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A high price tag on an otherwise strong fund

The managers of IA Clarington Global Equity look for firms that combine quality and value.

Shehryar Khan, CFA 24 July, 2018 | 5:00PM
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IA Clarington Global Equity is sub-advised by QV Investors and benefits from QV's strong investment team, which applies a well-defined investment process. Unfortunately, high fees take some of the lustre off an otherwise strong offering for investors looking for a core global equity fund for their portfolios.

QV has a tightly-knit and experienced team of portfolio managers, supported by a growing group of young associates. Although the firm makes investment decisions by consensus through a committee structure, Joe Jugovic, who serves as the firm's president, CEO and chief investment officer, is tasked with leading its global equity research and is supported by associate portfolio manager Mathew Hermary.

The firm's name, which stands for "quality and value," stems from its house style which searches for strong businesses trading at attractive valuations and run by competent management who have demonstrated a track record of success. This means finding firms that have generated consistently high returns on equity while maintaining sound balance sheets and trading below fair value. There are other managers that look for stocks with similar attributes, but the investment committee at QV sets itself apart with the rigour with which they carry out each phase of the investment process.

The source of the team's edge comes from the strength of its vetting process. Stocks are run through a gamut of seven qualitative and quantitative criteria, and they must meet the majority of them to be considered for the portfolio. The team's stock research assesses whether companies have a competitive advantage and whether it can create consistent cash flows. The thesis for any stock is debated at the investment committee level and consensus is required for inclusion in the portfolio.

Once confident in a company's business model, the managers then derive a value estimate based on its discounted cash flows, as well as historical and relative value models that are tested under various scenarios. Often, a company's short-term stumbles may provide the team with the chance to buy a business that meets their quality criteria at an attractive price.  American Express (AXP) is an example; the termination of its relationship with  Costco Wholesale (COST) announced in 2015 caused its share price to drop more than 40%. Since bottoming out in early 2016, the stock has nearly doubled.

QV's strict valuation discipline helps the managers avoid falling in love with any current or potential holding; no matter how strong the thesis may be, if a stock is not priced at an appropriate discount or the valuation stretches too high for their liking, they will not invest in the name or, for existing holdings, will trim or liquidate the position. Management owns between 30 and 40 names, with single holdings kept below 6%. If a stock they own starts to rise to a valuation that is high relative to historical levels, they will trim but continue to hold the stock if there is still upside, as they recently did with  Microsoft (MSFT) after a strong runup in the stock's price. For the committee to include a stock in the fund, it must also enhance either the portfolio's quality, value and/or risk characteristics.

Every month, the fund is reviewed on both the security level and portfolio level to ensure it reflects the manager's style and to try and capture potential unintended exposures the portfolio may have, such as sensitivity to changes in interest rates or how correlated their holdings on aggregate are to the change in the price of oil. This allows the managers to focus on their bottom-up security selection while being aware of the broad risks facing the portfolio.

Unlike regional funds, this fund's global mandate means that despite higher valuations in certain regions, Jugovic and the team are not struggling to find ideas trading at attractive prices. One of the fund's top holdings is E.On, a European energy company whose share price dropped close to 50% due to issues with its balance sheet and a German government policy to exit the nuclear energy space. QV however was comfortable with how management cleaned up the balance sheet and how the firm's gas, electricity and renewable energy businesses all had long-term contracts at attractive rates of return. Overall, the portfolio's holdings on aggregate are priced cheaper than the MSCI World Index. The fund's sector weights relative to the benchmark will be reflective of where they are finding value, but the team is generally invested across the 11 GICS sectors.

The fund's fees take some of the lustre off this otherwise attractive offering, as the 2.54% management-expense ratio for the series A and 1.31% MER for the series F both rank in the third quartile of fees in the Global Equity category when taking into account the fund's trading-expense ratio of 0.12%. The fees dampen the fund's long-term returns; its 9.6% annualized return from its inception in August 2014 to the end of June 2018 trails the MSCI World Index by more than 3% per year. That is, however, still 0.6% better than the average fund's returns in the Global Equity category.

The fund's volatility, as measured by standard deviation, has also been very low at just 8% per year over that span, resulting in a top-decile Sharpe Ratio -- a measure of volatility-adjusted returns. In other words, despite the higher price tag, investors have enjoyed a smoother ride.

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Shehryar Khan, CFA

Shehryar Khan, CFA  Shehryar Khan, CFA, is a senior investment analyst for Morningstar’s Investment Management group.

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