Investment opportunities at home and abroadBy Andrew Rickard | September 12 2010 03:23PM
Markets will continue to be volatile for the rest of the year, but the long-term prospects of Canadian and foreign markets are generally positive, according to Gaelen Morphet, CFA, and Senior Vice President and Chief Investment Officer of Empire Life.
Late last year, Ms. Morphet left CIBC Asset Management to join Empire Life where she is responsible for managing the insurer’s segregated fund portfolios. During a mid-year conference call for financial advisors July 20, Ms. Morphet described the first half of 2010 as a tale of two markets. In the first quarter, investors were optimistic about a global recovery and the Canadian, American, and European markets were up 3.1%, 5.4% and 3.5%. By the end of June, however, concerns about sovereign debt in Europe and fears of a double dip recession in the United States had erased these gains, and the same markets posted declines of -5.5%, -11.4% and -9.9% respectively.
While the Chinese economy has slowed, due in part to rising interest rates and an appreciating currency, she suggests it is not enough to derail global progress. “Our view is that this is an orchestrated slowdown,” she says.
Since much of the recent boom in our domestic market has been fuelled by the Chinese demand for raw materials, we should not be surprised to see things cool off at home. “Certainly people will have to adjust their expectations,” says Ms. Morphet. “It may be that, going forward, you will not have the same kind of expectations for the Canadian market because you will not be seeing a $200 oil price any time soon, and you will not have nickel prices go back to $25, and it does not look like potash is going to make that $15 earnings estimate,” she comments.
While Canadians have profited from the commodities boom, Ms. Morphet says that it is preferable to have a more diverse economy rather than one focused on energy, raw materials and fertilizer. “You are seeing other areas of the market perform, and that is really healthy,” she comments.
“We have all sorts of other things in Canada. I was always very wary of us being labelled a commodity market because we have so much more going for us. We have the best financial institutions in the world, we are a dynamic market, and we are very successful at growing small companies like RIM (Research in Motion),” she says. “It gives us a chance to shine in other ways when the commodity story is more neutral, and not blown out of proportion.”
In fact, the two most recent additions to the Empire portfolios are both Canadian firms from outside the commodities sector, namely Tim Hortons and Celestica.
“Tim Hortons is an iconic brand in Canada, and one that we really believe in,” comments Ms. Morphet. She says that the company has a number of competitive advantages, and points out that with such a large share of both the breakfast and lunch market, Tim Hortons is able to generate a steady cash flow, meaning they can not only pay a healthy dividend, but can also fund their own expansion rather than having to raise capital elsewhere. “That is always a good model,” she comments.
Ms. Morphet said that she did not buy into the initial hype when Tim Hortons went public some years ago. Instead, it was the way the company has come through the recession that impressed her. “It weathered the 2008 storm very well,” she says. “We like to see how stocks do in challenging economic times, and it did extremely well, and that gave us the confidence we did not have prior.”
Electronics manufacturer Celestica has been through a number of difficulties over the last few years, changing both board and senior management several times and struggling with declining demand in their Mexican subsidiary. Ms. Morphet says she had been watching the company for some time, and now that earnings have stabilized, she believes it was a good time to buy some of the company’s shares. “We really felt that most problems with it have been cleared out, both at a management level and some of their operational issues. As value manger, that is what you are looking for: a limited downside with plenty of upside,” she says. “We think the valuation warrants investing in it for the payoff resulting from the restructuring of their business.”
What about the European situation? Ms. Morphet believes that the recent stress tests that European regulators have applied to their banks have helped to build more confidence in their financial institutions, but there is still work to be done. She notes that European governments have committed to cutting costs and bringing down their deficits by 2013. “Those austerity programs are going to take their pound of flesh,” she says.
However, as long as the Euro stays low, that should help to stimulate growth for exporting nations like Germany. When she has spoken with executives from companies who are either located in, or do business with Europe, she says that they have been cautiously optimistic about the future. “It is a balancing act, but so far the news looks good,” she says. “We will have to wait a quarter or two and see.”
For diversification and the opportunity to invest in high-growth sectors, Canadian investors should look beyond their domestic market, suggests Noah Blackstein, CFA, and the lead portfolio manager of the for the Dynamic Power Global Growth Fund, which he has managed since its inception in 2001.
Mr. Blackstein describes the fund’s investment strategy as as “one hundred percent bottom up,” meaning that the focus is on the individual merit of each company rather than on macroeconomic conditions or market cycles. “We are looking for fast growing companies that can sustain that growth,” he says.
As of June 30 of this year, the Dynamic Power Global Growth Fund held 18 stocks, with total assets totalling $399.4 million. More than 60% of the fund was invested in the information technology sector, and the fund’s single largest holding was the American computer giant, Apple Inc.
What is it that Mr. Blackstein likes about Apple? “It has been a long time holding for me,” he responds. “I think the secular growth opportunity is really there, whether it is the move from traditional cell phones to smart phones, or the move to Mac computers, which still represent less than 5% of the global computer space. And mobility things like the iPad and the iPhone still have a very long way to grow.” Based on current price to earnings valuations, he suggests that Apple stock remains quite inexpensive.
Three years ago, about a quarter of the fund was invested in the health care sector. Today, however, that amount has been roughly halved. Why has he moved away from that area? “I only run twenty stocks in the portfolio, and I tend to have some big weightings in some individual stocks,” he explains. If health care is down to 13% of the portfolio today, Mr. Blackstein says that may simply be the result of his selling one or two stocks.
He says that the fund has investigated several Asian medical companies with an eye to investment, and the proportion of the portfolio invested in that sector could increase again in the future. “There is no top down, schematic reason as to why the percentage invested in health care changed. There were just different opportunities somewhere else,” he says. “Overall, my focus is always on finding unique, individual companies that have the ability to become significantly larger in terms of revenue and earnings growth,” he comments.
Geographically, the fund is most heavily invested in the United States and China, which account for 49.5% and 20.5% of the total portfolio respectively. But once again, this weighting is simply a result of the fund’s bottom-up approach and the choice in individual companies, and not any sort of conscious decision. “I am not benchmarking off of anything. I do not follow the Morgan Stanley index, and I do not care about the Morgan Stanley index.” he says. “I try to hold the best opportunities in certain growth stocks.”
Another stock Mr. Blackstein likes is online search engine Baidu, which he says he has held inside the Dynamic Global Growth Fund for some time. He describes the company as the Google of China, and notes that Baidu has posted three-year growth rates of 70% in terms of both revenue and earnings. If Canadian investors want to participate in the high tech sector and enjoy this kind of growth, Mr. Blackstein suggests that they are going to have to look outside of their own borders.
“The opportunities in information technology really exist in the United States and in China,” he says. “If you look at the Toronto Stock Exchange, it has only 3.6% in technology, and pretty much all of that is in RIM.” Now that the Ontario based drug manufacturer Biovail is going to merge with Valeant, he points out that the percentage of the Toronto index that is tied to the health care industry will drop from about half a percent to zero. “These are sectors that just do not exist in the Canadian market,” he says.
Canadians who invested most of their assets at home have certainly done well over the last five years thanks to surging prices in energy and metals. However, Mr. Blackstein suggests that those with too strong a home bias could be missing out.
“Canadians are really not that well diversified by sector,” he says, citing data collected by the Investment Funds Institute of Canada which revealed that 90% of Canadians’ stock market investments are located in Canada. “If 90% of your equities are in Canada, that means half of them are in energy and materials,” he comments. “Now I actually believe in the bullish case for commodities, but what I am saying is that 50% is one hell of a big bet.”
If advisors want to discuss the subject of global investing with clients, they could begin the conversation by talking about the benefits of diversification. “I am not making predictions and saying if technology starts to outperform, I am saying it is outperforming,” concludes Mr. Blacksteinn. “So you should probably take a look, because you are very heavily concentrated in a couple sectors here in Canada.”