To say we’ve been living in interesting times is an understatement. This past year has seen:
• A global pandemic.
• The fastest gross domestic product (GDP) contraction on record.
• The sharpest rise of unemployment on record.
• Elevated civil unrest in numerous countries around the world.
• A complete change in how we live our daily lives.
• Record government support and stimulus programs.
• Near record low interest rates.
• Enormous levels of price volatility across asset classes.
These are unprecedented times and we believe it is difficult, if not impossible, to know exactly what lies ahead. In this time of uncertainty, we believe Cambridge Canadian Dividend Fund is an attractive option to include as a part of an overall investment strategy. Protecting and compounding investor capital over time is this fund’s objective, and in a period of elevated valuations, record low interest rates and continued uncertainty, these objectives are as critical as ever. The Cambridge Canadian equity team aims to accomplish these objectives by:
- Owning a collection of high-quality businesses.
- Owning these businesses at a reasonable price.
- Owning our best ideas while ensuring we remain adequately diversified.
Cambridge Canadian Dividend Fund: performance
Over the long-term, the fund has performed as we would have hoped – outperforming peers and the index. Shorter term performance has lagged behind what we were striving for, and as a team we have made several changes to better position the portfolio within the new reality. Some of these specific changes have been discussed in a prior blog post as well as quarterly commentaries.
||SINCE COMMON INCEPTION
|CI Cambridge Canadian Dividend F
|Canada Fund Canadian Dividend & Income Equity
|S&P/TSX Composite TR
|Trailing returns; Source: Morningstar as of July 31, 2020
Current investment environment
The current environment offers a number of interesting challenges, but also opportunities. From a macro perspective, many (including ourselves) find it to be one of the more complex environments we have experienced. The following table lays out a number of points which are gaining increased attention today.
|CURRENT REALITY OR POTENTIAL SCENARIO
||THE “SO WHAT?” FOR INVESTORS
|Interest rates are near zero.
|While this has encouraged investors to take risks, we believe this makes the portfolio’s collection of high quality and free cash generating businesses even more attractive. The current yield of the portfolio is 3.6% and we expect dividends to increase over time at a similar rate to earnings growth.
|The potential for rising inflation.
|Quality businesses with a strong competitive position (i.e. pricing power) enable investors to absorb moderate levels of inflation. Should inflation materialize, businesses with pricing power are likely to fare far better than assets that do not carry this advantage. Our investment in gold royalty company Franco Nevada also provides a modest hedge to the overall portfolio.
|There could be a material second wave of infections.
|There absolutely could be. We believe businesses with strong balance sheets and business models that continue to generate cash flow through difficult times are a critical defense against the unknown.
|Markets are already pricing in a recovery following the major rebound.
|While markets have recovered, the recovery has been more concentrated in specific pockets of the market (with the spread between growth and value stocks being at nearly the widest since the tech boom in the late 1990s). There are currently even many high quality businesses that are very attractively priced.
|Insiders are selling at elevated levels.
|All in all, insider selling has increased, and given the valuation many “new age” companies are trading at, we understand why. That being said, for our portfolio companies overall, the opposite is the case. For example, the chief executive officers of Fairfax Financial and Gildan Activewear each recently purchased $200 million/$5 million respectively of their company’s shares.
While the performance of any fund will ebb and flow, we believe in staying steadfast in our investment process and philosophy while also being flexible in the application of it, given the changing world we currently find ourselves in. This approach has yielded strong results over the long-term and we believe strongly that owning a collection of high-quality businesses at reasonable prices and being properly diversified drives solid investor outcomes over time.
Fund profile: what you get today when you invest
CAMBRIDGE CANADIAN DIVIDEND FUND CLASS F
Number of Companies
Dividend Payout Ratio
Under 50% in 2021
Expected Earnings Growth
6-8% per year earnings per share (EPS) growth from 2019 to 2023.
This would be meaningfully higher if calculated off of a depressed 2020 base.
~16x 2021 EPS
|Source: Cambridge GAM as of August 19, 2020
The businesses within the portfolio have weathered the storm and we believe are strongly positioned to thrive in the coming years under many different but realistic scenarios. At the same time, we are being paid well to wait, particularly given alternatives in the market.
Fund profile: top five holdings
While aggregate statistics are interesting, let’s provide further insight into our five largest positions, what those businesses do and why we own them.
Power Corporation – approximately 5.4% of the fund
Primary business segments include Great West Life (provider of life insurance and annuity products) and IGM Financial (asset and wealth management services).
Why we own it: Life insurance businesses have only experienced a modest impact from COVID-19. The wealth and asset management business has benefited from the sharp rebound in the markets. At the same time, Power’s discount to its underlying net asset value (NAV) is near historical highs despite recent moves to simplify the structure. We expect NAV per share to compound over time and believe management will make prudent capital allocation decisions.
Fairfax Financial– approximately 5.3% of the fund
One of the largest North American property and casualty insurers/reinsurers, specializing in commercial property and speciality lines.
Why we own it: We are entering one of the best pricing environments for commercial insurance since 2001. At the same time, undue market concerns over Fairfax’s investment portfolio has provided a compelling return profile with the shares trading at a substantial discount to book value despite peers trading at meaningful premiums to book.
Empire Co. – approximately 5.0% of the fund
A leading Canadian grocery store operator. Operates under brands including Sobeys, Safeway, Farm Boy and Voila.
Why we own it: Under improved management, the company has substantially enhanced operations, margins and capital allocation discipline. There remains further room to improve versus peers, and their Voila e-commerce solution is the most advanced in Canada.
Enbridge – approximately 4.5% of the fund
Critical North American energy infrastructure with a 53%/30% skew to crude oil/natural gas pipelines as well as 14% of regulated gas distribution to consumers.
Why we own it: In many cases, Enbridge’s assets are the only energy transportation alternative, creating an irreplaceable infrastructure system and a stable cash flow stream, a fact we have seen with the resiliency of Enbridge’s crude pipeline system in the recent downturn. The business has also been diversifying towards critical natural gas transmission/distribution while reducing corporate leverage over the past few years. The underlying free cash flow yield, which supports the 8% dividend yield, is attractive and sustainable in our view.
Dollarama – approximately 4.1% of the fund
Leading dollar store operator in Canada.
Why we own it: Dollarama benefits from substantial scale, lean operations and excellent unit economics. The business model has also proven to be very resilient during times of turmoil and provides increased earnings stability for the fund. Finally, the Canadian dollar store market remains under-penetrated allowing for an attractive growth pipeline of new stores in addition to the option value provided by their Latin American investment.
While market indices have recovered much of the recent losses and considerable uncertainty remains, we feel confident in the businesses we have partnered with. They remain very profitable, have strong balance sheets and are operated by excellent management teams. They have all come through COVID-19 and in many cases have only improved their competitive positioning. Changes in the portfolio were made along the way, including reducing or eliminating businesses that we believe are not positioned for future success in the new reality. In a handful of cases, these were difficult decisions which resulted in capital losses. Portfolio management will always remain a continuous process, with less attractive opportunities being sold to make way for the best opportunity set we see today.
We thank you for your continued support and will continue to work hard to protect and compound client capital.