Strategic portfolio defense amidst challenging environment

Ryan Crowther and Les Stelmach, co-lead portfolio managers for Franklin Bissett's Canadian Dividend Strategy and Dividend Income Strategy, find attractive points despite the equity market's macro environment

Strategic portfolio defense amidst challenging environment

This article was produced in partnership with Franklin Templeton Canada

In 2022, investors leaned towards conservatism, but 2023 saw them becoming more audacious, displaying behavior that some fund managers deemed imprudent. Given the ever-changing market trends, the value of a meticulously crafted and steady portfolio approach cannot be emphasized enough.

Co-lead portfolio managers, Ryan Crowther and Les Stelmach from the Franklin Bissett’s Canadian Dividend Strategy and the Franklin Bissett Dividend Income Strategy dive deeper into the nuances influencing these shifts, the role of technologies like artificial intelligence, and the steady approach of dividend portfolios. In 2022, the allure of momentum stocks dwindled, with market sentiment appearing more grounded, but 2023 has seen a return to ‘risk on’ sentiment.

Artificial intelligence (AI) has become the new mantra. Proclaimed by many as the harbinger of the next technological revolution, AI has swiftly transitioned from being a mere buzzword to a core investment theme. There is no doubt that certain properly positioned companies will unlock significant value. But the hype surrounding AI has also engaged the growth seekers and is driving what Crowther and Stelmach believe is unwarranted expansion of multiples.

The Franklin Bissett portfolio managers highlight, “Our dividend portfolios largely did not participate in the hype-driven performance. Their absolute performance has been commendable and given a potential return to the rational sentiment reminiscent of 2022, these portfolios might be well poised for relative outperformance.

“Presently, dividend strategies are noticeably more defensive than they were a year prior. This shift is evident with overweight positions in sectors like consumer staples, utilities, and telecoms.”

Defensive portfolio positioning

When asked whether their more defensive positioning in dividend strategies was a reflection of near-term market views or a result of their specific selection process, Crowther and Stelmach responded:

“Our perspectives on the market are somewhat shaped by our valuation assessments. Our wariness regarding the broader economic climate influences our analysts' projections for cash flows and profits, especially for consumer-driven or cyclical sectors. At this point, we see greater value in companies whose cash flows are bolstered by contractual agreements, and those in essential service industries.”

Information Technology (IT) has emerged as the leading Canadian sector in terms of performance this year. However, the dividend portfolios lag in this sector in Canada due to the absence of stocks like Shopify and Constellation Software. The only Canadian IT stock held in the portfolio is Open Text Corp.

The enterprise software company was among the portfolio’s top performers this year. Open Text is not strictly an AI-centric firm. Its superior performance can be largely attributed to its accretive acquisitions and their successful integration rather than its direct involvement with AI.

The portfolio managers are wary of the Financials sector, especially considering the recent quarterly results from the major banks. A significant concern is the cumulative effect of the notable rise in interest rates, which borrowers haven't fully experienced yet.

While still cautious on banks, Stelmach and Crowther are keenly monitoring loan loss provisions, which, for the moment, haven't raised significant alarm.

Banks, known for their adaptability, are already exhibiting signs of adjusting to these shifts. Evidently, the portfolio managers have witnessed initiatives from the banks geared towards workforce downsizing and a tapering in spending.

Presently the large Canadian banks are exceptionally well-capitalized, and financial regulators such as OSFI (Office of the Superintendent of Financial Institutions) remain early in nudging banks to improve capital ratios. The portfolio managers note, “We have recently added to our bank holdings, just picking away on weakness. But we would be poised to buy more aggressively should the right circumstances emerge.”

Unfazed by yield figures

Although the portfolio's dividend yields are generally higher than benchmark levels, it's noticeable that the current average yield difference is lower than typical levels. This begs the question as to whether the portfolio managers are putting a lower emphasis on dividend paying companies. 

They note, “Our focus remains undeterred: our decisions stem from in-depth evaluations of fundamental company metrics and valuations.

“Take, for instance, our position with Canadian Pacific Kansas City. It exemplifies our strategy of seeking value in securities with lower yields but consistent growth potential. Our anticipation is that what they might lack in immediate yield will be counterbalanced by the prospective capital appreciation in the long run.

“It's essential to articulate that our objective isn't simply to chase after high yields. We adopt a fundamental-centric approach, ensuring we prioritize the entire scope of return possibilities, rather than being blinkered by yield alone.”

Despite an impressive track record of outpacing benchmarks over the past two years, the portfolio has, admittedly, lagged year-to-date. The prevalent narrow equity market leadership observed in both the Canadian and American equity markets has significantly influenced this outcome. The Information Technology sector, spearheaded by a few behemoths, has overwhelmingly contributed to the broader index returns.

However, Stelmach and Crowther maintain, “This takes me back to where we were a few years ago when we last underperformed. Then, as today, the focus was temporarily on expectations of significant growth in the future justifying high prices today. Our disciplined approach meant we avoided some of those ‘story stocks’.  When the inevitable unwinding of that enthusiasm happened, we benefitted by continuing to generate good returns while the market faltered.

“We feel comfortable with the current positioning in our portfolios. The quality of the holdings is high and cash flows are generally quite durable. We have confidence in the growing stream of dividends that the portfolios are generating for clients and the total return potential across various market scenarios.”

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This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market.

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