Kevin Hall has a foot in two camps: preferred shares and Canadian small/mid cap stocks. Yet there is some overlap, since both asset classes are deployed in two funds that he oversees: the $877-million BMO Guardian Monthly High Income II Mutual and the $434-million BMO Guardian Monthly Dividend Ltd Mutual
"Certainly the preferred shares would have a different risk profile than the high-yielding equity strategy employed in Monthly High Income," says Hall, senior vice-president, Guardian Capital LP, in Toronto. "But Monthly Dividend does have an overlap with the other fund, as one-third of the portfolio will be dedicated to higher-yielding equities, and two-thirds to preferred shares."
Both funds are designed to deliver stable monthly income and pay out a set distribution. Common to both funds, as well, is the stock selection process. "The primary driver is identifying solid business franchises that have a very visible free-cash-flow profile that can support stable and growing dividends over time," says Hall, lead manager of BMO Guardian Monthly Dividend since 2002.
One key factor is a management team that has demonstrated its ability to deploy capital over time, and generate good returns. "That leads to stable and growing dividends over time," adds Hall. Another consideration is a balance sheet that is in keeping with the industry. "It's not a one-size-fits-all approach. If we're talking about an oil and gas player versus an apartment REIT, we judge their balance sheets relative to their industries."
One typical long-term holding in both funds is H&R Real Estate Investment Trust HR.UN. "We see a very visible dividend growth strategy over the next 18 months or so," says Hall, pointing to the construction of The Bow office tower in Calgary, whose sole tenant will be EnCana Corp. over the next 25 years. "They have a high-quality tenant, and long contractual revenue stream, which will allow them to grow dividends every quarter into the end of 2012."
On a price-to-net-asset-value basis, the REIT is trading at a small premium. "On a relative basis, though, it is trading below the peer-group average, as well as on a price-to-cash-flow basis," says Hall, noting that the firm has a 4.3% distribution yield. "The valuation, combined with a very positive outlook in terms of dividend growth over the next year and a half, makes for a very attractive holding."
Hall limits single positions to about 4%. Turnover in Monthly High Income was a very low 16.8% in 2010, and a similarly low 10.8% in Monthly Dividend.
A native of Sarnia, Ont., Hall has been in the industry since 1993 when he graduated from McMaster University with a bachelor of commerce degree. His first job was at Trimark Investment Management Ltd., where he worked in client services.
About 18 months later, Hall joined Guardian Group of Funds as a wholesaler. In 2000, two years after earning his CFA designation, he switched to the investment side and joined Guardian Capital.
"The tech bubble had just burst and income trusts really took off," recalls Hall, who works alongside John Priestman, managing director and lead manager of BMO Guardian Monthly High Income II. Although income trusts took a hit in 2006 when the government removed their preferential tax treatment, Hall believes it was a one-time event.
The managers kept the vast majority of income trusts that converted to corporations. "The legal structure had changed, but the businesses themselves had not. Some ex-income trusts have continued to deliver very strong returns."
BMO Guardian Monthly High Income II returned 29.8% as of May 31, compared with 27.9% for the median fund in the Canadian Small/Mid Cap equity category. Over the last three- and five-year periods, the 4-star rated fund returned an annualized 6.3% and 5.7%, respectively, versus 5.6% and 5.1% for the median fund.
One representative holding is AltaGas Ltd. ALA, an Alberta-based firm which offers power generation and processes natural gas. "It did reduce its distribution on conversion to a corporation," says Hall. "But it still remains a high-yielding equity, with a roughly 5.25% distribution."
Meanwhile, with his foot in the preferred-shares market, Hall has become cautious as the exposure in BMO Guardian Monthly Dividend is slightly underweight. "A neutral position would be 70/30 preferred shares and equities," he says, adding that the fund holds about 63% preferred shares.
"We're positioning the fund for gradual increases in short, mid-term and long-term rates," says Hall, noting that straight perpetual preferred shares are most vulnerable to rate increases.
The fund returned 14.1% for the 12 months ended May 31, versus 11.9% for the median fund in the Canadian Neutral Balanced category. It returned an annualized 4.2% and 3.1% over three- and five-year periods, compared to 2.4% and 3.7% for the median.
The 3-star rated fund cannot be expected to deliver strong returns in a bull market. "But over a cycle," says Hall, "it should be very competitive, with lower volatility."
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