Portfolio manager Gary Chapman has underweighted financial and energy stocks over the past several years.
As the sectors have become more dominant, he says, this has helped him also look “for growth in some of the mid-cap and smaller mid-cap companies in the index,” rather than only focusing on larger, more mature companies.
Chapman is senior portfolio manager and managing director of Canadian equity at Guardian Capital, and he manages the Renaissance Canadian Growth Fund. He says he’s been diversifying that portfolio by underweighting the top 50 companies on the TSX, which has allowed him to increase the weightings of growing companies that are ranked lower.
Otherwise, he notes, highly valued financial and energy stocks take up a lot of capital that can be used to invest in other areas of the market.
Still, Chapman cautions underweighting can backfire. He’s been underweight in infrastructure, pipeline and midstream companies, and he finds growth in that sector has been spectacular.
Regarding financials, “Canada’s in a period where economic growth is low,” says Chapman. And that means lower loan growth, [which] makes it harder for the banks to exploit the revenue expense gap, where they ideally grow revenues 3% faster than they grow expenses.”
He continues, “In a slow-growth environment, it’s a lot harder to do that. Having said that about banks…we are bullish on the market in general and banks too can have a multiple revision. When we get into a period where interest rates start to rise, [banks’] net interest margins will improve and we may have to take a more favourable approach to the banks.”
In this space so far, Chapman’s started to add exposure to asset management companies. Growth in the investment industry going forward will be on the wealth management side, he says, since low interest rates are impacting the earnings of life insurance companies. Still, insurers have “done a very good job at re-pricing and repositioning products,” and many are building up their wealth management arms.
Within the energy sector, Chapman’s also started to increase the weightings of heavy oil and natural resource companies due to talk of new pipelines and the growth of oil sands firms. “We’re positive on heavy oil differentials coming down. Going through last year…differentials were quite wide but we felt they would come down as new pipe[lines] were built and as some refineries came on that needed heavy oil. That has been the case. And though differentials have shrunk quite a bit, there’s still some room.”
He predicts benchmark “natural gas prices in the U.S. should stay in the $350 to $450 range.”