As the fund’s moniker suggests, to be chosen for the portfolio of Beutel Goodman Canadian Dividend a company must be paying a dividend currently. It doesn’t make the grade if it has promising potential to pay a dividend in the future, no matter how much cash is flowing.
This requirement, along with the investment team’s discerning stock-picking strategy and strict selling protocol has led to superior returns and soothingly low volatility for investors in the $470 million fund, ranked silver by Morningstar. The most difficult year in the last 10 years saw the Class F series of the fund drop 4.8% in 2018, a year when many funds suffered more painful losses and Morningstar’s benchmark index sunk by 8.7%.
The ability to hang to past gains during difficult markets has led to healthy long-term numbers, with the fund showing a robust three-year average annual compounded return on Aug. 9 of 11.5% and a 10-year average of 8.2%.
How the Fund Does Dividends
A company must have a minimum dividend yield at the time of purchase of 1.5%, says Stephen Arpin, managing director of Canadian equities at Beutel Goodman & Co. Ltd. of Toronto. The goal for the fund is a dividend yield that exceeds the S&P/TSX Composite Index over rolling three-year time periods.
Holdings in Beutel Goodman Canadian Dividend are drawn from the portfolios of three other funds in the stable: Beutel Goodman Canadian Equity, Beutel Goodman American Equity and Beutel Goodman International Equity. Foreign content in Beutel Goodman Canadian Dividend can be as high as 30% to enhance diversification and returns.
Quality at a Discount Drives Stability
“The focus is on total return, not just dividend yield,” Arpin says. “We look for high-quality businesses that trade at a discount to intrinsic value and buy them at a discount, and that enhances the stability of the portfolio.”
The team is selective and runs a concentrated portfolio that currently consists of 36 stocks. Aside from dividend yield, cash flow is king when analyzing companies. Holdings must have healthy and sustainable free cash flow to be sure of paying their dividends, as well as the ability to grow cash flow.
To make it into the portfolio, Arpin says a company must have the potential of a 50% total return over three years, including dividends and stock price gains.
“Focusing on free cash flow and buying companies at a discount to their business value is the core of what we do,” Arpin says.
Banks Fit the Bill
The process is value-oriented and bottom-up, and individual stock selection ultimately determines the sector weights in the fund. The influence of single stocks can be significant. The Royal Bank of Canada (RY), for example, recently accounted for an 8.6% weight in the fund.
There is a heavy emphasis on financials, which currently account for 35% of fund assets. The top holdings in this sector include what the team considers the best banks – RBC, Toronto Dominion Bank (TD) and Bank of Montreal (BMO). Beyond the Canadian banks, financial exposure includes wealth management conglomerate Power Corp. (POW) and insurance giant Sun Life Financial (SLF).
The foreign content side of the portfolio has presented opportunities in such areas as health care and technology, where there is less selection in Canada. A key foreign holding is U.S.-based multinational pharmaceutical firm Amgen Inc. (AMGN), which has three promising drug launches underway including a drug for severe asthma, another for lung cancer and one for psoriasis.
The rapid rise in interest rates has had a dampening effect on the prices of some traditional income-paying stocks due to the increased competition posed by alternatives such as Guaranteed Investment Certificates and government paper. But the negative impact has been felt more strongly by slower growth stock sectors, such as Real Estate Investment Trusts, pipelines and utilities, and the fund has less exposure to these areas, Arpin says.
Avoiding Slow Growth Sectors
“The biggest impact of rising rates has been on REITs,” Arpin says. “We continue to look for opportunities but do not yet find this group interesting on a total return basis. There have been better opportunities elsewhere, such as in consumer discretionary stocks.”
The team added to its stake in auto parts maker Magna International Inc. (MG) during the last year and a half. Magna’s stock price had dropped as investors feared a recession and supply chain issues would hurt revenues, creating a buying opportunity for the firm, which the team perceived as a strong global player with a healthy balance sheet and the ability to survive down periods in the economy.
While a recession continues to be a possibility, the team seeks companies with the ability to withstand the vicissitudes of economic cycles.
“We look for companies that have a strong moat to protect against competition, and have survived downturns in the past,” Arpin says. “We concentrate on the best franchises, they need to be well-financed with no significant balance sheet leverage.”
Pessimism Makes for Underpricing
While the team doesn’t try to predict the direction of the economy or interest rates, fear in the market can create buying opportunities, Arpin says.
“Recession is a risk right now, and generally valuations will decline if we’re dealing with that, but predicting the timing is difficult,” he says. “Fear on the part of investors can moderate stock prices, but the best returns are never made when people are universally positive. When there’s pessimism, it’s a better environment for buying.”
Measured Stock Selling Rules
The team has a strict sell discipline. Once a company’s stock price reaches the target established at the time of purchase, one-third of the position is sold. The team reexamines prospects for the next three years and decides on whether to continue to hold the remainder of the stock.
Additionally, as part of the strategy to reduce risk and preserve capital, every stock in the fund also has a downside price target, which if hit, triggers a review and possible sale.
Turnover tends to be in the relatively low range of 20% annually due to the enduring quality of the companies and their long-term potential.
