Fund Manager’s Difference is Diversification

The Diversification Advantage Shows in Superior Returns

The F Series, ranked gold by Morningstar, shows top quartile five- and ten-year performance, and has also done well in recent months. As of June 14, its 10-year average annual compounded return was 10.2%, beating both Morningstar’s Canadian Focused Equity Category and the comparable index return. Shorter-term, for the year-to-date as of June 14, the fund was up a healthy 8.9%, again beating its category and the index.

“We avoid making any direct calls on macro events and instead factor in various probabilities in our analysis,” says Robert Cavallo, portfolio manager of North American equities at Toronto-based RBC Global Asset Management. Adds co-manager Marcello Montanari, vice president and senior portfolio manager, North American equities, “We stay away from very concentrated mandates and try to avoid errors of omission.”

Concentration Works If You Pick Winners, But What If You Pick Losers?

Montanari says studies have shown stock market returns tend to be concentrated in a small number of stocks at any given time, which means that a portfolio concentrated in the wrong names can lag severely.  Highly concentrated portfolios tend to be either at the top or bottom of performance rankings, he says, whereas a broadly diversified portfolio can achieve steadier performance.

“We aim to hit singles and doubles, rather than the big home runs,” says Montanari. “If you consistently earn second quartile returns, in the longer-term that can lead to being a top-quartile performer.”

The Fund Management Team Focuses on Winning Sectors

The RBC North American equity team, which also includes portfolio managers Jeffrey Schok, Matthew Gowing and Shanthu David, overweights sectors expected to be leaders. The focus is on companies with dominance in their industries or “strong moats”, as well as talented management teams who clearly articulate their strategy and have a history of executing it. The team picks their spots in terms of entering or exiting stocks when valuations are attractive.

“While we don’t make giant sector bets, we so make tilts to express our views,” Montanari says.

For example, the team currently sees opportunities in technology and communications services and is overweight in these sectors relative to the index. The fund is typically underweight in utilities and real estate, which are low-growth sectors.

Once the team has identified attractive companies it tends to hold on to them as their growth potential unfolds, which often means weathering short-term stock price volatility triggered by such things as quarterly earnings or temporary operating glitches.  Annual turnover is about 11%.

“We like to get it right and sit tight,” says Montanari. “Turnover is quite low.”

Current Themes in Favour are AI and Digital Transformation

Big picture themes and trends play a role in stock selection. For example, artificial intelligence and digital transformation are having a massive impact on society. Other big picture themes are the shift to clean energy or “decarbonization,” and developments in health care.

“As much as we refrain from macro calls on the economy, we do participate in scenario analysis,” says Cavallo. “We examine possible outcomes and seek companies with favourable risk/reward characteristics.”

Late last year and into the beginning of this year the team “added a little more torque to the portfolio,” says Montanari, by beefing up exposure in companies related to the rising use of artificial intelligence. Initially, the position was a bit early and hurt the portfolio’s returns, but it is now working in the fund’s favor as stock prices rise.

“It’s a bit more ‘risk-on’ in this area, but we think the theme has real legs,” he says.

Two Tech Stocks the Managers Like

One of the key tech holdings is Microsoft Corp (MSFT), which is also the largest position in the fund. The team views the company as a major beneficiary of digital transformation and developments in AI.  As a leader in cloud-based technology it is in position to make inroads with “large enterprise clients” and is on the “speed dial” of top executives, Montanari says.

The fund has also recently increased exposure to Shopify Inc (SHOP). The company provides ecommerce and digital advertising services to retailers, and during Covid was a hot stock as consumers retreated to their homes and turned to online shopping. But as Covid lockdowns ended and people ventured back to restaurants and actual stores, Shopify’s business fell, and the stock retreated.

Now, with better tools available for clients to measure the impact of online advertising, supply chain disruptions clearing up, and both ecommerce and advertising activity coming back into balance, things are moving in a better direction for Shopify, Montanari says.

Highlight: One European Stock, One Pharmaceutical Stock, and One Canadian Stock

In terms of geographic exposure, the RBC North American Growth portfolio currently has just under 50% assets in the U.S. and the same Canada. Most foreign holdings are U.S.-based, but the fund holds one European stock, Bayerische Motoren Werke AG (BMW), known as BMW, a German multinational manufacturer of luxury vehicles.

In health care, holdings are largely U.S.-based due to a greater abundance of opportunities relative to Canada. A key holding is pharmaceutical giant Eli Lilly and Co (LLY), a long-term position in fund. The company stands to benefit from the impending launch of two “blockbuster” drugs, says Cavallo, one that will slow the progress of Alzheimer’s disease and one that combats obesity. The company is also a global leader in medication for diabetes, a disease on the rise. Its anti-obesity drug was actually derived from its diabetes solutions.

With the clean energy trend gaining momentum, the team has become more positive on nuclear energy, and holds a position in uranium miner Cameco Corp (CCO), a supplier of fuel to nuclear power plants.