Bearish on bonds, cautious on stocks

CI Cambridge's Robert Swanson says neither asset class is cheap.

Sonita Horvitch 17 December, 2014 | 6:00PM
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Robert Swanson , principal and chief market strategist at Cambridge Global Asset Management, still favours equities over fixed-income securities in the Canadian asset-allocation fund for which he is responsible. "But the reality is that both these asset classes are no longer cheap." Fixed-income securities are overvalued and equities are getting expensive too, he says.

Given these valuation challenges, "we have been building our cash position in the balanced fund for some time." This cash, Swanson says, is mainly earmarked for bonds, "but we could also deploy some of it in equities if there is a significant pullback in the stock markets."

Based in Boston, Swanson says his enthusiasm for stocks over bonds has been in place since early 2009, when the equity markets bottomed. "Many stocks have rebounded strongly since and some are reaching or have reached our valuation targets."

As for the macroeconomic outlook, Swanson says U.S. interest rates are expected to "edge higher in 2015, which would represent a headwind for bonds." The increase in interest rates is likely to be more modest than what was forecast a year ago, he says. At that stage, financial markets were focused on the prospect of the start of the U.S. Federal Reserve Board's tapering of its fixed-income asset-purchasing program in early 2014.

"The Fed has persistently reduced its asset purchases since January 2014 and has recently completed this program," says Swanson. U.S. interest rates have not risen, as yet, he says, in part due to the economic weakness globally and the flow of funds from other areas such as Europe and Japan into the United States.

The U.S. economy is steadily strengthening, says Swanson, and is expected to produce a 4% increase in its gross domestic product in 2015. Currently, the rate of U.S. inflation is around 2%, making for an expected 2% increase in real GDP (adjusted for inflation).

The 10-year U.S. Treasury rate is around 2.3%. Swanson says this means that the real rate of interest (after deducting inflation of 2%) on these bonds is barely positive. "This is out of whack relative to the GDP growth rate, but could remain out of whack for a while."

A plus for the U.S. economy and for the U.S. consumer is the recent weakness in the oil price, though it is not good news for the producers, says Swanson.

"The fundamentals for the commodity are weak," Swanson says. "At present, global oil-supply growth is outpacing growth in demand." Also, "there is negative psychology surrounding this commodity, which is also adversely impacting the oil price." It will take time to unwind the excess supply, he says, but the supply-demand balance will revert to a more equilibrium level as global demand increases and some producers reduce output.

Robert Swanson

Swanson, who has been in the investment business for more than 30 years, joined Cambridge, a separate portfolio-management group under the umbrella of CI Investments Inc., in 2011. At Cambridge, his responsibilities include CI Cambridge Global Dividend  and the flagship balanced fund, CI Cambridge Canadian Asset Allocation Corporate Class , which he co-manages with colleague Brandon Snow .

The balanced fund's mandate provides "considerable flexibility" in allocation by asset class and by industry sector "in what is a conservatively managed portfolio," says Swanson. The constraint, he says, is geographic in that foreign content is limited to 49%.

Currently, Cambridge Canadian Asset Allocation has some 58% in Canadian assets, which includes the fund's 30% cash holding. The remaining 42% is held in predominantly U.S. securities.

Besides its 30% cash holding, the fund has 10% in bonds, mainly high-yield bonds of issuers on both sides of the border. These have an average duration of three years, which is substantially below that of the broad market benchmarks in both countries. The fund's equity component, including real estate investment trusts, is 60%.

Cambridge's discipline is to buy quality businesses at a reasonable price. The target companies tend to be larger-cap, Swanson says. Within the equity portion, he reports that he and Snow recently reduced the fund's weighting in the energy sector, which consists mainly of holdings in Canadian energy companies.

Specifically, they sold the fund's holding in Peyto Exploration & Development Corp. PEY  and trimmed holdings in other energy names such as EnCana Corp. ECA  and Keyera Corp. KEY . At the same time, they increased their holding in Canada's Tourmaline Oil Corp. TOU , which is one of the fund's biggest equity holdings.

"I have known Tourmaline's management for a long time," says Swanson. Michael Rose, president and CEO, and other key members of his team, have successfully built and managed other Canadian energy companies, he adds. "Tourmaline is a low-cost producer of natural gas and natural-gas liquids and its production is going up."

With the proceeds of sales from among their energy-sector holdings, Swanson and Snow have been shopping elsewhere, including among consumer-related stocks. They have added to the fund's holding in Viacom Inc. VIAB . "In the media space, content is king and this entertainment company, which creates television programs, movies, videos and other entertainment content, has a solid library of offerings," says Swanson. "Viacom is a strong cash-flow generator, which is something that we focus on."

A new consumer-related name in the portfolio is Starbucks Corp. SBUX . This premier retailer of coffees, tea and snacks around the world is seeing some profit-margin expansion and sales growth, says Swanson. The team added Starbucks to the portfolio during the market dip in October.

The biggest consumer-related name in the portfolio is Canada's George Weston Ltd. WN . This company and its subsidiaries represent both Canada's largest food retailer and drug retailer. George Weston is also a significant baker of fresh and frozen products.

Turning to technology, a new name in the fund, also purchased during the October market correction, is the Internet giant Google Inc. GOOGL . "We established a small position in the stock," says Swanson. "The company is expanding its offering."

Google Inc. Starbucks Corp. Viacom Inc.
Dec. 15 close $515.84 $80.89 $73.08
52-week high/low $614.44-$511.00 $84.20-$67.93 $89.76-$65.86
Market cap $347.5 billion $59.4 billion $30.0 billion
Total % return 1Y* -2.8 7.4 -8.4
Total % return 3Y* 18.5 24.4 21.4
Total % return 5Y* 11.7 30.0 20.8
*As of Dec. 15, 2014. All figures in U.S. dollars Source: Morningstar

In the financial-services sector, Cambridge Canadian Asset Allocation Corporate Class has no holdings in Canadian bank stocks. Instead, it is focused on those U.S. banks that have survived the meltdown in the U.S. financial-services sector in 2008.

The U.S. banks are at a different stage in the cycle than the Canadian banks, says Swanson. "The U.S. banks have dealt with the steep fall in the U.S. real-estate market and replenished their balance sheets, and we are starting to see the glimmer of U.S. loan growth, which is key to the economy moving forward."

By contrast, he says, the Canadian chartered banks are still dealing with a housing market in which prices continue to ascend, and consumers whose leverage continues to go up. "The U.S. banks are already pre-shrunk and their valuations are more attractive than those of Canadian banks."

However, the fund has avoided the major U.S. money-centre banks. "These have been the target of regulatory scrutiny and have, in some instances, been forced to pay hefty fines." Instead, the fund is invested in smaller players that are out of the line of fire and are survivors.

Swanson and Snow recently added to the fund's holding in Signature Bank SBNY , during the October pullback in the market. "This is a full-service bank that focuses on small and medium-sized business, as well as on the business owners." Signature prides itself on its strong relationships in this market, says Swanson.

The biggest bank weighting in the fund is U.S. Bancorp. USB . This bank, he says, weathered the recession better than most other U.S. banks.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Alphabet Inc A2,155.85 USD1.88Rating
George Weston Ltd152.93 CAD0.37Rating
Keyera Corp33.52 CAD0.18Rating
Ovintiv Inc53.76 USD5.25
Peyto Exploration & Development Corp15.19 CAD-0.33
Signature Bank203.46 USD2.75
Starbucks Corp74.49 USD2.77Rating
Tourmaline Oil Corp76.45 CAD0.28
U.S. Bancorp52.14 USD1.86Rating

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Sonita Horvitch

Sonita Horvitch  

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