Deciding what names to leave out is the secret behind the best-performing preferred shares fund in Canada, according to its manager.
Ryan Domsy, of Foyston, Gordon & Payne Investment Counsel is the sub-advisor for the Evolve Active Canadian Preferred Share ETF, which has just passed its one-year mark.
Domsy brings the expertise of having managed Foyston’s own pref fund for a number of years and the ETF delivered an 8.55% return for its maiden 12 months. The portfolio manager puts its success down to an easily repeatable bottom-up security selection process, with the rigorous methodology leading him to omit Element Fleet and Aimia from the fund, avoiding significant losses.
He said: “Sometimes what people forget is that if you have an equity you own, there is a good chance that equity can double if very good things are happening to it.
“In fixed income it’s kind of the opposite in where you get the performance. You can’t really make up for big mistakes because there are not very many securities that can double. So you have to try to avoid making those mistakes that end up really costing other players in the market.
“For example, over different points of time over the past couple of years there were huge losses that were generated from Element Fleet and also Aimia because of problems they were having and the impact of that on the portfolios that held them was pretty dramatic. In funds like ours we don’t hold names like that because they don’t meet our quality requirement, so as a result you’re already a step ahead because you didn’t lose.
“If it’s a large enough impact, it might make you underperform for the whole year. We’re very cognizant of things like that, though, so we put a lot of work into making sure we don’t have them. Our focus is so much on quality that we are willing to give up bits of return here and there to make sure the portfolio has the proper amount of safety.”
Domsy said the fund is about to come into its own in an even bigger way thanks to the rising interest rate environment. He believes portfolio managers can offset this by using preferred shares as a good substitute for traditional bonds.
He said: “Fixed income is a space that’s quite challenged because there’s the inverse relationship between interest rates and the price of bonds, so preferred shares slot in nicely as a substitute for traditional bonds within the fixed income portfolio because preferred shares in Canada are likely to see a positive correlation with interest rates in the coming years and so if rates are going up we are also likely to see an increase to the pricing of preferred.
“So it provides a great offset for a portfolio if they can shift some of their bond allocation to preferred shares.”
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