As lead manager of four-star Fidelity Canadian Disciplined Equity, Andrew Marchese, Toronto-based president and chief investment officer at Fidelity Canada has managed to achieve the ideal combination of superior long-term performance and lower volatility relative to his peers and the market benchmark.
Marchese has applied his steady hand to shaping the portfolio for more than 21 years, as a member of the team since he joined as an equity analyst in 1998, and as lead manager since 2009.
As of Dec. 31, 2019 the fund’s performance placed it in the top two percent of Morningstar’s Canadian Equity category for the 15 year period with an average annual compounded return of 8.36%.
All-sector with select stock focus
Marchese’s method is to diversify across all industry sectors, but ferret out the best companies within those sectors. He will confidently place significant weights in his favourite holdings and will sometimes go close to the legal maximum of 10% of fund assets. The $3.3 billion portfolio is relatively concentrated and recently held 68 stocks.
“Stock selection is the driver of excess returns,” Marchese says. “We focus on bottom-up fundamentals and look for the best risk/reward opportunities. We represent our high confidence ideas with the highest active weights.”
His approach is “sector neutral” relative to the S&P/TSX Composite Index. He avoids tilting the portfolio toward specific industries based on big picture trends or economic currents and doesn’t omit any sectors. Fidelity Canadian Disciplined Equity always has representation in all 11 major TSX subindices, matching the index’s percentage weightings, plus or minus 300 basis points.
“During any 12 month period, there is always a best and worst sector, but ultimately there is a reversion to the mean,” he says.
This philosophy of broad sector diversification combined with superior stock selection has helped the fund ride through economic downturns with less damage than many competing funds.
Along with its “below average risk” and “above average return” rankings from Morningstar, the fund has a lower standard deviation than both its category and the benchmark. It’s upside capture is 97% of the index, while its downside capture is 87%. In 2018, a year when many funds lost value and the S&P TSX Composite was down 11.6%, Fidelity Canadian Disciplined Equity F was down only 6%. In 2019, the fund gained 24.5%, beating the index’s 19.13% gain.
Not betting on market movements
Market movements are difficult to predict, and Marchese’s wide-angled approach allows him to be positioned to take advantage when markets take unexpected turns and avoid being badly bruised when high-flying sectors stumble.
“We don’t try to call the turn. Our approach is consistent and allows us to ride through all phases of the market cycle.”
He does look to buy at attractive prices to “generate a margin of safety” and his time period for holding a stock is at least three of four years.
“We don’t have a short-term thesis,” he says. “We seek businesses that will generate returns and drive value over a long period of time.”
While staying within his sector guidelines, Marchese may enhance returns by holding some smaller companies that aren’t included in the TSX Composite as well as some foreign content. He keeps foreign content at less than 10% of the portfolio, and it was recently about 5%.
“We will look outside the index and prepared to look outside Canada in a small way,” he says. “We will also look ‘down-cap’ to find new ideas and hope to hold for multiple years as our thesis comes to fruition.”
Financial favourites and energy upside
As with the index, the fund’s largest sector weighting is financials, at about 29% of assets. Top holdings in the category are the Royal Bank of Canada (RY), Toronto-Dominion Bank (TD) and Brookfield Asset Management Inc. (BAM.A), an alternative asset management firm focusing on real estate, renewable power, infrastructure and private equity.
Marchese is selectively concentrating on his two favourite banks, rather than all of the big five. With TD, he likes the business mix, including the bank’s interests in the large U.S. market. He says RBC, the largest bank in Canada, has “tremendous scale,” which gives it extra strength to weather any tough times that may lie ahead. Brookfield has a talented team of managers that have proven to be astute investors and wise allocators of capital, he says.
Dividends are a factor in assessing return, but a company doesn’t have to pay a high dividend to be of interest, he says.
“There has been a global chase for yield in this period of low interest rates, and many dividend-paying companies have benefited from multiple expansion,” he says. “We don’t require dividends necessarily, we look for total return. We also look for companies that the market is not fully appreciating. For example, they may have balance sheet values greater than the stock price would indicate.”
While some fund managers have been avoiding the sluggish energy sector, in keeping with the TSX Composite the Fidelity fund’s weighting was recently about 17%. The energy industry in Canada has been plagued by stagnant commodity prices, as well as lack of pipeline capacity and bottlenecks in reaching international markets.
Rather than holding integrated exploration and production companies, Marchese is focused on energy companies diversified in stable businesses such as pipelines and mid-stream operations and less reliant on strong global growth. Fund holdings include Suncor Energy Inc. (SU), TC Energy Corp. (TRP), Enbridge Inc. (ENB) and Canadian Natural Resources Ltd. (CNQ).
A favourite in consumer staples is Quebec-based international convenience store operator Alimentation Couche-Tard Inc. (ATD.A), which has enjoyed profitable and steady growth in both its merchandise and fuel operations, powered by strong same-store sales and strategic acquisitions.
While Marchese doesn’t make investment decisions based on economic forecasts, he foresees a scenario of continuing slow growth this year, with a de-escalation of trade conflicts and North American governments engaging in accommodative interest rate policies -- and possibly pulling some fiscal levers to stave off recession.
