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Andrew Zimick, portfolio manager at Connor, Clark, and Lunn Investment Management.
We’re probably in the later stages of this economic cycle. We’re 10 years in, and it seems as though we’ve passed peak economic growth for this cycle, which was in 2017. Not only are we in the late stages of the cycle, which in itself leads to uncertainty, but we have the added challenge of politics interfering in the economic world. This creates very high levels of uncertainty, and one reason why market volatility has picked up substantially in the last 18 months or so.
The key question is what to do about it.
Higher volatility is a trend we expect to continue. As a result, we expect investors will continue to favour stable, consistent and high-quality companies as these are the characteristics that are scarce when the economy is more volatile.
Stability and consistency can come in many different forms. So, I wanted to spend a minute talking about what we mean by this. Across sectors, we continue to find good opportunities in companies that have strong balance sheets and are not suffering under heavy debt burdens in the face of rising interest rates or at least higher interest rates than what we saw a few years ago.
One example is we’ve added BCE to the fund. BCE of course is a telecommunications company. It’s quite defensive. It also has a very low financial leverage. As the cycle drags on, we expect investors will continue to favour companies that have low leverage. Many of these companies also are larger or have higher trading liquidity that we’ve added to the fund more recently. This makes them for one, more stable because they’re larger—more diversification within their business—but also allows investors to feel confident that they can get in and out of their positions in those companies quite quickly.
Recently, for example, we added Coca-Cola—of course a U.S. mega-cap consumer staple company. This well-known company has very defensive characteristics, including its exceptionally high trading liquidity.
We also continue to favour those that have strong and stable earnings growth, even in the face of moderating economic growth. We’ve increased the fund’s weight in Empire, for example. Empire being a large-cap Canadian grocer. Empire has exceptionally stable earnings, in part, because of the importance of its products—groceries—in our daily lives.
In the same vein, companies that have high and stable margins or consistent free cash flow generation tend to out-perform their peers in this type of environment because of the consistency that those margins and free cash flow generation provide. Element Fleet is a good example of this. Element Fleet is a global fleet leasing business. It has high levels of recurring revenue, and is less exposed to the economic cycle than many of its peers in the financial sector in Canada. This leads to more stable margins.
What’s important to note here is that all these characteristics are ones we’re looking for. In our process of managing the fund, it all comes back to our target prices. Companies that have these characteristics are more likely to stand out based on those target prices and, as a result, will have attractive risk-return or risk-reward opportunities. We’ve migrated the fund to higher quality companies, and this has made up the bulk of the activities in the last year. These are spread out across sectors. We continue to look for those good characteristics or good companies within each sector.
More recently as an example, as the market sold off in the fourth quarter of last year and also in May of 2019, it was encouraging to see a lot of these more high-quality, stable positions perform really well. Microsoft was a top contributor over this timeframe. Of course, Microsoft has very high levels of recurring revenue. Intact Financial is a property and casualty insurance company that is quite a bit more consistent in its business model than many of its life insurance company peers. It performed very well. Also, Element Fleet, which I mentioned earlier, a relatively stable, diversified financial company has been one of the best performers in the fund over the last year.
This high-quality, more stable positioning theme we think will continue as we expect volatility will remain elevated throughout the rest of the cycle. This positioning has enabled us to achieve our objectives of capital preservation and a sustainable dividend yield throughout the more recent market volatility. With this backdrop of heightened volatility and at a minimum increased uncertainty, we believe this high-quality bias is the most prudent way to position the fund on a go-forward basis.