Why a Top-Performing Stock Fund Has Stumbled

Morningstar Key Stats for Mackenzie Bluewater Canadian Growth Fund

• Morningstar Medalist Rating: Under Review
• Morningstar Rating: 4 stars
• Morningstar Category: Canadian Focused Equity

Mackenzie Bluewater Canadian Growth boasts an impressive long-term track record, but the C$5.5 billion fund has seen returns suffer in recent years.

Now Mackenzie is losing one of its longtime portfolio managers, Dina DeGeer, who is retiring in September 2024. “It is a big loss for the strategy,” writes Morningstar analyst Michael Dobson, who notes that DeGeer co-founded Bluewater over 25 years ago. “Her knowledge and experience in Canadian equities greatly helped this strategy.”

DeGeer will be leaving the fund in the hands of portfolio manager Shah Khan and David Arpin, senior vice president and current team co-lead. Khan, with 14 years of investment experience, joined the Bluewater team in 2010 after graduating from Hamilton’s McMaster University with a BSc in biochemistry and an MBA. Arpin is a 30-year industry veteran.

“This was expected; Khan has been DeGeer's designated successor for years,” Dobson writes. “However, an open question remains about who will backfill Khan.” He notes that Khan would be responsible for monitoring the entire Canadian equity market.

Morningstar has placed Mackenzie Bluewater Canadian Growth under review, pending an evaluation of the team's plan.

Mackenzie Bluewater Canadian Growth’s Performance Woes

The F Series of the $5.5 billion fund demonstrates impressive long-term performance, with a 15-year average annual return of 11.2% and a 10-year average annual return of 11.4%, putting it in the top 1% of funds in the Morningstar Canadian Focused Category. But it’s a vastly different story when drilling into its performance in recent years.

The fund, which may have as much as 49% foreign stocks, has largely shied away from the gargantuan technology stocks that have dominated the US market. Instead it has leaned toward broader diversification and opportunities that its managers believe have more attractive valuations. But even as the mega-cap growth stock rally stalled out over the last two months, Bluewater has lagged.

After a four-year run of top-quartile annual performance from 2017 to 2020, returns have been disappointing in recent years.  The F Series showed a one-year return of 12.2% on Aug. 17, landing it in the bottom 10% of its category. That one-year return compares with 19% for its category and 22% for the benchmark index. For the last three years, the fund lands in the bottom 25% of its category, with an average annual return of 4.6%.

Missing Out on Two Big Rallies

Khan says recent returns were impacted by two particular underperforming years: 2022 and 2023. In 2022, the team expected slowing economic growth when inflation and interest rates rose, but the economy and employment picture remained strong, and a strong rotation into value stocks took place. “Some of what we owned went down, and much of what we didn’t own went up,” Khan explains.

Dobson notes that the fund’s performance especially suffered from a lack of energy stock exposure that year, when rising oil prices led to strong returns across that sector.

More recently, the fund has missed out on another big rally among big technology stocks, especially those that have benefitted from the artificial intelligence boom. In 2023 and into the first half of 2024, index returns were highly concentrated in the handful of stocks known as the Magnificent Seven: Nvidia NVDA, Meta Platforms META, Apple AAPL, Amazon.com AMZN, Microsoft MSFT, Alphabet GOOGL/GOOG, and Tesla TSLA. 

Even as the US stock market’s rally has broadened, those seven stocks were responsible for nearly 40% of the 29.13% gain in the Morningstar US Market Index. The biggest contribution can from Nvidia, which surged nearly 180% over the last 12 months, fueled by massive growth in semiconductor chips used to power AI.

While there were some price declines in the sizzling tech kings with the market selloff in early August, the continuing dominance of a small group of stocks has led many actively managed funds to underperform relative to index funds and momentum followers.

It’s unknown how long this market concentration will continue, although there has been a broadening of interest to a wider selection of stocks in recent months. “We adhere to our style, and that will continue,” says Khan. “Our process is tried and tested, and it works in the long term. There will be no changes to our philosophy, process or implementation.”

Steering Away from the Magnificent Seven

The team has steered away from most of the Magnificent Seven, but in October 2023 it initiated a position in Microsoft, and earlier this year it invested in Google parent company Alphabet.

Khan says the team was originally concerned that AI could have a negative impact on these two companies, but as the technology has developed, the team has become more comfortable about the “long growth runway” for Microsoft’s cloud technology and Alphabet’s Google search engine.

“The level of market concentration has been extremely challenging for active managers, but trends are never linear,” says Khan. “We expect returns to broaden out, and that would be a tailwind for our investment style, which is more diversified.”

Heavy Weightings in Industrials and Financials

The fund usually holds between 30 and 35 companies. The team minimizes “risk overlap” by investing in companies with complementary characteristics. For example, although the industrial sector has the largest representation in the fund, with a 27.1% weighting as of the end of July, it contains a broad mix of companies. Significant holdings in this sector include Canadian firms such as engineering and consulting services giant Stantec (a 4.87% position as of the end of July). In addition, the fund held information conglomerate Thomson Reuters, Dublin-based multinational chemical company Linde, and US-based heating and air conditioning equipment manufacturer Trane. 

Financial services is the second-largest sector represented in the fund, with a 25.7% weighting. The portfolio contains only one bank, Royal Bank of Canada, at a 5% weighting. Other financial companies include property and casualty insurer Intact Financial, which was the largest investment in the portfolio as of the end of July at 5.16%, global insurer AON at 3.85%, financial information and ratings company S&P Global, and credit card company Visa. “We don’t own four of five banks; we look for the best bank,” says Khan.

The team analyzes big-picture trends and seeks companies that can benefit. Rather than attempt to pick the winning producer of a particular product like alternative energy or semiconductor chips, the team often invests in “enablers” of a trend. Khan describes the strategy as akin to supplying picks and shovels in the gold rush rather than investing in potential mines.

For example, Stantec provides the engineering and consulting expertise required to build renewable energy plants, offering value-added services in the infrastructure-building phase. In the technology arena, rather than own a chip producer like Nvidia, which must build manufacturing facilities and supply product in an era of evolving competition, the Bluewater team prefers firms that offer needed services and have recurring revenues.

For example, Accenture offers consulting services that help companies assess AI’s practical applications. “Many companies are asking what to do with AI and are figuring out how they can benefit, where to start, and how to develop a strategy,” Khan says. “They need consultants to help put the building blocks in place and address issues like cyber security. We don’t try to predict who has the best AI tools, but instead try to find businesses that can help companies implement AI.” However, Accenture stock is down roughly 3% in US dollars for 2024 and up just 7.3% over the past year.