Macro-economic tensions can have an influence on the stock-picking process, says David Arpin, co-manager of the 5-star rated $3.1 billion Mackenzie Canadian Growth Fund A, and senior vice-president at Toronto-based Mackenzie Investments. And more often than not the choices are businesses that are less impacted by global uncertainties.
“When something happens on the macro front, you have to think through how it will affect individual companies and industries. For many, it won’t have much effect. But in other cases, they will have a very large effect,” says Arpin, a 25-year industry veteran who in 2012 joined Bluewater Investment Management Inc., which was absorbed by Mackenzie in 2016. “It’s more [to do with] the U.S.-China trade tensions. If you are a business that [is] reliant on importing goods made in China and [you’re] selling them to the U.S., it will have a big effect. If you [are] a U.S.-based service company, it [will] have almost no effect. It’s business by business, industry by industry when you look on the macro front. That’s how we approach this one.”
From a geographic standpoint, this approach has seen Mackenzie Canadian Growth allocate 44% of its assets outside of Canada. That’s what Arpin is mainly responsible for, along with Hui Wang, associate portfolio manager. The 50% balance is looked after by Dina DeGeer, senior vice-president, together with Shah Khan, vice-president. (The remaining 6% is in cash). “The issues around U.S.-China trade are not new. It goes back to 2016 when President Trump was running as a candidate. Whether he would act on it, there was no way to forecast it. But if you owned something where [the] impact could be potentially catastrophic you would have to think through how much of a risk was there, and whether it is a good decision [to stay invested in a particular company].”
Global reach for resilience and diversification
The reason for the heavy global exposure, Arpin explains, is that the Canadian market is limited because it is dominated by commodity and financial services stocks. “If you want to build a resilient, more diversified portfolio, it is helpful if you go outside of Canada. If you go to the U.S., for example, you’ll find a much larger proportion [of the market] is in information technology or healthcare, where you can find some terrific stable-growth businesses. If you add those to a Canadian portfolio, it makes it more stable over time. It also benefits from slightly faster growth,” says Arpin a native of Kingston, Ontario who earned an Honours Bachelor of Arts from Queen’s University in 1993 and an M.A. in economics the following year.
From a performance standpoint, the fund returned 16.21% year-to-date (Nov. 5), compared to 15.19% for the Canadian Focused Equity category. Over the last five years, the fund has averaged 10.76% versus 4.71% for the category average.
Concentrated on independence
Core to the team’s investment philosophy is the search for companies that are less cyclical than most and are consistent growers no matter what is happening in global economies. As a result, the portfolio is highly concentrated and has about 33 holdings. “One of the challenges, when you run a fund with hundreds of stocks, is that it’s very hard to perform differently from the underlying market. Statistically, you end up providing results that are similar to the underlying benchmarks,” says Arpin. “If you want the opportunity to out-perform you need to be more concentrated in our view.”
The chief corporate attribute that Arpin seeks is the ability to grow free cash flow at above-average rates across an economic cycle. “These businesses tend to be less cyclical in nature and always generate substantial free cash flow. They are not growing at super-high rates, but consistently outperforming the overall economy,” says Arpin. Almost 25% of the fund is in industrials and 17.6% in healthcare stocks, although the sector weights in Mackenzie Canadian Growth A are a by-product of the bottom-up stock-picking process.
One of the key themes that Arpin has focused on is the gradual shift of developed economies away from manufacturing and towards services. “If you went back 100 years about half of the time the economy was in recession. That has come down steadily and seems to be about 10% of the time,” says Arpin. “There’s been a structural change. Over the last 30 or 40 years, we’ve seen a move from manufacturing to more service-oriented businesses. From an investment standpoint, we have been a beneficiary of [this trend] since the services area has been growing as a proportion of GDP. That means these businesses have tended to grow faster. A number of our investments are very much service-oriented companies and have benefitted from that shift.”
In addition, Arpin notes, that these companies do not tend to be cyclical. This applies to the healthcare and education sectors, for instance. “As a bigger proportion of the economy becomes service-oriented, you should see fewer and fewer recessions. And the recessions should not be as deep as they were historically,” Arpin observes. To be sure, the 2009-09 global financial crisis did precipitate a severe recession and significant mortgage defaults in the U.S. “But the economy really did not slow down that much. You had one year of minor negative growth. And then it picked up again.”
Recession risks mitigated by service stability
Arpin and his team argue that from an investment standpoint we should be less worried about extremely deep recessions than in the past. “As the economy gets more service-oriented, you get a steady, more stable world,” says Arpin, adding that in contrast housing construction and business spending tend to be far more vulnerable.
One top holding that is representative of this theme is Aon PLC (AON), a London, UK-based firm which provides a broad range of risk, retirement and health solutions to companies around the world. “They are a very large global consulting firm,” says Arpin, adding the team tends to hold stocks for about three years.
In a similar vein, he likes Accenture PLC (ACN), a Dublin-domiciled firm that provides strategic, digital and information technology and operations consulting. “Information technology is a very complex and fast-moving area. Companies know that they need to spend money on IT and upgrade. The problem is, most companies don’t have the internal expertise to do it. Accenture is the global number one IT consultant. They are leading in areas such as cloud computing and artificial intelligence.”
Looking ahead, Arpin is reluctant to predict how markets will perform. “The underlying economies have been growing around low mid-single digits, so you should not expect corporate earnings to grow massively faster than that. That means you should not expect stock markets to go up over time massively faster than their underlying earnings,” says Arpin, noting that much of this year’s strong return was simply a case of markets returning to where they were just before the 2018 fourth quarter drawdown. “Over a cycle, you should expect that companies will grow more or less in line with their earnings, or free cash flows. If corporate earnings are growing at high single digits, then that is what you should expect markets to do over time.”
