JMRD Market Observer for November 24th 2017 – JMRD Due Diligence Day in Toronto

November 24, 2017

In This Week’s JMRD Market Observer

 

 

  • JMRD Due Diligence Day in Toronto

  • Canadian Banks: Q4/17 preview: turning the page on a strong year

  • The BoC’s “new” communication process: Same old same old?

  • JMRD Investment Beliefs

  • JMRD Basket Corner

  • Retirement Corner

  • Reads of the Week

  • Economic Calendar

  • Earnings Reports

 

 

JMRD Due Diligence Day in Toronto

 

Last week, the five principals of The JMRD Team hosted a due diligence day in Toronto.  The purpose of this due diligence day was to talk with third party money managers whose funds we use within the JMRD Model Portfolios and across many other client accounts as well.  It was meant to be a ‘check-in’ to see if the fund managers were adhering to the processes and beliefs that convinced us to hire them in the first place.   If we see a drift away from these initially stated beliefs then it’s incumbent upon us to make the necessary adjustment, if such an adjustment is warranted.  We also met with Daniel Strauss and Tiffany Zhang from NBF’s Exchange Traded Fund (ETF) Research Team to get an update on the trends shaping the ETF industry.  There has been a massive influx in the number of ETFs now trading on the market and we’re very fortunate to have highly coveted experts in this field readily available to us.  Some of the money managers we met with and highlights of the conversations are provided below:

 

Canso/Lysander Investment Counsel – Brian Carney

 

  • Manager of the Lysander Corporate Value Fund which is an actively managed corporate bond fund.
  • The weighting of this fund in our models ranges from to 1.5% in the Max Growth Model to 7.5% in the Conservative Model.
  • They have a three-pronged philosophy:
    • Reject investor fashion and consensus (look to go against the herd).
    • Exploit market inefficiencies.
    • Find opportunities not obvious (or available) to others.
  • Many times companies have approached Canso as a lead order in a bond issuance, illustrating Canso’s clout in the corporate bond space.  Apple recently issued bonds in Canada and Canso was a lead order.
  • The management team has become more defensive of late as they don’t feel that the yields on many issuers are compensating enough for the risk. 
  • Forty-five percent of the portfolio is comprised of high quality (banks) floating rate Canadian issuers, to protect from higher interest rates.
  • Recently added a position in Sobeys after their recent struggles with the integration of the Safeway Canada acquisition from a few years ago.  This is an example of going against the herd mentality.  Since then the company has started to right the ship.

 

Manulife Investments – Joe Rothwell, Chuck Tomes and Chris Chapman

 

  • Co-managers of the Manulife Strategic Income Fund.   The exposure to this global bond fund within the Models is the same as the Lysander Fund above.
  • The management team out of Boston strives to:
    • Increase the return profile in a low interest rate environment.
    • Maintain volatility consistent with fixed income investments.
    • Protect against rising interest rates.
    • Diversify fixed income allocation away from benchmark-centric and domestic exposure.
    • Preserve liquidity.
  • The portfolio is managed 24 hours a day through Boston, Hong Kong and London.
  • They are currently ‘cautiously optimistic’ when looking at the global economy.
  • They are more exposed to Australia and New Zealand at the moment where rates have been cut and remain low.
  • They are moving more to emerging market investment grade offerings.
  • The team also actively manages the fund’s currency exposure and thinks the CAD will rise from here versus the USD.
  • The average term to maturity of its holdings is well below the benchmark, which stands to protect the fund if rates continue to rise.

 

Cambridge Investments – Geoff Scott

 

  • Co-manager of the CI Cambridge Growth Companies Fund, a small/mid-sized company equity fund with a ‘go anywhere in the world’ mandate.  It comprises anywhere between 4.5% of the Max Growth Model to 1.5% of the Conservative Model.
  • The Cambridge team adheres to three objectives:
    • Active Management is key.
    • Absolute Return/Capital Preservation is important.
      • Look to achieve higher risk adjusted returns.
      • Always monitoring the upside potential of an idea versus the downside risk.
      • Look for management teams of the companies they invest in to have similar philosophies which means high insider ownership and responsible bonus structures.
    • Employees of Cambridge have about 99% of their net worth invested in their own funds (alignment with their investors).
    • The fund has a high ‘Active Share’, which means 98% of its holdings are unlike the index/benchmark that it tracks.  We hire money managers to be different from the index!
    • Currently they have raised some cash in the fund and they are taking a cautious approach.  Overall the number of holdings are concentrated within 30-40 names.

 

Black Creek Investment Management – Heather Peirce

 

  • Co-manager of the CI Black Creek Global Leaders Fund.  This global equity fund comprises anywhere from 5.5% of the Max Growth Model to 1.8% of the Conservative Model.
  • Their philosophy is simple: 
    • Think long term.
    • Think like business owners.
    • Think independently.
    • Think about valuation.
  • Black Creek’s funds are also concentrated with a smaller group of companies than most funds within its peer group.  They find businesses that they like and that they want to invest in for the long term.
  • They are very focused on governance and aren’t afraid to vote against aggressive pay for management teams.
  • They look at the purchasing power parity numbers when deciding whether to hedge currencies or not.  They also know what currencies each company they own is exposed to.  Because most are selling products or providing services within a number of different countries with difference currencies, companies tend to be naturally hedged.
  • We discussed active share above and Black Creek also has a high active share of 98%, again meaning their fund holdings look radically different that the benchmark.

 

We came away very feeling very confident in the management teams that we met and will continue to actively monitor their inclusion to the JMRD Models and clients’ portfolios.  We found that their beliefs and philosophies very much aligned with ours, which gives us even more conviction that we are invested with the right managers.  

 

A key takeaway was from our ETF analyst, specifically on the fixed income side.  There is no shortage of risks to a fixed income portfolio in a rising interest rate environment like we’re seeing now.  There are times when passively managed bond/fixed income investments (ETFs) may not perform the way one would expect in such an environment and for this reason, actively managed, fixed-income mandates like Lysander and Manulife can add more value under such circumstances.  For this reason we will be tweaking the fixed income holdings within the model to include more actively managed ideas.

 

Please do not hesitate to call or email if you wish to know more about the managers above or have any questions on the JMRD Models.

 

 

Canadian Banks: Q4/17 preview: turning the page on a strong year

 

Next week, Canadian banks will begin reporting Q4 results. The Bank of Nova Scotia will be the first bank to report, on Tuesday and bank earnings will wrap up the following week with Bank of Montreal, the last of the big 6 banks to report. The best performing bank this year has been National Bank with a return of 16.12% with Bank of Montreal lagging the group, with a return of 3.04% plus dividends. Below is a look at the Q4 results as well as a peak at what to expect in 2018 from the Canadian Banks.

 

A good quarter, but with recent performance limiting potential upside. On average, we are forecasting 5% Y/Y average EPS growth for the Big-6 (excl. BMO hurricane loss estimate). On the positive side, we are expecting a strong finish for the group in Canadian retail banking (benign credit environment, strong operating leverage) and Wealth segments (i.e., supportive markets). All things considered, we would not be shocked to see yet another quarter of positive EPS surprises. However, with the banks outperforming the market by ~450 bps since reporting Q3/17 results, we believe that upside “into the quarter” is limited.

 

Mortgage market: any change to B20 impact guidance? Based on Canadian bank balance sheet data filed with OSFI, the Big-6 banks grew their mortgage books by 1% during the first two months of Q4/18 (i.e., August and September), equating to an annualized rate of 7%, led by uninsured mortgage growth. More important than the upcoming quarterly growth rate, though, is what banks have to say about their 2018 mortgage growth expectations ahead of revised B20 regulation. We forecast 2018 asset growth of 4-7% in Canadian P&C banking segments, which implicitly includes a similar growth rate for domestic mortgages. We believe many investors view revised B20 rules as a trigger to cause mortgage growth to tumble, which would have important implications for the Canadian economy as a whole. We believe this issue (along with pricing data Toronto, in particular) could act as an overhang on the sector to start the new year.

 

Credit performance: the gift that keeps on giving. Nearly every bank, every quarter, has been reporting lower than expected loan losses this year. In short, PCL forecasts have become a buffer in street estimates that enable banks to exceed expectations more often than not. To that end, we are forecasting a 12% average increase in PCLs in 2018 (reflecting a sector PCL ratio of 30 bps, up from 28 bps in 2017). If anything, this quarter’s credit performance helps determine whether the “slope” of the increase is too conservative (or not).

 

Introducing 2019 estimates. We are forecasting average growth just shy of 7% in 2019 (following 5% growth in 2018). At a high level, our forecasts are driven by the following key assumptions: (1) 4% earning asset growth; (2) low bps increase to consolidated margins; (3) ~90 bps of NIX ratio improvement/2% operating leverage; and (4) consolidated PCLs ratio increasing by 3 bps to 33 bps.

 

See the full article

 

 

The BoC’s “new” communication process: Same old same old?

 

In a November 15 speech in New York, titled “Embracing Uncertainty in the Conduct of Monetary Policy,” Bank of Canada senior deputy governor Carolyn Wilkins said the Bank had decided, “starting next year, to advance the timing of speeches providing economic updates to align them more closely with the fixed announcement dates between MPRs.” Like many others, we thought that meant the Bank was planning to communicate its concerns about the policy outlook sometime in advance of non-MPR fixed announcement dates. But it turns out the Bank plans to communicate its thinking after, not before, non-MPR fixed announcement dates.

 

See the full article

 

JMRD Investment Beliefs

 

Just in case you missed reading the Market Observer the past couple weeks, over the summer months, the principals of the JMRD Team, who form the JMRD Investment Committee, set about to articulate our Team’s investment beliefs.  We have been a Team for over 10 years and largely have the same investment views.  However, with added members to the Team and an ever changing investment world, we wanted to dig deeper into our key beliefs.  Our team has processes in place and holds regular strategy conference calls in order to improve our investment decision-making process. We feel that testing and confirming our investment beliefs provides the solid foundation on which to make important investment decisions on an ongoing basis. 

 

Belief #7.  Costs and taxes need to be managed.  We balance risks, costs and tax implications when developing and implementing long term investment strategies.

 

 

JMRD Basket Corner

 

DIG Basket

 

Royal Bank (RY) – After several years of dodging the designation, RY was finally added to Basel Committee’s list of Global Systemically Important Banks (G-SIB). This list is comprised of 30 of the world’s largest banks, and appearance on it imposes a higher regulatory capital requirement (CET 1). Depending on its ranking, a bank will be designated to “buckets” 1 through 5 that trigger additional CET 1 buffers ranging from 100bps to 350bps (we note that no banks are currently assigned to the most onerous “bucket”). While the story attracted headlines this week, OSFI seems fine with RY’s capital position which is the most important fact and not a market moving event for Royal Bank. 

 

All-Cap Growth Basket

 

Premium Brands (PBH) – Premium Brands Holdings Corporation announces acquisitions of Buddy’s Kitchen, Raybern Foods and an Investment in Shaw Bakers

 

U.S. Growth Basket

 

Broadcom (AVGO) – Broadcom considering sweetened Qualcomm bid

 

XPO Logistics (XPO) – Deals Fuel XPO Logistics Into the Fast Lane

 

 

Retirement Corner

 

 

 

 

Reads of the week

 

 

 

 

 

 

 

 

 

 

 

Economic Reports

 

Monday November 27th – New Home Sales (US)

Tuesday November 28th – S&P Case-Shiller Home Price Index (US), Consumer Confidence (US)

Wednesday November 29th – GDP (US), Beige Book (US)

Thursday November 30th – Chicago ISM (US)

Friday December 1st – Real GDP (CAN), Employment Change and Unemployment Rate (CAN), Manufacturing ISM and PMI (US), Vehicle Sales (US)

 

 

Earnings Reports

 

Monday November 27th – None

Tuesday November 28th – Couche Tard, Bank of Nova Scotia

Wednesday November 29th – Arizona Mining, Royal Bank of Canada

Thursday November 30th – CIBC, Toronto-Dominion Bank

Friday December 1st – BRP Inc., National Bank of Canada

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