operating risks faced by miners/producers. When the fear level in the market rises, gold tends to perform well, hence the attraction of Franco.

Stocks you don’t see in other portfolios

Although the fund is concentrated in 25 stocks or less, it owns a number of businesses you won’t typically see in other funds. This is because CGOV isn’t constrained by the size of company it can invest in. The fund owns stocks across the market capitalization spectrum (small-cap, mid-cap and large-cap). This allows the manager to uncover some unique opportunities, particularly in the mid-cap space. Throughout its history managing the fund, CGOV has had a lot of success investing in lesser-known stocks, such as Asia Pacific Breweries, Idexx Laboratories and Lincoln Electric. Current holdings in this category include Ritchie Bros. Auctioneers and Evertz Technologies.

What about technology?

As always, there were some good questions from the crowd following Ted’s discussion on the portfolio. The one we’ve heard a few times has to do with technology stocks, so it’s worth expanding on. The fund’s newest holding is Keyence, a Japanese company that manufactures automation sensors and vision systems for manufacturers. The question, essentially, was “Why go to Japan to buy technology when there’s so many tech stocks in the U.S.”

Technology stocks have been absent from, or have made up only a modest part of the fund, for quite some time. Ted admitted it’s an area they’ve missed the boat on. The FAANG stocks (Facebook, Amazon, Apple, Netflix, Google) have been growing fast and have performed exceptionally well, but they’ve also been too expensive in CGOV’s view. Based on their valuations and outlooks today, Ted and the team feel the downside risks of many American tech stocks outweigh their upside potential.

Circling back to Keyence, it’s in a more stable phase of its business cycle and trades at a lower valuation, which makes it more attractive than its U.S. counterparts in CGOV’s view.

In closing, we’ve been very happy with CGOV’s management of the fund. They’ve produced excellent long-term results for our clients (including us, of course!) and haven’t wavered from their process.

If you’ve got a question on the fund, give us a call at 1-888-888-3147 or enter it in the Comments section of this post.


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