Equity-income roundtable: Part 2

Dividend-rich picks in the financial sector

Sonita Horvitch 13 November, 2013 | 7:00PM
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Editor's note: In this week's second instalment of Morningstar's manager roundtable on equity-income investing, the managers discuss their investment disciplines and some of their picks in the dividend-rich financial sector.

Our panellists:

Jason Gibbs, vice-president and portfolio manager at 1832 Asset Management LP. Gibbs is a senior member of the firm's equity-income team, which has a wide range of mandates including Scotia Canadian DividendScotia Diversified Monthly Income and Scotia Income Advantage.

Michele Robitaille, managing director and equity-income specialist at Guardian LP, a sub-advisor to the BMO family of funds. The Guardian equity team's mandates include BMO Growth & Income and BMO Monthly Income II.

 Peter Frost, vice-president and portfolio manager at AGF Investments Inc. Frost's responsibilities include two income-oriented balanced funds: AGF Monthly Income and AGF Traditional Income. He also manages AGF Canadian Stock, the domestic-equity flagship.

Their moderator was Morningstar columnist Sonita Horvitch, whose three-part series began on Monday and concludes on Friday.

Q: Let's talk about asset allocation within balanced funds.

Frost: AGF Monthly High Income emphasizes high dividend yields in the equity sleeve while AGF Traditional Income focuses on stocks growing their dividends. These are tactical asset-allocation funds. I actively move around the strategic long-term asset mix of 50-50 for both funds. Both funds currently have some 64% in equities.

Gibbs: We have taken up the equity weight in our balanced funds. The big picture is that you want to be overweight equities in this environment. Bonds continue to act as good ballast to a balanced portfolio.

Q: Discipline in stock selection?

Peter Frost

Frost: When I buy stocks, I look for a target return of at least 30%, two years from purchase date. My benchmark for the equity component is the S&P/TSX Composite Index. I screen for dividend growth on 5,000 companies every month-end, of which 650 are Canadian. I target companies that focus on growing earnings and cash flow, with a minimum market capitalization of $200 million. There are some 56 names in the equity sleeve of Traditional Income and around 60 in Monthly Income.

Robitaille: My mandates include BMO Monthly High Income II, a Canadian-focused equity-only portfolio. We have 39 names at present. We are bottom-up fundamental stock pickers. We continually review the universe to identify companies that have not only sustainable dividends, but dividends that can grow. We focus on the top 75% of the dividend-yielding Canadian universe; that would be a minimum yield of 1.7% or 1.8%. We have a minimum market cap of $1billion.

Gibbs: My current responsibilities include Scotia Canadian Dividend. I have 50 names in this portfolio. We look for quality businesses trading at a reasonable valuation. We target best-in-class businesses. To us, quality businesses mean great management teams that have an equity interest in the business and a history of doing well by their shareholders. It's tough to get these high-quality businesses at a cheap price. We look for strong balance sheets and assess free cash flow. We ask management what it will be doing with that cash flow. We are also very disciplined in our sells.

Q: Let's talk about the financial sector. Michele, at the end of September, you had 40.9% in financials (a sector that includes real estate investment trusts) in BMO Monthly High Income.

Robitaille: REITs continue to be a core part of the portfolio. We are quite underweight relative to our historic weight. We increased our weighting slightly over the summer. It's currently around 17%, which is still a healthy weighting. About 18 months ago, we started paring back our REITs. Valuations were becoming stretched, following two to three years of strong performance. We felt that there were better opportunities in the other financials.

Michele Robitaille and Jason Gibbs

REIT fundamentals are still strong, particularly if you are in the right REITs. For example, Canadian Real Estate Investment Trust REF.UN is a long-standing core holding and continues to be attractive.

Q: Canadian chartered banks?

Robitaille: We have about 15% in the banks. This is a relatively high weight for us. Earlier in the year, we took advantage of the fact that the banks were trading at a historically low price/earnings multiple of 10 times. There was concern about the slowing growth in bank retail lending. Our emphasis was on those banks that had strong operations outside of Canada and sufficient size in Canada to get operating leverage. Our core holdings are Toronto-Dominion Bank TD, Royal Bank of Canada RY and Bank of Nova Scotia BNS.

Bank stocks have had a nice run, particularly over the last two months or so. They are now trading at P/E multiples of 11 times, which is still reasonable relative to historic levels of about 12 times. They are doing well with their earnings growth at around 8% and then you get your 3% to 4% dividend yield on the stock. These stocks are still reasonably attractive.

Bank of Nova Scotia Royal Bank of Canada Toronto-Dominion Bank
Nov.11 close $64.44 $70.09 $96.33
52-week high/low $64.60-$52.30 $70.80-$54.51 $97.05-$78.05
Market cap $77.6 billion $101.0 billion $88.5 billion
Total % return 1Y* 24.2 30.0 24.4
Total % return 3Y* 9.7 12.8 12.7
Total % return 5Y* 14.3 11.8 14.5
*As of Nov.11, 2013
Source: Morningstar

Q: Insurers?

Robitaille: Among the insurers, we own Manulife Financial Corp. MFC. We put the position on at the end of 2012 with our view that the macro environment had improved and that we would start to see the beginnings of core earnings growth. Manulife's valuation today is such that we would not actively add to it, until we see further strength in its core earnings. We also own property and casualty company Intact Financial Corp. IFC. It has a good growth trajectory.

Gibbs: I also own Intact. The stock has had a good run. Intact has been growing through acquisition and is disciplined in this. It has a good management team. It's a tough industry. The business is subject to politics. For example Intact operates in Ontario, and the Ontario government is cutting auto-insurance premiums.

Q: Jason, you had 32% in financials in Scotia Canadian Dividend, at the end of September?

Gibbs: We had 14% in the banks, 9% in insurers and 9% in real estate. We own TD, Scotia and Royal. It has been a strong year for bank stocks. There were concerns about consumer leverage coming into the year and that impacted the stocks. There was some U.S. short-selling, which also impacted the stocks. But the banks have demonstrated how durable their business model is. Their wealth-management business is doing well and the international operations of banks like TD and Scotia are strengthening. The banks' interest margins are showing signs of bottoming, which is so important for this business. Consumer-loan growth has been fine, as has business-loan growth. The banks' earnings growth has been stronger than expected. It is still a fair place to be. You can get a 4% dividend yield on the stocks, an attractive yield relative to the risk-free Government of Canada yield.

Frost: I am underweight the financial sector in AGF Traditional Income. These stocks constituted 13.1% of the equity holdings at the end of September. I am focused on growth and can find faster-growing companies outside of the financials and the Canadian financials. I had 26.6% foreign content in AGF Traditional at the end of September.

Gibbs: Scotia Canadian Dividend can have up to 30% in foreign content. We had 27% at the end of September.

Frost: The financial holdings in AGF Traditional Income are all Canadian and mostly banks. The banks have delivered high single-digit per annum earnings-per-share growth. National Bank of Canada NA would be my biggest bank weight. But, I must emphasize that when I construct a portfolio, I like to have most of my holdings equally weighted. Scotiabank and Canadian Imperial Bank of Commerce CM are two other holdings. I also like TD.

I have only one insurance company in this fund, Intact Financial. I bought Manulife and Sun Life Financial Inc. SLF in AGF Monthly High Income in the fall of 2012. But these stocks have had a big lift. We have sold Sun Life and trimmed Manulife.

Peter Frost, Michele Robitaille and Jason Gibbs

Photos: paullawrencephotography.com

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Sonita Horvitch

Sonita Horvitch  

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