NCM Core Canadian - Fifth Anniversary
February 19, 2021
When we started NCM Core Canadian five years ago, we were looking to create a differentiated product in the large cap Canadian equity space that could work as either a standalone fund or as a complement to a passive fund or ETF. Because there are so many Canadian equity funds to choose from, we decided to look different from our peers on many fronts: Canadian only, low volatility, high active share, increasing dividends and lower fee.
First off, we decided to be a Canadian only, Canadian equity fund. It sounds funny but much of our peer group invests 25% or more of their portfolio outside of the Canadian stock market. We felt if advisors wanted to allocate 10% of their clients’ portfolio to Canadian equities, they did not want us to reduce that allocation to 7% by investing outside Canada. Every name we own trades on a Canadian exchange. It is a simple concept, but this decision allows advisors to control their desired asset mix more effectively.
We manage a low volatility fund so, by definition, we will typically look for ideas that have historically had lower volatility than the market. One of the better places to start is to invest in low Beta stocks. A basic explanation is that if a stock has a Beta of 0.80 then it will get 80% of the moves of the market. If the market goes up 10% then the Fund should go up 8% and if the market goes down 10%, it should go down 8%. While this is a generality and does not always hold true, it should have these types of moves over time.
We do not restrict ourselves to low Beta stocks as there continue to be opportunities in higher Beta names but the portfolio, on average, targets a Beta around 0.80. To reduce volatility, we also search for companies with stable earnings. We look for established companies that just go about their business and grow earnings year after year rather than owning cyclical companies whose earnings go up and down as commodity prices fluctuate or stocks whose earnings vary greatly as the economy slows. Low earnings variability, more often than not, dampens volatility.
Active Share is a measure of how different a portfolio looks from its index or benchmark. The higher the number, the more different a portfolio looks and thus, the better the complement and the greater the diversification to a client’s overall portfolio. When comparing large cap Canadian funds' active shares, one needs to account for non-Canadian holdings which artificially inflate active share numbers. With a high current active share of more than 67% (meaning we look two thirds different than the S&P/TSX), we believe NCM Core Canadian is significantly different than the index making it an excellent complement or diversifier to other Canadian equity funds or ETFs.
Dividend-paying companies and, more specifically, companies that have a history of increasing their dividends tend to be more stable and tend to have more visibility into future earnings results. Currently, 91% of the holdings in NCM Core Canadian are dividend payers and 67% of the holdings are dividend growers.
Finally, our low fee structure and our innovative flat fee Z series is another advantage of NCM Core Canadian. With our already low management fee of 0.75% for our Series A and F, NCM introduced a flat management fee of $1,000 + taxes for investments up to $1 million which means, NCM Core Canadian can be purchased with a management fee as low as 0.10% for true active management. We call this solution A-Z as it allows investors to start with a purchase of $5,000 in Series A or F and move into Z as the investment
At this point in the market cycle, investors seem to be more influenced by growth rates of revenues and price momentum than they are with valuations and profitability. NCM Core Canadian has always had a value bias and should continue to over time, but we currently have placed an added emphasis on looking for companies that are growing faster than the market and continue to look for companies with strong earnings and price momentum.
We have always factored in price momentum and the logic is as follows. Stocks, in general, go up and down for a reason. If a stock is going up, typically good things are happening. If a stock is going down, typically bad things are happening. We want to own stocks to which good things are happening, so we like to buy new highs on stock prices provided valuations are still reasonable and growth rates are solid.
With the investment methodology of this fund, we will usually be overweight the more established sectors such as consumer staples, utilities, communication services and real estate. We will also typically be underweight sectors such as energy and non-gold materials. The gold weighting will vary over time but is often near the index weight as gold, on average, should reduce portfolio volatility and help performance during inflationary times.
After a solid first four years in NCM Core Canadian, our investment style lagged a little in 2020. In 2019, it should have been expected that a low volatility fund underperformed given the market was up more than 22% and yet the Fund still provided a respectable 18.7% return. In 2020, the market, much like the world, was turned on its head. Shopify drove almost all the market performance as it increased by nearly 200% in 2020. After another 30% share price increase so far in 2021, Shopify is now the largest company in Canada in terms of market capitalization. To put that in perspective, Shopify is now worth more than $200 billion versus Royal Bank at just over $150 billion. For further context, in the last quarter, Shopify posted adjusted net earnings of $141 million on $767 million in revenues and Royal Bank posted net earnings of $3.2 billion. Factors that historically and logically should lead to strong performance, did not in 2020. For example, high dividend-paying stocks underperformed low dividend-paying stocks by more than 43%, low trailing P/E stocks underperformed high trailing P/E stocks by more than 14%, high ROE stocks underperformed low ROE stocks by more than 17% and low Beta stocks significantly underperformed high Beta stocks. We see this as an opportunity rather than an issue. Investment styles often take a break but then return to favour as logic and a solid investment methodology wins out. Another thing we noticed was that since 1970, Canadian banks have never underperformed the index three years in a row. Given they have underperformed the last two years, we see banks as a low multiple, high dividend place to invest in 2021.
Going forward, we expect the market to reward companies for doing things right. Strong companies tend to worry about the things they can control such as Return on Equity, growing their earnings, exceeding their expectations, and creating a stable earnings stream allowing them to increase their dividends to shareholders. The things they cannot control such as the P/E multiple the market assigns to them or price momentum will eventually come if they just continue to improve the company’s earnings and prospects in both the short and the long term.
We believe in our process and the below attributes speak for themselves. Buy highly profitable companies that are significantly cheaper than the market yet are growing faster, are more stable and have been increasing their dividends. We believe that while this style is a little boring, it should produce solid long-term results. We are excited about the future of NCM Core Canadian as markets normalize and reward companies for profitable earnings growth rather than just increased revenues.
|Quarterly Earnings Momentum (QEM)||9.4%||3.3%||6.1%|
|Free Cash Flow Yield||6.3%||4.1%||2.2%|
|Cash Flow / Debt||0.38||0.28||0.10|
|Beta (3 year)||0.83||1.00||0.17|
|# of holdings||34||-||-|
We are happy with the first five years of this fund and are looking forward to what the next five years bring when COVID-19 is in the rearview mirror and markets return to normal.
As Ben Graham famously stated, “The essence of investment management is the management of risks, not the management of returns.” I could not agree more and that is how we manage NCM Core Canadian.
For more information, please contact your local NCM Sales Representative.
For More Information:
Keith LesliePortfolio Manager
He has over 20 years of investment management experience. Prior to joining NCM in 2001, Keith worked as a Quantitative Analyst at a western Canadian investment firm. Keith brings a different perspective to the firm’s investment process, using statistical techniques, valuations…
Keith Leslie CFA
- ExpertiseQuantitative Investing
He has over 20 years of investment management experience. Prior to joining NCM in 2001, Keith worked as a Quantitative Analyst at a western Canadian investment firm.
Keith brings a different perspective to the firm’s investment process, using statistical techniques, valuations tools and modelling. He is the Portfolio Manager of NCM Canadian Enhanced Equity Fund and NCM Core Canadian.
Keith graduated from Western University with a Bachelor of Science in Statistics and Mathematics and is a CFA charterholder.
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