What is an Active MindSet? IA Clarington Investments believes that, now more than ever, taking an active approach in providing advice to your clients is essential in guiding them through today’s financial complexities. Together, active advice and active portfolio management can help investors maximize their wealth and reach their financial goals.
Live from the Roadshow with Bryan Borzykowski
Welcome to the IA Clarington road show’s blog. I’ll be documenting today’s event, which should start momentarily. First up is an introduction by IA Clarington president David Scandiffio, then IA Clarington’s Dan Bastasic, then Aston Hill Asset Management’s Ben Cheng will talk about the challenges of generating income for clients.
And here we go. Starting with a quick video of portfolio managers talking about value investing, choosing investments, preparing for economic uncertainty and the importance of advisors.
David Scandiffio, president of IA Clarington, is up first, welcoming the advisors in attendance. The theme of the event is Active Mindset. David’s of the view that “taking an active approach in providing advice for clients is essential in guiding through the risks and complexities of a changing world.”
Historical levels of market volatility are driving investors to be active, he says.
Highly correlated and integrated markets have been characterized by quick ups and downs. But risk tolerances are lower, so the focus is on generating sustainable income streams. The barrage of information available in today’s media results in an increase of second-guessing of decisions, he says. That’s why being “truly active” in all parts of an advisor’s business is critical for success.
David is showing a chart that explains that investors who work with advisors invest earlier and smarter and stay invested during trying times. Clients have ended up with better results than when they go at it alone.
“The relationship between and advice and results will continue to widen,” he says.
There’s a growing acceptance of a more passive approach, he says, but points out that active management, with smart portfolio managers, makes sense in today’s volatile world.
He says truly active managed funds have outperformed the benchmark, but you need to find the right ones — not all active funds are created equal.
Now he’s talking about how to find a good active manager. A study showed that U.S. equity managers with a high deviation of their holdings from their benchmarks outperformed their benchmarks and more passive peers. A large sustained difference can have a “hugely meaningful” impact on a client’s wealth, he says.
BNN’s Kim Parlee is introducing the day’s events. According to Kim, today’s speakers have over 120 years of asset management experience. There will be a panel discussion then a Q&A led by Kim. First up is the income panel.
Kim’s talking about how low interest rates make it difficult to find income in the markets. Dan and Ben have to answer three questions: Number one — what’s unique in driving active investment decisions that can bring value to an investor’s portfolio? Number two — what’s the biggest issue in the market and in the economy that investors need to be actively managing and how does your investment process deal with that issue? Number three — can you show an example of how you do this?
The first manager up is Dan Bastasic.
He’s starting off with a historical look at the markets. Why were the 80s and 90s such a great time to invest? “It was really easy back then,” he says. Everything went up 12% a year. The reason for this is that interest rates came down. Also there was leverage going from historical low levels to record high levels. That was also a boon to the stock market. Also, inflation.
However, in 2000 that got turned on its head. Private debt levels went from 80% of GDP to 190% at peak in 2007. Catalysts that drove the passive market in the 80s and 90s are no longer with us. Interest rates aren’t falling anymore. We’re not in an inflationary environment anymore. So a number of things are supporting active management today, he explains.
Dan explains that he doesn’t pay attention to the index. His funds don’t reflect the index, “for good reason.” To maximize returns, he says, you have to minimize risk and try to preserve capital and that’s how he approaches his portfolios.
Dan has a unique macro overlay. At end of 2008 they decided to get back in the market and buy the high-yield space. In 2010 they said to get defensive. In 2011 they also said to get defensive. This strategic outlook has helped them make prudent decisions.
What’s the risk, he asks? Private debt levels are much higher here than in the U.S. He sees 3% growth in our future for the next 10 years. But if we keep going on current trajectory he sees the economy getting back to 5% or 6% growth. Active and passive environment does well when economy grows 6%, he says. Given the way things are going in the U.S., we’ll have a much better opportunity in the stock market in 10 years.
But, in the shorter term, there’s still reason to be in the market. Dan sees an opportunity in dividend-paying stocks. Right now the dividend payout ratio is 27%, but historically it’s 50%. So there’s room to grow those dividend ratios.
Long-term 50-year nominal EPS for companies has grown at 7.5% but we are in that 5% environment. 3% real growth, 2% inflation, get about 5% plus dividend yield. If we think we’ll have PEs like Japan had in the 90s and 2000s — a bit of a stretch, he says, but he’s being conservative — then dividend-paying stocks will pay 20%. So there’s a lot of downside and pessimism in the market today, but there are, clearly, opportunities, says Dan.
Dan says that he tries to get two ideas from every one and populate portfolio from that.
Kim is back up, introducing Aston Hill’s Ben Cheng.
Ben says that if you’re going to be an income investor today, you have to look across the balance sheet of all companies you’re investing in, he says. Simply going out and buying a government-grade bond, investing in regular fixed-income instruments carries “more risk,” he says.
For his investments, he often invests in different parts of the balance sheet. He’s taking about investing in a discount dollar store’s bank debt — if they stopped investing in their stores, everything goes to pay back investors first. So that’s protection of capital and, because it’s bank debt, it offers a higher level of income. But as the company began to pay down debt aggressively, the company went public in 2010 and he bought the IPO of the equity. “Not as simple as picking one spot of the balance sheet,” he says.
What’s the risk? China, he says. The country has seen a slowdown in GDP and manufacturing. Though there could be a recovery occurring, he explains — though mostly in the high-end electronics side, which is driven by demand from U.S. consumers. For the demand to keep up, U.S. consumers have had to eat into saving rates. At the peak of the financial crisis the savings rate was around 7%. It’s declined to 3% today. There’s a trend. Unless there’s more job growth in the U.S., that demand will affect Chinese manufacturing.
Three largest housing price surveys in China show declines in month-over-month and year-over-year. That concerns Ben. “The vast majority of housing prices are declining,” he says.
His point is that China will be no different than other housing markets we’ve seen around the world. China is tightening credit and raising interest rates over the last three years, so that made it more difficult for homeowners to get access to credit. “We will see housing market volatility in China rise quite dramatically in the next six to 12 months,” he says. Then China will jump into action and drop interest rates “quite dramatically.” Rates are around 7%, so they do have a lot of room to drop rates, he explains.
Ben says he has an optimistic long-term view of China, but there are short-term worries.
Another risk: the U.S. unemployment rate has dropped, but lots of people in the U.S. — some estimates put it at 13 million to 15 million people — have given up looking for work. Those people need to be engaged. When there’s job growth in the U.S., around 350,000 or 400,000 jobs per month, then things will look better.
An example of a company is the convertible preferred shares of PPL Corp. — an investment-grade utility in the U.S. The coupon at IPO was 9.5%, well into the high-yield zone. Gets to participate in equity upside, because it’s a convertible preferred. The company is cash rich, cash table, paying that coupon with the added benefit of having equity upside.
Kim is about to start the Q&A with Dan and Ben. She’s asking about weightings.
When Dan looks at opportunities outside of dividend-paying equities he only sees high-yield bond market. So he wants to put a bigger portion of portfolio in equity space for now. In 2009 he would have had 50% or 60% in high-yield, but he’s finding opportunities, based on expectations for returns, in some of the safer parts of the equity market.
Ben says that the high-yield market is turning the whole debt equity relationship on its head. The vast majority of a company’s capital is equity and then a thin sliver of bank debt is at the top. For high-yield, there’s a thin sliver at the bottom, which is equity and the vast majority is debt. So he says to investors you should get equity like returns for the debt because you’re taking on the risk of the company.
Guy at bottom — who invests in equity — essentially has a lottery ticket, says Ben. If company does what it’s doing, debt declines and equity climbs dramatically. Can grow five- or tenfold. But because the debt holders own the risk of the company they should get paid a risk-adjusted return for that. The proper fair value for high-yield market should be somewhere around 7% or 8%, he explains — that’s where the market is right now.
He’s happy to own the majority of his fund in high yield.
Dan says that’s a good way to approach the market, but says not to worry as much about the income level, but focus on total return. He expects to see portfolios change 5% or 6% or 7%, go back to equity to cash to high yield corporate debt. Having higher proportion of high-yield corporate debt is a good play, but what he has — more equity — is a good play as well.
Ben says income managers can all arrive at the same spot, but get there by a different path. “But the goal is always the same,” he says.
Kim’s next question is how is today’s investing environment different from 15 years ago?
Ben says that the biggest difference today compared to investing 15 years ago is that low rates hurt the government’s ability to help the economy. They don’t have the “lever to pull down,” he says. But as long as rates stay low, companies will continue to be net benefactors of low rate market.
Dan says the level of fear and amount of emotion coming into the marketplace is much different. Investors have to control their emotions, which is why as a passive investor, in this type of market, the emotional part of investing comes into play. You feel great one month and then lousy the next, he says.
Kim asks Ben about his views on inflation.
Not an inflationist — he says people…will get inflation rising when housing prices start to move and real unemployment starts to come down. When those 15 million unemployed people shrinks to 7 million, then wages — and inflation — will rise.
One risk Dan sees is the Feds targeting unemployment rates. They think 5.5% or so is where it should be. But the real sustainable unemployment rate is around 7%. If Feds keeps putting on simulative policy to get the rate down lower, that’s when we run the risk of serious inflation. But that’s yet to be seen, he says. It’s just a risk that’s on the horizon for him.
If you over stimulate for too long and start generating 200,000 a month, instead of a more appropriate 70,000, then you get inflation risk.
Question from the crowd: Where are the opportunities?
Dan responds first. He says the opportunities in the U.S. were far greater for growth and safety. On high-yield side, about 40% U.S. exposure. “It’s a North American market to me,” he says. A much more diversified universe of bonds in the U.S.
Ben says that he likes private finance corporations in the U.S. He’s been buying convertible first lien bonds of these companies.
Brad Radin, CEO & CIO of Radin Capital Partners, is up, talking about his various IA Clarington global funds. (Find out more here.)
He says he views the world as “danger” and “opportunity.” He looks for stocks that have problems — he’s a value investor — and looks for the best opportunities to invest in. The best opportunities have been after there’s a problem with the company, sector or country, he says.
So investments he finds are stocks that have had a really challenging year. He has to do the fundamental research to make sure those issues are fixable and resolvable. If they are, the stocks will enjoy big multiple increasing over the next three or four years.
Best time to buy a stock is the point of maximum pessimism, he says. That’s when good stocks sell for very cheap prices. The best time to sell is the polar opposite — when stocks are at the point of maximum optimism. When share price is “up and away and everyone knows it.” That’s when he sells.
He’s focused on the entire spectrum — not just the largest cap names. He thinks too many managers are focused on large-cap funds. He thinks the best opportunities are in the small- and mid-cap space. He has the flexibility to buy these smaller companies because he’s not burdened by having billions of dollars to invest. Others who have that much have to stick to large-caps, because of liquidity issues.
There’s an excessive focus on the short-term, he says. More today than any other time in his 20 years in business, investors are focused on the short-term — that leads to the risk-on risk-off trade we’re seeing. However, he takes advantage of the risk-off to buy great companies cheaply.
He’s finding stocks that are near the “dark days” levels of 2008 and 2009. He thinks that some of these stocks have great potential over the long term.
The biggest risk factor for most Canadians today is that most of us have the majority of our money in Canada. Take some money off the table and put it overseas, says Brad.
Now he’s talking about stocks. Peak Sport Products. The company makes shoes and sports clothing. They focus on basketball, sold in mostly third-tiered cities in China. Make all clothing in China. Sell 95% of products in China. It was a $7 stock a few years back, he bought it at $2. Reason it fell was they were swept up in the risk-off trade.
He likes the company because he sees good growth opportunities from China. Getting that growth for an “unbelievably” cheap price. Company has no debt on balance and net cash equal to about $1.40 a share. Really cheap company with huge safety cushion of cash, he says.
He also likes Morgan Stanley. “One of the truly top tier investment banks,” he says. It was a $90 stock a few years ago. He bought it for about $15 a share. Paying less than half of what he valued for the company. The stock trades for about two times book value — he bought it for less than half of book value. The reason why it’s down is that people are still nervous about financials. He thinks the stock today is much safer than it was four years ago, but share price is close to where it was in late 2008.
Now up is Larry Sarbit, CIO of Sarbit Advisory Services Inc. to talk about his investment strategy.
He says he’s from the Warren Buffett school of investing. His principle has always been about protection of capital. That’s what he’s been focusing on for the last 24 years as an investment manger.
He says it’s the last chance for baby boomers to compound their money. How will they compound those assets if they’re in low paying fixed-income or cash? The U.S. is where he sees the best opportunities for compounding.
He’s quoting from a Warren Buffett article. Buffett says that investments “that are denominated in a given currency include money market funds, bonds, mortgages, banks deposits and other instruments. Most of these current based investments are thought of as safe. In truth, they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.”
The alternative is the U.S. says Sarbit. He says clients are not in the States. The reason is that people are so focused on the problems down south. Debt, political deadlock, unemployment, problems in Europe — it’s a rear view mirror investing, he says, and that’s dangerous.
There are many undervalued companies in the U.S. and people are ignoring them. “America is not going out of business,” he says.
Companies, he says, need to have sustainable competitive advantages in the marketplace, weak competition in their business, repeatable business, keep getting paid over and over again. Model doesn’t change over time. Doesn’t require a lot of capital, generates a lot of excess capital and free cash flow. That’s what you’re looking for as investors. Excess capital is what it’s all about.
He likes Cogent Communications because it has about 75,000 km. of fiber optic in the ground, making it one of the biggest Internet traffic carriers in the world. They host a “little” website like YouTube (he’s joking) and other big name sites.
He also owns Six Flags. It’s a cheap form of entertainment, he says. People go to the park despite the economy. They go to get away from the bad news. They have about a 5% dividend yield and it’s been growing.
David Taylor, president and CIO of Taylor Asset Management, is about to give his outlook.
First time he’s given a presentation for IA Clarington and his new firm, Taylor Asset Management. He seems quite excited to speak.
Over the last six months — since he started his firm — he’s been building his team, including hiring a COO, a trader and a “high ranked” sell side analyst. If he was an advisor, he says he would look at his team and how much time he’ll take running the funds. He says he’ll manage and market the funds all the time. The team is set up and he’s ready to go.
He adds that he will own the funds he’s talking about today. He’s focused on building long-term, risk-adjusted returns that beat the index, inflation and his peers.
He’s now talking about the value-added process. He says he doesn’t spend too much time worrying about the economy, but adds that consumers are coming back. “There are a lot of good things going on,” he says. Where he can add value is finding companies that aren’t covered by analysts. He wants companies that have cut their dividend; in other words, the companies that people don’t want to buy.
His three funds will launch in June, but he’s finding great opportunities.
He’s now focusing on active management. He builds portfolios that don’t look like the average portfolio. He does things that others wouldn’t think of, like being overweight in energy in 2008 when oil prices were low. He was fully invested in the market in 2009. He does say he’s had underperformance in his career, but he has fixed it afterward. He learns from mistakes and moves on.
He joined IA Clarington because they have an interest in the client. The first thing he recognized was that to service clients he needed a firm with a strong distribution record. He thinks there’s a lot of potential with IA Clarington — assets should be at a growing company. He thinks IA Clarington is a one-stop shop — it offers everything investors need.
Now on to his views on the market. He’s seeing massive inflow to bond funds rather than equity bonds. They’re all chasing 10-year treasuries at 2%. If you buy a 10-year treasury you’ll earn 2% on money if rates don’t rise. But they will rise and bond holders will lose money.
So, there’s incredible opportunity in equities because people are still nervous about a double dip. If you wait until the economy improves, then that’s the worst time to buy stocks. March 2009 was the best time to buy stocks, and today’s not much different.
He too likes that the U.S. interest rates are at record lows, but the country is coming out better than others. Why? Because they were the first to cut rates. U.S. banks have improved balance sheets, they’re lending again. Payrolls are increasing, building permits are up, home sales are down, yet stocks are still so cheap, he says.
40% of S&P 500 stocks have a dividend yield as good or higher than 10-year treasuries. He asks, “Why lend money to a government with a lot of debt than a company that has no debt?”
Kim’s now leading a panel with David Taylor, Brad Radin and Larry Sarbit.
She’s asking Larry about the difference between “then and now.”
Information flows, he says, have changed a lot. You get information instantly now, but people haven’t changed. People didn’t want stocks in 1988 and 1990, but couldn’t get enough of them in 2000. He was in cash then. There was nothing to buy in 2000.
He says he has a small fund in the U.S. market; the market presents an “extraordinary” opportunity for compounding. He owns small companies; many are under $1 billion.
David says the change is the attention to short-term performance. When he hears analysts talk about earning expectations that doesn’t tell him if that’s a good business or what it’s worth. If a company beats expectations by two cents, “so what?” He wants to look at fundamentals and evaluate.
What’s the biggest missed opportunity in the market, Kim asks.
David says people need to get into equities. The biggest risk is giving up on equities. Don’t follow the same trap and make the same mistake over and over again.
Larry agrees with David. He says most people won’t get into equities. It happens time after time. We’re wired to make the same mistakes over and over again. He says that’s wonderful, because that’s what gives you the opportunities.
He has a bias to the U.S. He thinks they’ll fix the mess they’re in and the businesses are solid.
Kim’s asking about the U.S. and this idea that “it’s broken.”
Larry says that’s too much of a focus on what’s going on right now and problems that have occurred. Look at businesses instead.
Brad says it goes back to the macro focus. He’s focused on individual companies. 75% of the companies he’s bought have net cash on the balance sheet. They have more cash than debt and 90% of the companies he’s been able to buy pay a dividend; 60% are below book value. At an individual company level there is not a debt problem, says Brad. But, human nature is what it is and people aren’t wired to buy when there’s pessimism.
Now Kim’s asking about what investors look for in management.
David says that management needs to have experience and a game plan, but at the end of the day they’re a slave to industries they’re in and some of these industries have specific margins on capital and they can’t escape that. Even if you find bad management but the stock is cheap, you can make money — and replace management.
Larry says that they do a full legal background check on these people. Have they been to jail? He says they’ve actually found management that have bad stories floating around and they have avoided the business. You need to have assets and management, not just one or the other, he says.
Brad says that he talks with management for the vast majority of companies he buys, but he finds a lot of them are promotional. It’s just one data point. When people say the company has great management, what they really mean is that the stock has done well lately. He looks at each situation independently and if he’s not comfortable with what he’s seeing he won’t buy the stock.
He likes when his overseas companies use a large, international audit team and the owners own company stock. It’s also a plus when a Chinese company is listed on a Hong Kong stock exchange. He has a high degree of comfort with Chinese companies listed elsewhere in Asia.
An advisor asks if they can really ignore the macro economic issues.
David says no, he is paying attention, but he invests for the long-term. If he just sits here and says he’ll only buy cheap stocks and ignore the economy, then that’s foolish, he says. “But it’s so hard to add value when we talk about my view of U.S. economy. Everyone’s talking about that,” he says, so how can he add value based on the economy? He works very hard to find companies that are cheap.
An audience member is talking about the cynicism in the market and the cynicism around how CEOs manage companies. It’s that “Occupy Wall Street” cynicism. How can he find ethical executives that care about shareholders rather than themselves?
Larry says it’s about finding businesses and people who represents shareholders. He doesn’t need to be hanging around people who don’t have the shareholders’ interests in mind.
And that’s it. Kim wraps up the panel. Carl Mustos, SVP and national sales manager of IA Clarington is closing the event.
Being passive won’t work, he says. Being contrarian will help people achieve their long-term goals. He’s now thanking the guests, panelists and the people in attendance. For more information, he says, go to the IA Clarington website.
