There may be many macro-economic concerns pressing on markets today, but veteran fund manager Doug Warwick remains optimistic in the long run overall.
“There is a lot to worry about and the headlines are scary,” says Warwick, managing director at Toronto-based TD Asset Management Inc., and lead manager of the 4-star rated $4.1 billion TD Dividend Income A. “But I wonder whether the U.S. consumer has ever been in such good shape. The unemployment rate is the lowest since the 1960s and we’re getting wage growth, and it’s probably higher than what the statistics tell us. This is carrying over into Canada as well since we have very low unemployment and good wage growth. In the last 12 months wage growth was 4.3%, which is above inflation, so that’s helpful. Consumer confidence is high. North America looks good.”
Healthy anxiety
Still, people are nervous about the market, Warwick concedes, and many point to tensions in the Middle East and unrest in Hong Kong. “I think it’s a good sign that everyone is worried and the markets still creep up. I would be concerned if everyone was bullish and the world looked really rosy, because you would have the last marginal buyer already into the market. This is a better situation. There is not a lot of euphoria in this market,” says Warwick, a 39-year industry veteran who joined TDAM in 1984, four years after he earned a bachelor of business administration from University of Western Ontario. Currently, he is lead manager for about $19.7 billion in mutual fund assets and is co-manager for $4.5 billion in assets. Warwick shares duties on TD Dividend Income with Michael Lough and Lauren Bellai, both vice-presidents.
From a performance standpoint, the fund has done well and year-to-date has returned 13.16% (as of October 14), versus 11.37% for the median fund in the Canadian Equity Balanced category. On a five-year basis, the fund averaged 5.59%, versus 5.1% for the peer group. And on a 10-year basis, the fund averaged 6.69%, compared to 5.93% for the peer group. The fund has a running yield of 3.6% before fees.
Warwick acknowledges that he is concerned that the ongoing tension between the U.S. and China is hurting global GDP numbers. With 19.9% of China’s exports going to the U.S., and 6.4% of U.S. exports going to China, it has been taking some steam out of those economies. Meanwhile, he is also worried about tensions in the Middle East as the U.S. slowly withdraws from the region. That move may impact crude oil prices. “A spike in energy prices may slow the [U.S.] economy, but may be good for Canada because we have a lot of energy stocks that could use a higher energy price, and so could a lot of Middle East producers,” says Warwick. “But it would slow world GDP numbers down. And that’s a worry.”
Mind the Canadian valuation gap
From an equity standpoint, Warwick notes that Canada has lagged the U.S. by a wide margin for about eight years. This has caused a valuation gap that in Warwick’s view means that many stocks are much cheaper than U.S. counterparts. “Canadian banks are trading at around 9.5-10 times next year’s earnings. They are yielding over 4%. Their growth rates are lower but their returns on equity are still in the high teens. And if you look at the energy sector, and exclude the pipelines, there’s been a huge decline in the value of Canadian energy stocks,” says Warwick. “Yet leading energy players, such as Suncor Energy Inc. (SU), are spinning off strong cash flow even at these [low] energy prices. Hopefully better pipeline access to get our product out of Canada in the next two or three years will change the valuations for the better.”
From a strategic perspective, Warwick is fully invested with about 2% cash. He is also cautious on fixed income and has allocated only about 17% of the portfolio to fixed income, the bulk of which is in Canadian securities. The duration of the bond holdings is about 8 years.
“We would prefer to buy higher-yielding utility shares or pipeline shares or preferred shares. We can buy preferred shares at a discount to par and get an after-tax yield much higher than bonds as well as some capital appreciation,” says Warwick, adding that about 5.4% of the portfolio is in preferred shares which yield on average about 5.43%. “We can do much better than fixed income.”
On the equity side, which accounts for about 75% of the fund, Warwick manages 64 names. Banks are the dominant sector, with about 35% of the portfolio. Conversely, there are much smaller weights in areas such as energy (10.4%) and industrials (7.4%).
Defensive dividend sweet spot
“We tend to migrate to companies that are less cyclical, and those that generate growing cash flow which they pay out in growing dividends,” says Warwick. “There are a few stocks that don’t pay a dividend. On average the yield on the portfolio, at 3.6%, is higher than the TSX.”
Among the top holdings is Royal Bank of Canada (RY). “They are the largest in Canada and benefit from their scale. In banking, bigger is better,” says Warwick. “RBC is very big in wealth management and does a very good job at it. It’s a very attractive area because it’s not like a loan portfolio where you risk the bank’s capital. Rather you earn a percentage on assets under management, which can vary, but is generally consistent.” The stock is trading at the upper end of the range, at 11.4 times forecasted 2020 earnings, and pays a 3.73% dividend.
On the energy side, Warwick likes Enbridge Inc. (ENB), one of the largest pipeline providers in North America. “They had some trouble in Minnesota trying to replace some older pipeline with new pipes and getting the line back up to its original capacity. But we think they are largely through the process. We hope that in the next five quarters they will be up and running. That will help earnings with an extra 350,000 barrels a day in that particular pipeline.” Enbridge is trading at 17.8 times trailing earnings and pays a 6.12% dividend.
Looking ahead, Warwick remains optimistic, based on the slow, but steady growth pattern in global economies. “Equities are a way of participating in that growth so, yes, I like equities longer-term. I am never quite certain what will happen in the immediate future. But I like to think longer-term. The turnover on our portfolio is very low,” says Warwick, noting that in the past year turnover was 0.77%. “So I tend not to be too antsy about short-term events. I focus on the longer-term – three to five years.”
.jpg)
