Challenging Canadian Notions of Portfolio Construction

Challenging Canadians' Notions of Portfolio Construction and Global Investing
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Jeremy Burge (Investment Analyst, Capital International Asset Management, Canada): I'm just going to make some comments that will challenge some existing perceptions that the markets have about Canada, just to get you to think. For more than five years, you've been able to invest in a basket of Canadian stocks, and that would have served your clients very well. They would have materially outperformed many of the global indices or major market alternatives for you. But today, the major reasons why you would have done that over the five, last five years are no longer as compelling as they were, or in some cases, the reasons no longer exist.

First of all, valuation. For much of the last five years, you've been able to buy the Toronto Stock Exchange and its components for cheaper valuations than you can the global alternatives, not just for the market as a whole, but for every single element of the industry components. And you were able to get superior yields than you can get on many of the major marketplaces.

Today, the Toronto Stock Exchange is trading at a premium to the vast majority of the global and G8 marketplaces and the emerging markets. And on top of that, it is now just producing an average yield. Secondly, fundamentals. Canada offered that rare mix, particularly over the last three years, of growth and defense and a good, solid dividend yield. Canada offered you twin surpluses, trading budget and was a standout in its fiscal position versus the developed world, both for the consumer and the government. Today, we're already in a trade deficit, and that might well grow.

The debt position is still strong at the federal level, but if you add the provincial debt, Canada now is just an also-ran in total government debt to GDP. And the consumer is as highly levered as the U.S. consumer was when they entered the 2007 problem. Canada is no longer a standout or a paragon of fiscal restrain. It is still strong, but you need to think of the implications this will have on certain of the marketplaces, in my view.

Canada entered the recession late. The recession was more mild than it was in many other places. It exited it earlier and in a v-shaped recovery that was faster than even when it recovered after the Second World War. I worry that when other economies recover, and they will eventually, that Canada will not have the torque to the upside that many people think.

Thirdly, Canada was seen as a bridge between the developed world and the emerging markets with its heavy commodity and energy exposures and doing what Carl was saying, providing what the emerging world needed to grow. Today, that is still very true. But, and it's a big but, Canada is still inextricably linked to the U.S. economy, and particularly U.S. consumption. Twenty-five percent of GDP in Canada is linked to U.S. consumption. Seventy-five percent of manufacturing exports go to the U.S. For Canada to outperform, it needs some sort of U.S. economic recovery. Yes, Canada is a bridge to the developed, between the developed markets and the emerging markets, but its blood supply is still inextricably linked to the U.S. economy.

And lastly, currency. If you'd held your Canadian basket of companies, you would have not only outperformed those markets with a standalone currency, but any foreign returns were dampened or eliminated by the incredible rise in the Canadian dollar over the last seven years. The level of currency appreciation is unlikely to repeat itself over the next five years. We're not going to, in all likelihood, go to 140 to the U.S. dollar.

We must be careful, too, in my view, not to interpret the current widespread U.S. dollar weakness as Canadian dollar strength. Over the past six months, although the Canadian dollar's appreciated four percent, 15 other major currencies have done double or triple that performance relative to the U.S. dollar, including the Swiss franc, Australian dollar, the Euro, the Japanese yen, the Brazilian Real and the pound. Indeed, Canada only marginally outperformed the Chinese currency, which is pegged.

So I think we need to think about how these things that we've relied upon, our bedrocks, our foundations for our investment portfolio construction for Canadians, is going to be challenged as we go through some of these changes in these underlying issues.

Country of domicile: No longer an effective screen
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Rob Lovelace: Carl mentioned that we went with 80 plus associates to China. I was part of that group. And I guess in some ways, it's probably not too surprising to you, right? I mean, it's sort of our hallmark. We have offices around the world, we go and visit companies, kick the tires, so to speak, in Carl's case literally, and figure out what's going on. You expect that from us. So what made this unusual? Well, part of it was to prompt questions, so if you want to ask about China or India, Carl's letting you know he's ready to answer questions. But I think the thing that makes this unusual is, it wasn't just our global and international team that went to China. We brought portfolio counselors who manage in funds that are basically, invest only in the United States. And we brought them because everything we do now is effectively global, particularly in the team where Carl and I manage money. We were effectively breaking down the silos as much as we can between any regional research or ways we look at things.

As the Daimler story highlighted, and as all three of us, you know, mentioned that Canada's a gateway to the emerging markets, country of domicile is an increasingly ineffective way to screen for where a company does business. It tells you what currency the stock is traded in, but it doesn't even tell you what currency is impacting the underlying P&L or balance sheet of the company.

So country of domicile, even though we're still forced back to it in so many ways with different restrictions, legal, taxation and otherwise, but it's not a very effective investment screen to tell you what you're getting in either investment exposure, business exposure, currency exposure, etc. So the way we are structuring ourselves as a company is to move away from country of domicile or regional silos as a way to do research. And I bet if you look at most of our competitors, they may have a global footprint, but I'll bet you anything that the people in Asia are investing mainly in Asia and the people in Europe are investing mainly in Europe and the people in the U.S. are investing, or Canada, are investing in those countries. And they might take one trip or they might make a phone call or have a conference call, but I doubt that any of them flew the whole team to Asia to see what's really going on there to have them then come back and say, this is why this is going to change the companies in which we invest.

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