Banks will survive housing crash

Hanif Mamdani says he strives to be a mediocre golfer. But when it comes to managing billion-dollar funds, superior performance is par for the course for the head of alternative investments at PH&N and RBC Global Asset Management.

When Mamdani, who likes to stay active, isn’t out jogging, he’s in his Vancouver office as the lead manager of the Lipper and Morningstar awards-winning $3.3 billion PH&N High Yield Bond Fund and the $796 million PH&N Absolute Return Fund.

Before that, he spent 10 years in New York at Credit Suisse and Salomon Brothers as an investment banker and head of a convertible bond trading operation.

Mamdani’s best-kept secret? “I’m a nice guy in a tough business,” he says. In fact, if there’s one thing he could change about the industry, it would be the arrogance of some of its participants.

“When you start to believe you know exactly what will happen in the future, you are destined to stumble,” he says.

It’s not surprising, then, that some of the fruits of Mamdani’s labour fall far from Bay Street. He volunteers on the London, U.K.-based Investment Committee for the Aga Khan Development Network, a non-governmental organization that works to improve the welfare of people in the developing world.

He brings the same drive and passion to his day job.

What are your short- and long-term global outlooks?

As long as quantitative easing is in place, asset inflation will continue and capital markets will remain buoyant in a sea of liquidity. So while I am not excited by valuations of most asset classes at this juncture, as long as the Federal Reserve is pumping unprecedented amounts of liquidity into the system, recent market trends will continue.

In the longer term, there may be a price to pay for all this money printing. This may mean a rise in inflation or inflation expectations at some point down the road. This could happen in the next year or two, or it could take longer—say, three to four years.

What about your sector outlooks?

Most parts of the fixed-income market are fully priced or even overpriced, so there aren’t a lot of eye-catching opportunities there.

The recent bearish views on Canada and Canadian banks in particular have created a near-term opportunity to own terrific businesses that generated pretty consistent 15% to 20% returns on equity at only nine to 10 times forward earnings. I do not subscribe to the view that a Canadian housing crash will decimate CIBC or other domestically focused banks.

That’s because the bulk of banks’ mortgage portfolios are CMHC-insured. On the non-insured portfolios, loan-to-value [ratios] are conservative, providing a solid cushion. Also, Canadian lenders have recourse to home mortgage borrowers (unlike in the U.S.) and banks’ capital ratios are strong—with that of CIBC amongst the strongest.

What are your controls for both short-term and longer-term risks?

At some point down the road, interest rates will normalize, which will have profound implications for the valuation of bonds of all varieties. Valuations may also dip on REITs, utilities and some overpriced dividend-paying stocks. To control for this risk, we are keeping durations on the shorter side—shorter than three years in the PH&N High Yield Bond Fund—and avoiding richly priced yield-oriented stocks.

Where are the wildcards?

Tapering quantitative easing could have a significant short-term impact on the market. As far as ignored or unloved investments, there are few right now. Materials and mining stocks look beat up, but they are down for a reason. These stocks are contending with much lower spot prices. They have, in many cases, grossly mismanaged their businesses with wasteful capital expenditures or overpriced acquisitions in risky locales.

For instance, Kinross Gold’s disastrous acquisition of Red Back Mining led to $5.5 billion in write-offs on an $8-billion acquisition. Recently, Barrick Gold announced a $4.2-billion impairment charge mostly related to a struggling copper mine in Zambia.

The mining business is dominated by large personalities that pursue ego-driven acquisitions, which do little more than destroy shareholder value.

I still come back to Canadian banks at nine to 10 times earnings per share as a good opportunity for contrarian investors.

What are some unforeseen dangers?

One would be a melt-up scenario in equity markets that sets the stage for a sharp decline.

It appears many large institutional and retail investors gave up on equities in favor of fixed-income and other so-called safer investments after 2008.

Cheap valuations post-2008 in corporate bonds, high yield bonds, mortgages, asset-backed bonds and commercial real estate helped investors keep pace with equities until recently.

However, these fixed-income investments seem played out now, and in many cases appear overpriced. On the other hand, equities are fairly priced; maybe even slightly below historical multiples.

This could set the stage for a major shift back into equities by frustrated investors that could send the stock market considerably higher than justified by fundamentals. That throwing-in-the-towel-type buying could be the last stage of this big market move and could deplete any marginal buyers while making stocks overpriced.

That could create a dangerous market environment, as any negative fundamental catalyst could cause a sharp decline in markets.

What currencies do you hedge against?

We currently hedge most of our U.S. dollar exposure in our high-yield and absolute return portfolios. However, we believe the U.S. dollar will do better as the American economy gains steam, while weak economies in Europe and Asia keep monetary policy loose. Those events could pressure those regions’ currencies versus the U.S. dollar.

What would drive you to go all cash? What is your cash limit?

I don’t take all or nothing bets like that, so nothing could. The maximum cash in the PH&N High Yield Bond Fund is between 12% and 15%.

How do you identify quality companies?

They’re the businesses that have some element of predictability such as some recurring cash flow streams from subscription models or leasing. Also, quality companies are characterized by high ROEs and lower leverage.

We think the Canadian banks such as CIBC and Bank of Nova Scotia are quality companies, as are companies like Loblaws, Cogeco Cable, H&R REIT and Astral Media. We have owned these stocks at some point in our hedge fund portfolio.

What’s your sector exposure?

We don’t think in terms of pure sector exposure. We try to find value where we see it, but with some overall limits to industry concentration, such as a 35% maximum in PH&N High Yield Bond Fund.

We have about 25% in media and telecommunications, which represents our largest industry allocation at present. We like these industries because they tend to be less cyclical and enjoy strong cash-flow characteristics thanks to their recurring revenue streams and subscription-based services.

And your geographic dispersion of funds?

PH&N High Yield Bond Fund has 55% Canada, 40% U.S., and 5% Europe right now.

How are your picks doing?

We’ve had a pretty good year. The PH&N High Yield Bond Fund has returned +3% year-to-date, whereas PH&N Absolute Return Fund has gained +6% YTD.