by Tom Bradley

In a recent article in the Globe and Mail, I talked about trends that are profoundly impacting the capital markets. The focus was on trends that have been going on for a while and have reached great heights (or lows in some cases). In attempting to make sense of it all, I divided them into two lists – Running on Empty (a Jackson Browne reference meaning unsustainable) and Time on My Side (the Rolling Stones ... there’s a long way to go).

This follow-up post is in response to client requests. In it I’ll link these trends to what we’re doing in our portfolios. The comments below are aimed at clients who have balanced portfolios at Steadyhand (including the Founders Fund).

Running on Empty

Near-zero interest rates

• In general, our portfolios have less exposure to rising rates (and as a result, have benefitted less from falling rates). An uptick will likely negatively impact our returns in the medium term, but much less than our competitors that are more narrowly focused on high-yielding securities.
  
• There are pluses and minuses throughout the portfolio. On the plus side, we own fewer stocks in the industry sectors that are bond-proxies (real estate, utilities, and consumer staples) or are fueled by low rates (housing and autos). In the Income Fund, we have a good weighting in insurance companies, which will benefit from higher rates. And in the Founders Fund, we have a high cash level (16% of total fund), which has been a drag on performance to date, but will act as a stabilizer when rates rise.
  
• In the bond segment of the portfolios, however, Connor Clark & Lunn has the Income Fund neutrally positioned. While they’re wary of rates increasing, they have (correctly) continued to keep the fund’s term-to-maturity relatively long (Duration: 7 years).

Borrowing from the future

• With few exceptions, our funds are invested in companies that generate lots of spare cash (what’s referred to as free cash flow) and are well financed. Their competitive position will improve if interest rates normalize and there’s a debt-induced shakeout.
  
• We have minimal exposure to the debt-burdened Canadian consumer. Outside of Loblaws, we have no exposure to retailers and are light on bank stocks.
  
• Over the last year, CC&L has high graded the corporate bond holdings, erring on the side of caution when assessing potential default.
  
• We are exposed, however, to the heavily-indebted countries in Europe through our holdings there.

Chinese investment spending

• The commodity boom of five years ago was driven by China’s investment in planes, trains and automobiles (i.e. ports, rail lines and highways). Overall, we have very little exposure to basic commodities that are driven by Chinese imports. This is mostly due to the cyclical nature of the companies, but also because China’s transition to a consumer-based economy means a super cycle is years away.
  
• We do have some fertilizer (Agrium) and a variety of energy companies, however.

U.S. profit binge

• Our lack of exposure to U.S. stocks has weighed on our returns over the last three years. Needless to say, we’re well positioned for a time when other parts of the world take over the economic leadership.

Growth beating value

• We think of ourselves as being style agnostic – we don’t ask our managers to fit into a particular box – but the trend towards growth stocks has nonetheless impacted our results in recent years.
  
• Our Equity Fund has benefited from the market’s preference for steady, growing companies. This is indeed our manager’s (CGOV) sweet spot.
  
• On the other hand, our Global Equity Fund has viewed these stocks as being expensive and shifted towards companies that are more cyclical and/or less predictable, but are significantly cheaper. These value-ish stocks have not kept up with the market and remain reasonably priced, while growth stocks have seen their valuations rise to the point where they’re now well above historical averages.
  
• Overall, Steadyhand portfolios are diversified across the style spectrum.

Time on My Side

In the piece, I reviewed a number of long-standing trends that I think will continue.

Cheap energy

• None of our managers have high expectations for oil and natural gas prices, but hold some energy companies based on low valuations.
  
• With the change of manager on the Small-Cap Equity Fund, we own less energy today. Galibier has significantly reduced the fund’s exposure to oil and gas.
  
• Our economic thesis, however, is predicated on low energy prices helping boost the world economy, particularly in importing regions like Japan and Europe.

Climate change

• In doing their research, our managers consider each company’s corporate governance and environmental stewardship.
  
• At present, we have little exposure to alternative energy. We own Panasonic that is a joint venture partner with Tesla in a battery plant, but generally we’ve found valuations to be high (little or no earnings) and the territory to be a bit of a minefield.

On-line and technology acceleration

• We don’t own Amazon or Facebook, although we’ve had a position in Google for a long time.
  
• More to the point, however, the rapid change to how we do things will show up across a broad range of companies and impact competitive dynamics in all industries.
  
• Again, we’ve got little exposure to areas that are currently under siege like conventional retailers and media companies.

Emerging middle class in Chindia

• The geographic mix of the portfolios are misleading because they’re based on where the companies are headquartered, not where their revenues come from. Based on revenue, we have a significant tilt towards emerging economies, particularly in the Global Equity Fund. It doesn’t come from owning Chinese stocks per se, but rather global companies with strong franchises in these countries.

Aging Boomers

• Sorry, I had to bring it up.
  
• Overall, healthcare accounts for 9% of our equity holdings. This comes mostly through the Global Fund.

In my view, we’re well positioned with respect to the big trends in the market. We’re still riding some on Jackson Browne’s list, but our contrarian nature has us well represented on the Stones side (cash; lots of healthcare and Europe; little housing and commodities).