A concentrated portfolio of stocks based on core beliefs pairs well with long-term equity strategies focused on quality and income.
That’s what Lutz Zeitler’s been finding with the BMO Dividend A portfolio while serving as managing director and head of Canadian fundamental equities at Toronto-based BMO Asset Management Inc.
“Our portfolio of roughly 35 top-quality holdings,” says Zeitler, “reflects one of the four strong beliefs on our investment team. We only invest in competitive, differentiated, sustainable business models, that’s the first point.”
The second point is the very long-term approach. With a portfolio turnover that typically ranges from 10% to 15% annually, the investment team of five portfolio managers, including Zeitler, analyzes what each company can look like five or even 10 years from now.
The third belief is constructing concentrated portfolios. Zeitler thinks if you over-diversify a portfolio, it impedes the ability to generate alpha. The holdings are characteristically large-cap growth companies able to consistently and sustainably grow their dividend stream.
The fourth belief is based on risk management that starts with understanding the companies they invest in intimately. “We construct portfolios based on that kind of conviction within a diversification framework,” says Zeitler. “We only invest in those companies where we have a high level of conviction and therefore know those companies inside and out.”
The team’s research process is a purely bottom-up, fundamental, “kick-the-tires,” analysis of a company. And the team applies a framework of 'pillars' for all investments, Zeitler says.
Key Investment Pillars
The economic moat “speaks to the competitive advantages of the company,” says Zeitler about the first pillar. The investment team analyzes how well the company can protect against adversity, whether that is competitive or economic disruption, which speaks to the durability and duration of the moat.
The second pillar is focused on understanding the growth trajectory of the company. That starts with understanding the industry, the thematics, and the position of the company within that competitive landscape.
The third pillar is the leadership of the company. According to Zeitler, they look for a management team that has the experience and the competence to run a company and follow their vision and strategy for success.
The fourth pillar assesses responsible investing. When you’re investing in a company five-to-10 year’s out, ESG risks and opportunities can be very important in that analysis. “We integrate that right into our fundamental analysis,” says Zeitler.
Favoured Stocks
Four of the big banks are included in the top 10 holdings; Royal Bank of Canada (RY), The Toronto-Dominion Bank (TD), Bank of Nova Scotia (BNS), and Bank of Montreal (BMO). Zeitler says that the Canadian banks have compounded earnings tremendously over their history. “Are the banks going to make or break a portfolio,” says Zeitler, “I don’t think so, but over the long term, drive that consistent return, almost like an anchor in the portfolio.”
Outside of financials, a favoured holding in the mandate is Northland Power Inc. (NPI), a Toronto-based company that operates in the renewable energy space, including wind turbines and solar power. “The company has both defensive and offensive characteristics,” says Zeitler. “The defence comes from long-term contract cash flows and the offence comes from the incredible growth pipeline of a multi-decade thematic tailwind of global renewable power development.” In addition, the company is favoured for its very capable and experienced management.
Another holding, Waste Connections Inc. (WCN), represents one of the largest integrated waste companies and recycling services in North America that spans the entire value chain of collections, transfers and landfill. The investment team likes the company’s strategy of focusing on exclusivity in markets and secondary markets that allows for much greater pricing power. “So when you combine that strength,” says Zeitler, “with what I think is top-level management and the culture, it’s really contributed to this company’s industry-leading stats, including return on investment.”
A U.S. holding that Zeitler says may not be as well known in Canada is Prologis Inc. (PLD), a leading global REIT company. “They’re one of the largest industrial logistics REITs out there,” says Zeitler, “they have incredible strategic locations, which means there’s lots of room for development. Combine all that with the tailwind of e-commerce and the need for sufficiently bringing products to market and this company is at the center of that.”
Geographically, the mandate is characteristically weighted in approximately 70% Canadian equities and 20% to 25% U.S. equities for opportunities. According to Zeitler, there are fantastic business models in the U.S., especially for large-cap dividend managers that are not available in Canada. For example, areas of the market or sectors such as technology, healthcare and retail.
From a sector perspective, the top three weightings include approximately 43% in financials, 11% utilities and 10% industrials.
Challenges and Opportunities
“For our approach of investing,” says Zeitler, “the challenge is more related to some of the short-term noise in the market that we’re seeing right now, the greed end of that spectrum. Our style tends to underperform as we go through these periods that do come about from time to time. We are honestly steadfast in our belief system and long-term goals of value creation while trying to minimize volatility.”
In positioning the mandate for stock-specific opportunities, the dividend fund is exposed to thematic opportunities that include Cloud computing, the transition to a cashless society, e-commerce, healthcare and technology.
