The quest for a better core portfolio

When CI Global Asset Management completed its acquisition of WisdomTree’s Canadian ETF business in February 2020, it not only complemented the company’s existing lineup of ETFs, but also reinforced its position as a top-five ETF provider in Canada. 

With many investors concerned about narrow market leadership or potential pricing bubbles in market-cap-weighted solutions, CI GAM sees opportunity in the form of its CI WisdomTree Quality Dividend Growth Suite. The suite’s fundamentally weighted index provides a means to diversify away from some of the risk associated with pricing bubbles that can emerge in a traditional market-cap-weighted index. 

“WisdomTree indexes were born in 2006 from the research of famed investor Jeremy Siegel,” explains Randall Alberts, senior vice-president and head of distribution for Eastern Canada at CI GAM. “These were some of the original smart beta ETFs, long before traditional indexes had been market-cap-weighted. This was also the first time a weighting mechanism based on dividend stream was brought to the marketplace.” 

The suite covers multiple geographies and includes the CI WisdomTree Canada Quality Dividend Growth Index ETF (DGRC), the CI WisdomTree US Quality Dividend Growth Index ETF (DGR.B) and the CI WisdomTree International Quality Dividend Growth Index ETF (IQD.B). The US and international strategies also offer hedged and variably hedged options for investors looking to manage currency exposure. 

The suite screens dividend-paying companies for quality and growth using return on assets, return on equity and earnings growth expectations. It then applies a dividend weighting to determine the allocation of the 50 stocks in the Canadian ETF portion and the 300 that comprise the US and international assets. 

This process helps the investment team rank companies based on quality of earnings, quality of balance sheets and estimated earnings growth. As a result, the team can zero in on the best quality and growth opportunities. Once the different factors are applied, the team carefully selects the highest-ranking stocks and weights companies based on their dividend stream. The rationale behind this rigorous investment process, Alberts says, is to have a multi-factor quantitative approach that can avoid some of the problems caused by traditional market cap index and active strategies. 

With a rules-based approach, the methodology remains disciplined and focused, regardless of market environment, trends or index levels. One of the advantages Alberts sees with the CI WisdomTree Quality Dividend Growth Suite is its ability to diversify risk from overexposed areas, such as the FAANG stocks (Facebook, Amazon, Apple, Netflix and Google), which are sometimes found in market-cap-weighted index funds. 

“Reducing the reliance on FAANG stocks is relevant today because when we look at US markets, we see very narrow leadership,” Alberts says. “Most of the returns from the S&P 500 Index can be attributed to FAANG stocks and Microsoft. With a market-cap-weighted index, as security valuations climb, risks increase as these companies become an even bigger part of that index.” 

One way the Quality Dividend Growth Suite addresses this concern is by requiring dividends from its holdings, which eliminates some of the higher-growth stocks that have loftier valuations and don’t pay dividends. The suite’s rigorous quality and growth screening also filters out unsustainable growth and higher leverage opportunities. The result is a portfolio that tilts away from those higher-growth stocks and corresponding risks. Not only does this potentially create a much better core portfolio, Alberts says, but using the dividend stream provides a disciplined structure to rebalance in a way that makes sense to investors.  

In the Canadian marketplace, DGRC has no exposure to the major Canadian banks, which would be unusual in a market-cap-weighted index or a Canadian dividend fund. Given these banks represent about a third of Canadian indexes and are a significant holding in many active investments, the positioning in CI GAM’s Quality Dividend Growth Suite is unique. That’s because, when the quality and growth screens are applied, the Canadian banks fall outside the top 50 ranking. 

According to Alberts, this positioning is solely based on quality and growth factors. “Canada represents less than 3% of global investment markets,” he says. “Unlike market-cap-weighted indexes, we look at netting a differentiated portfolio that is adding value. It isn’t a call to avoid banks, but rather invests based on systematic factors such as quality and growth factors.” 

The suite also ranks well on environmental, social and governance (ESG) scores. While it has no specific ESG screening, the strict criteria used for stock selection does tend to result in holding higher-scoring ESG companies. For example, the IQD and DGRC have a four-star (out of five) sustainability rating from Morningstar.  

The long shadow COVID-19 cast on 2020 provided a test not only for the CI Quality Dividend Growth Suite but the entire ETF landscape. Alberts notes that the sector held up well, as it has done historically. 

“During this pandemic, the advantage we have relative to broad markets is that these ETFs offered better drawdown protection,” he says. “It is something we have experienced repeatedly over the history of these ETFs and their underlying index. They have outperformed in the majority of drawdowns.” 

Over the last 10 major drawdowns since 2006, the ETFs’ underlying index has outperformed seven times internationally, nine times in the US and every time in Canada. That resiliency, along with the Quality Dividend Growth Suite’s ability to offer a differentiated strategic approach, is why Alberts thinks advisors should seriously consider it as a core exposure for clients.  

“Our methodology is an improvement on traditional core strategies, and focusing on company fundamentals may provide a more intuitive approach to dividend growth,” he explains. “With a track record of outperformance, even in a robust growth era like the previous decade, but also how this methodology reduces risk during market turmoil, we see a compelling argument as a core investment.”