Equity Fund Commentary
July 2010
Equity markets were skittish in the second quarter, with the S&P/TSX Composite Index falling 5.5% and the MSCI World Index losing 8.4% (in Canadian dollar terms). Over the past year, the TSX was up 12.0%, while the World Index gained 1.0%.
The Equity Fund dropped 7.8% in the quarter and was up 1.6% over the year. Since the fund’s inception (February ’07), it has lost 5.8% per year while the Canadian market was down 1.3% and the World Index declined 10.5% per year.
As short-term price movements are out of the manager’s control, CGOV focuses on how the businesses they own have performed from an operating perspective. Among the key metrics they consider are revenue growth, earnings growth and ‘owner’s yield’, which is a calculation that takes into consideration a company’s book value and dividend yield. As a whole, their collection of 24 businesses have performed well based on these measures.
While there have been some individual issues, the portfolio’s holdings remain financially strong, profitable, and have gained market share at the expense of weaker competitors. Many also have attractive pricing power due to their leading brand status (e.g., Rogers and Unilever).
As a portfolio of stocks, however, the results have been more mixed. Higher quality stocks have not kept up with the overall market and the foreign holdings (40% of the fund) have been a drag on performance over the past several quarters (largely due to the impact of currency).
With corporate earnings growing and stock prices flat or falling, the price-earnings multiples (P/E) on many holdings have compressed to the low teens or high single digits. Research in Motion, Home Capital Group and Compass Minerals, for example, are all very attractively valued based on historical comparisons.
CGOV has taken a balanced approach in the post-crisis period, holding a mix of economically-sensitive stocks (Potash Corp., Canadian Oil Sands, Suncor), stable businesses (Rogers, Ritchie Bros., CVS, Diageo) and higher growth companies (Reseach in Motion, Cisco, Oracle). While the holdings are a diverse blend of growth and defense, the bias remains on ‘quality’.
Although many stocks were beaten up in the quarter, Administaff is an example of a company that is starting to be recognized for its quality attributes, after being a ‘goat’ the last few quarters. Rogers has also recently trended upwards in a falling market – a positive sign.
Manulife and Shoppers Drug Mart remain sore spots, but CGOV feels the businesses are valuable franchises and will eventually brush off the scars.
Trading activity was limited in the quarter. Idexx Laboratories was sold, as it continued to appreciate nicely and hit the manager’s valuation target. Conversely, positions in TMX Group, Potash Corp. and Oracle were increased, among others.
The manager’s research suggests that the portfolio has upside potential of approximately 50% (based on their best case scenario) compared to downside risk of roughly 15% (worst case). While patience will continue to be key, this is the type of asymmetrical scenario we like.