Manager Commentary - Q3 2019

One of the hallmarks of this long bull market has been its ability to continue despite adverse events, but that trend seems to be slowing as markets struggle to reach new highs. Abnormally low or negative bond yields have left investors searching for higher-returning assets, prolonging the current equity cycle. Global economic growth continues to slow, with most major economies finding themselves in advanced stages of the business cycle. Germany has been Europe’s economic engine for decades, but it is now on the verge of a recession after narrowly avoiding one last year.

China, the world’s second-largest economy, continues to grow at a healthy rate but is expanding at its slowest pace since the early 1990s. U.S. economic results have been mixed, with noticeable deterioration in manufacturing data. However, the consumer side of the economy remains strong as historically low unemployment levels and higher wages have propped up consumer confidence levels to near-record highs.

The Fund’s security selection in the communication services sector contributed to performance. Individual contributors to the Fund’s performance included AT&T Inc. as the company continued to deliver on its deleveraging targets and made modest progress toward stabilizing its entertainment unit. Additionally, an activist investor purchased shares with plans to focus on improving the company’s strategy and capital allocation process.

Security selection in the consumer discretionary and industrials sectors were the most significant detractors from the Fund’s performance, but security selection in energy companies also detracted. Individual detractors from performance included Macy’s Inc., which reported weaker-than-expected results owing to unfavourable weather, a decline in tourism-related sales and higher-than-expected inventory adjustments. The company was focused on maintaining adequate inventory levels, improving efficiency of marketing spending and delivering on productivity initiatives to improve its results into year-end. Apache Corp. was under pressure owing to lower expectations for commodity pricing and concerns surrounding longer-term potential for its Alpine High assets.

The fund manager added new positions in Johnson & Johnson (J&J), Rio Tinto Ltd., Bank OZK, Booking Holdings Inc., Citrix Systems Inc., McKesson Corp. and Novo Nordisk AS. The introduction of J&J increased the quality of the Fund as the company has generated consistent and predictable earnings and exhibits high returns on equity, low earnings volatility and a reasonable valuation.

Rio Tinto’s relatively new management team is focused on capital discipline, shareholder returns and continuous improvements to the company’s cost and safety performance. The company trades at a discount to its long-term price-to-book multiple (the ratio of market value of a company’s shares over its book value of equity), offers an attractive dividend yield of 5% and has generated strong cash flows through the cycle.

Bank OZK’s founder has demonstrated good capital allocation over multiple business cycles and has built a strong credit culture and niche market leadership in high-quality real estate lending. Booking Holdings is well positioned in Europe, where its suppliers rely on its offering to drive incremental traffic. Citrix has generated attractive returns on capital and persistent growth over a long period of time owing to its “sticky” product offering (which leads to higher customer retention). McKesson has generated consistent per-share growth, attractive returns on equity and strong credit metrics over its track record. Novo Nordisk’s best-in-class returns on capital over many years reflect its leading research & development and scale in a market niche with high barriers to entry. The company looks set to grow per-share value in the mid- to high-single digits while returning excess free cash to shareholders.

The fund manager eliminated the Fund’s position in Hyster-Yale Materials Handling Inc. as its operational execution has failed to meet expectations over time. Varex Imaging Corp. was sold at a small gain when the company management diverted from its previous commitment to reducing leverage through a debt-funded acquisition. OSRAM Licht AG, Whitbread PLC and Valmont Industries Inc. were sold in favour of more attractive opportunities.

While global economic data has deteriorated in recent months, equity markets remain strong, supported by a backdrop of low growth, limited inflation and accommodative monetary policy. The Fund remains well positioned with a stronger balance sheet, a more attractive valuation and higher dividend yield than the index. Despite the market’s recent preference for highly valued stocks, the fund manager believes its strategy of paying reasonable prices for sustainable businesses will lead to attractive risk-adjusted returns over the next few years as some of the current extremes in the market dissipate.

 

Fund and benchmark performance, as at September 30, 20191 year3 year5 year10 year
IA Clarington Global Equity Fund - Series T6-7.2%4.8%6.1%7.5%
MSCI World Index14.3%10.5%10.8%11.3%

 

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1Source: MSCI Inc. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI. The performance data comparison presented is intended to illustrate the Fund’s historical performance as compared with historical performance of widely quoted market indices. There are various important differences that may exist between the Fund and the stated indices that may affect the performance of each. The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. The MSCI World Index consists of 23 developed market country indices. The Fund’s market capitalization, geographic and sector exposure may differ from that of the benchmark. The Fund’s currency risk exposure may be different than that of the benchmark. The Fund may hold cash while the benchmark does not. It is not possible to invest directly in market indices. The performance comparison is for illustrative purposes only and does not imply future performance. Effective July 2, 2014, the portfolio sub advisor changed from BNP Paribas Investment Partners Canada Ltd. to QV Investors Inc.