Senior portfolio manager explains how Essential Equity Team's deep company-specific research sets portfolio up to withstand tough times
This article was produced in partnership with Manulife Investment Management.
Behind the Manulife Dividend Income Fund, which recently celebrated its 10th anniversary, is a team that’s been together for more than two decades. And while the performance and composition of the underlying portfolio has been a picture of consistency, the approach that drives it isn’t exactly formulaic.
"We’ve been together in operations for over 25 years,” says Conrad Dabiet, Senior Portfolio Manager within the Essential Equity Team at Manulife Investment Management. “Our process is always evolving as markets change. But the core tenets of the of the team have remained the same.”
It all starts with capital preservation. Not only are losses mathematically challenging to come back from – after a 20% decline, for example, a portfolio would need to gain 25% to get back to its original value – but they also tend to push people into making emotional decisions that override their long-term success. To that end, Dabiet and his team avoid taking excessive risks, which helps investors hold on during rollercoaster markets.
“We spend a tremendous amount of time learning about companies, their businesses, and their management teams,” Dabiet says. “We then take those ideas and try to construct portfolios, always trying to diversify amongst different sectors and making sure not to expose to one particular business risk.”
Finding strength in diversity
The Canadian stock market is dominated by the energy and financial sectors, with banks making up nearly a third of the TSX, so it’s hardly surprising how much investors in Canada rely on them for their dividend stock exposure. In keeping with its commitment to diversification, the managers and analysts who run Manulife’s Dividend Income Fund force themselves to look at other areas of the market.
“You can still find many other companies that generate very strong cash flows and return capital to shareholders in both the form of dividends and share repurchases,” Dabiet says.
Most of the companies in the portfolio have strong-enough cash flows that they’re able to invest in their business’s growth or future ability to generate cash flow, while still having enough capital left over to return to shareholders as dividends. Many of the companies typically have payout ratios in the 20% to 40% range, making for a portfolio that throws off attractive but sustainable dividends, while exhibiting a good amount of capital appreciation.
Fears of economic contraction are on the rise, but the businesses in the Dividend Income portfolio have continued to do very well and operate very consistently. Today, Dabiet says, the market is recognizing and rewarding that steady-as-she-goes quality as they rotate away from more cyclical elements of the market.
“We believe in the potential of companies with very durable businesses that aren’t so economically sensitive. We haven't made too many adjustments,” he says. “If you look at our top ten holdings, which usually represent about 40% of our portfolio, they've remained fairly constant.”
Turning adversity into advantage
It’s hard not to feel bearish in today’s environment. With headlines being dominated by inflation and fears of an economic slowdown, the forecast for equity market returns in general is decidedly softer than it has been in past years.
But many companies that the Essential Equity Team invests in are durable because of their ability to wield pricing power, with some having revenue streams that are indexed to inflation. That means even as inflation continued to heat up, they’ve been able to pass that on to customers.
“The real magic of the companies we focus on is their ability to manage their cost structure to make sure they have increasing margins and operating leverage,” Dabiet says. “If you have the right type of business, inflation will have been a big advantage to you, as opposed to the period prior to the pandemic when it was much more subdued.”
Those types of companies aren’t confined to one sector alone. Waste Connections, a mainstay holding, has a decades-long record as a well-managed company, and part of its revenues is contractually indexed to inflation. Thomson Reuters, a professional services business, is likewise able to pass along some price increases to customers, while its cost structure provides further insulation from inflation’s corrosive effects.
Looking out at the post-pandemic world
With a stable portfolio core of predictable businesses, the Essential Equity Team is able to devote more time to the important work of understanding how the world is evolving. That means continuing to stay close to companies as they do their fundamental research.
As the economy and travel rules started to open up, the team has been able to spend much of the spring and the summer attending conferences and in-person meetings with companies. The goal is to get an on-the-ground, inductive sense of what the post-pandemic world is evolving into.
“We’ve been focused on getting close to our companies and trying to understand whether some of these themes that emerged during the pandemic were something that was just short-lived, or whether they really will be longer-term structural changes,” Dabiet says.
While contractions and expansions are to be expected in any economic cycle, the past two and a half years have represented a true global disruption in people’s lives, both at work and at home. And while the unprecedented levels of government intervention, whether it’s through fiscal policy or monetary policy, provided fuel for the post-pandemic recovery, the markets have been going through elevated turbulence as those lifelines get pulled back.
“We really try to build a portfolio that can be robust through ups and downs, so that we have the conviction to stick with these companies during periods that are more difficult,” Dabiet says.
“Because we've done so much homework on these companies, when their prices get beaten down in the market, we have the confidence to buy more. And if you do that, in the context of a portfolio that's well diversified, you can build very nice outcomes for clients, and hopefully allow them to stick with the markets through tough times.”
Sponsored by Manulife Investment Management, as of August 2022.
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