Managers find value in U.S. banks, but clash on energy stocks

Michael Hatcher, head of global equities and director of research at Trimark Investments, a division of Toronto-based Invesco Canada Ltd. A value manager, Hatcher’s extensive responsibilities include that of lead manager of Trimark Fund and other key mandates such as Trimark Global Fundamental Equity and Trimark Global Dividend Class.

Peter Moeschter, executive vice-president and portfolio manager at Templeton Global Equity Group, Franklin Templeton Investments Corp. A value manager, Moeschter runs both EAFE (Europe, Australasia and Far East) and global portfolios for retail and institutional clients. Effective Feb. 1, he will become the lead manager of Templeton International Stock, succeeding Don Reed.

The three-part roundtable began on Monday and concludes on Friday.

Q: The benchmark MSCI World Index, when measured in local currencies, produced an average annual total return over the past three years of 7.3% to the end of November and 4.4% for the 12 months to November end.

Moeschter: Given where interest rates are, the question is, is the equity premium enough? The returns can change fast. Equities tend to outperform bonds over time, and you have to invest in the right companies. We’re in a lower-return world. Returns on equities have drifted down over the years. Given what has happened over the past eight years — a financial meltdown, huge bailouts of companies and parties elected in Europe that had to fix serious problems — the fact that there is any return is a plus. We should not be too surprised that returns are lower than they were 10 or 15 years ago, when there was strong global economic growth with Asia picking up steam. Going forward the returns can get better.

Q: We have said that the global equity market is expensive. Are you finding opportunities nevertheless?

Moody: There are some. In Mackenzie Ivy Foreign Equity, cash is high. But we’ve added a number of new names over the past year. We’ve had a bit more success in Asia-Pacific than elsewhere in terms of valuations.

Q: From a top-down perspective, the MSCI regional valuations are underscoring these differences. At the end of October, MSCI North America was trading at 22.8 times trailing earnings, Europe was at 22.4 times, the Far East at 16.2 times and Australia/New Zealand at 17.6 times. The benchmark multiple was at 21.5 times.

Moody: We’ve also found opportunities among companies that have a bit of a cyclical tilt to their earnings and have seen some of that cyclical impact from a slowing global economy. From a long-term perspective, we think that some of these companies are trading at decent values. In all, we’ve found some new opportunities, but these have been outweighed by the sale or reduction in stocks in the portfolio. So the cash balance has increased. Looking at sectors, we reduced our weighting in consumer-staples stocks as the valuations got quite stretched. They are no longer the biggest sector weight in Mackenzie Ivy Foreign Equity. Our weighting in consumer-discretionary stocks has gone up.

Hatcher: The global equity market is expensive. We haven’t added much this year, but we did add some U.S. names.

Moeschter: There are bargains all over the world. We’re finding ideas everywhere. Europe would still have the edge.

Moody: The macro picture in Europe has been a challenge for some time. We try to separate companies from the countries where they are domiciled.

Q: Time to discuss your portfolios in some detail.

Moody: We have 33 names in Mackenzie Ivy Foreign Equity. U.S. companies represent roughly 38%, Europe is 14%, Asia/Pacific is 13%, including 2% in South Korea, and Canada is 3.5%. Cash makes up the rest of the fund. If you take out the cash holding, the United States is around 56% of the equity portion of the fund.

Moeschter: I have close to 100 names in the global portfolios. The United States is just under 40%, Europe is around 40%, including 12% of the portfolio in the UK, and Asia is close to 20%. Less than 10% of the portfolio is in emerging markets, mainly in China and South Korea.

Hatcher: I have 37 names in Trimark Fund. I have roughly 15% in emerging markets, China, South Korea and Brazil, 45% in the United States and 35% in Europe. The remainder is cash.

Q: Time to start talking about sectors and your major holding in those sectors. Let us begin with the financial-services sector. It represented 16.8% of the benchmark MSCI World Index at the end of October.

Moody: A top 10 holding in Mackenzie Ivy Foreign Equity is U.S. Bancorp. We’ve owned the stock for three years. It’s the only bank that we’ve owned for some time. This is a plain-vanilla bank. It’s run in a conservative manner and has a great corporate culture.

Moeschter: Financials are our biggest sector weight. Based in the United States, JP Morgan Chase & Co. and Citigroup, Inc. are relatively large holdings. The portfolio also holds Capital One Financial Corp. It’s a fairly large holding for us. Capital One specializes in credit cards, home loans, auto loans targeting consumers, small businesses and commercial clients. It’s a good combination of banking and credit cards. It has acquired a few businesses since the financial crisis at reasonably good prices. A slightly rising interest-rate environment should be positive for Capital One. Also, consumer spending will go up if there is the government stimulus in the United States that we talked about.

Hatcher: A top-10 holding in Trimark Fund is Wells Fargo & Co. Almost everything that Matt said about U.S. Bancorp is applicable to Wells Fargo. It has a significant deposit base, which gives it a low cost of funding. It makes loans to consumers and small-and-mid-sized businesses. It had a corporate-governance hiccup and we used that dip in the stock to add to our holding. We don’t think that there will be a mid- or long-term impact on the franchise from this hiccup.

Q: Time to talk about the energy sector, which constituted 6.8% of the MSCI World Index at the end of October.

Moody: We don’t have any energy holdings in Mackenzie Ivy Foreign Equity, given our investment style and the type of high-quality businesses that we invest in. We have owned oil and gas companies before. It’s harder to find a business in the energy sector that is both demonstrably better than its peers on a sustainable basis and is also highly cash-generative. The industry is very capital-intensive and it’s selling a commodity. It’s a higher bar for a company to get over for us to invest in it. This is not a call on oil prices.

Moeschter: We are overweight energy in our global portfolios. We were adding to the energy sector as the stock prices were falling in the wake of the decline in the oil price. About a year ago, we trimmed some health-care holdings that had done well and put the proceeds into energy. We still have a large health-care weight. The energy stocks have had a nice run. I don’t think you’re going to find too many bargains in this sector. At this stage, we’re comfortable owning the stocks, but we’re not adding to them. Our diversified holdings in this sector include two U.S. energy producers: Apache Corp. and Devon Energy Corp. We have a significant holding in a major global energy-services company, Haliburton Co.

Hatcher: We are long-term shareholders in Canada’s Canadian Natural Resources Ltd., based on its Horizon Oil Sands project and the 100-year nature of that asset. We also like the quality of its management team and its ability to allocate capital across the company’s holdings. We have a significant holding in the global energy-services company Schlumberger Ltd. We added to the stock when the oil price cracked. This company is an efficient operator with significant economies of scale.

The three-part roundtable began on Monday and concludes on Friday.