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Global valuations "no longer compelling"

Mackenzie's Paul Musson favours defensive stocks.

Sonita Horvitch 27 March, 2013 | 6:00PM
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 Paul Musson, head of the Ivy team at Mackenzie Investments, says that it is increasingly challenging to buy high-quality companies at reasonable valuations.

"The global equity market has rebounded so strongly since March of 2009, after its sharp drop in the wake of the financial crisis, that valuations are no longer compelling," says Musson.

The team's discipline, he says, is to invest in "growing companies with both a sound business model and a commanding market position that trade within strict valuation parameters."

It is not only tough to find new opportunities, says Musson, but valuations of a number of existing key holdings in Mackenzie Ivy's foreign and European portfolios have also become stretched. "These stocks have been trimmed, in keeping with our discipline." The net result, he says, is that there has been a build-up of cash in both portfolios.

Musson and his team remain cautious about the outlook for global economic growth and, therefore, corporate revenue and earnings growth. "Factoring this into our business models, which look out 10 years, we find that the more defensive companies generally offer better value than those that are more economically sensitive." The latter, he says, still "look expensive."

However, he adds that, "our definition of defensive stocks is broader than the official definition -- consumer staples, health care and utilities." For example, he says, there are a number of consumer-discretionary stocks that have strong defensive characteristics.

At Mackenzie, Musson and his team are responsible for assets of $6 billion. They have a wide range of mandates including Mackenzie Ivy Foreign Equity and Mackenzie Ivy European Class.

 
Paul Musson

"We manage through the economic cycles," says Musson. The emphasis on either defensive or cyclical stocks changes slowly over time, he says, based on stock valuation. One key objective in managing these funds is to retain their low-risk characteristics over time, "irrespective of the weightings in defensive and cyclical stocks," says Musson.

Fifteen-year statistics measuring the risk profile of Mackenzie Ivy Foreign Equity, for example, "show that the fund has had a consistently much lower risk than both its peers and its benchmark MSCI World Index," says Musson. "Indeed, the fund falls into the same risk bracket as balanced funds," he adds.

Mackenzie Ivy Foreign Equity, with 29 holdings at the end of February, and Mackenzie Ivy European, with 18, are fairly concentrated portfolios. The investment philosophy is buy and hold. The emphasis is on larger-cap companies based in the developed world.

Applying both quantitative and qualitative analysis, the team, says Musson, can follow a company for some time before making a decision to invest. An important qualitative factor in the investment decision, he says, is corporate culture.

At the end of February, Mackenzie Ivy Foreign Equity's two biggest sector weightings were consumer staples at 28.2% and consumer-discretionary stocks at 18.6% for a total of 46.8%. Cash holdings were 12% of the fund.

For Mackenzie Ivy European Class, the weightings were 34.3% and 17% respectively for a total of 51.3% in consumer-related stocks. Cash represented 17.2% of the fund.

The two portfolios have little or no exposure to natural resources, says Musson. A U.S. energy company in Mackenzie Ivy Foreign Equity that does meet the team's criteria, he says, is EOG Resources Inc. EDG.

Historically, EOG Resources was a producer of natural gas, he says, but its management discovered that horizontal drilling could also be applied to shale oil. "Before this became widely known, the company quietly set about purchasing shale-oil properties on the cheap and ahead of the pack." The stock, says Musson, is a little expensive and has thus remained a small weighting in the portfolio.

A consumer-discretionary stock in Mackenzie Ivy Foreign that Musson considers to be good value is Omnicom Group Inc. OMC. A top-10 holding, Omnicom provides advertising, marketing and corporate communications services globally. "It is a great corporate culture; Omnicom has made tuck-in acquisitions and has successfully embraced the changes in its industry as a result of the Internet."

In the financial sector, neither of the two funds have any bank holdings, says Musson. But there are, for example, select property and casualty insurers that meet the Mackenzie Ivy team's criteria.

Musson points to Mackenzie Ivy Foreign Equity's investment in Progressive Corp. PGR, which specializes in automobile insurance in the United States. This company, he says, has made a large investment in establishing its brand, which is associated with product innovation.

Omnicom Group Inc. Progressive Corp.
March 25 close $58.41 $24.85
52-week high/low $60.05-$45.11 $25.38-$19.17
Market cap $15.3 billion $15.1 billion
Total % return 1Y* 19.0 14.6
Total % return 3Y* 15.7 14.6
Total % return 5Y* 7.0 11.3
*As of March 25, 2013. All figures in $US
Source: Morningstar

Progressive is also a savvy underwriter, Musson says, using data it has gathered over the years to give it a pricing advantage against its competitors. "The valuation on the stock is reasonable."

UK- based auto insurer Admiral Group PLC is in the top-10 holding in both funds. "It is conservatively run and makes a profit in its underwriting business," says Musson.

In the health-care sector, a top-10 holding in both funds is Sonova Holding AG, based in Switzerland. This company is one of the largest hearing-aid makers in the world. In keeping with their process, Musson says that he and his team had been watching Sonova for some time "but considered the stock to be expensive and had some reservations about its management."

Some two years ago, he says, the stock pulled back sharply after the company issued a profit warning. There was also a change in senior management, after allegations of insider trading. This is when the stock was added to the Mackenzie Ivy portfolios.

Musson and his team have trimmed a number of holdings in both portfolios that had had good run. "This was based on valuation." Stocks that have been pared back include the global consumer-products giant Unilever NV.

Another part of the sell discipline, says Musson, is to eliminate stocks for which the investment thesis has substantially changed. For example, in Mackenzie Ivy Foreign Equity, the team liquidated its holdings in Staples Inc. SPLS in the fourth quarter of last year. The concern was, he says, that key areas driving the business "are in structural decline" and the company was weak in "more sustainable areas," such as technology and mobile communications. "But we admire Staples' management and corporate culture and will continue to monitor the name."

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Sonita Horvitch

Sonita Horvitch  

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