Securities markets staged a powerful rebound last year, driven by drastic interest rate cuts and policy actions by central governments. Yet, as 2010 commences, markets are unsure about the economic recovery and are taking back some of the gains. Some managers of dividend and income equity funds are cautious, while others are staying the course.

One of those in the first camp is Martin Anstee, manager of Stone Dividend Growth Class Canada Fund, and vice president at Toronto-based Stone Asset Management Ltd.

“There were a lot of expectations in the marketplace, for the past six months or so. And they may not be realized,” he says, adding that the market may pull back by 10%-15% to reflect the weak fundamentals. “We’re probably halfway through it. The market is in a consolidation phase.”

Anstee argues that earnings are the key to positive performance in 2010. Last year, markets were driven by severe cost-cutting and layoffs — “And there isn’t much scope left,” he adds. “Once you cut through the fat, you’ll cut into the muscle. Earnings will have to come from top-line revenue growth. I just don’t see scope for significant revenue growth.”

The economic recovery will be a slow one, Anstee maintains, and Canada’s 3% gross domestic product growth in 2010 may be far lower than in typical recoveries in the past. This is largely attributable to the high debt levels in Canada, and applies more so in the U.S.

“Whether [the debt is] owed by individuals, companies or governments, it’s all built on debt. We have to unwind all that debt,” says Anstee. “The consumer has to change from being a consumer to a saver — but that trend has only just started.”

Another concern is that companies have not been taking up the slack in the economy, as governments scale back their involvement and try to control their deficits.

“How much stimulus can the government give?” asks Anstee. “Once the stimulus is withdrawn, toward the second half of 2010, will the private sector take over?”

Although China and other Asian countries are growing, he adds, “Asia cannot carry the world alone. Europe and North America need to contribute.”

Anstee notes that Canada is in only relatively better shape than the U.S. or many European countries.

A money manager who blends top-down and bottom-up investment styles, Anstee is keeping about 15% of the Stone fund’s assets under management in cash, in anticipation of better opportunities ahead. Moreover, he has an underweighted 17% of AUM in financial services stocks, vs 30% in the benchmark S&P/TSX composite index.

“I was buying the banks last spring, when the world was coming to an end. But I’ve taken some profits,” says Anstee, adding that there are still core holdings in institutions such as Royal Bank of Canada and Power Financial Corp.

There is also 19% in energy stocks (28% in the index), and 8.5% in industrials (5.6%) and 9.6% in materials (19.4%). Other, smaller sector holdings include 8.1% in consumer discretionary (4.3%) and 5.8% in telecommunications (4.3%).

“I am not cyclically biased at all,” he says. “People’s expectations are way ahead of the fundamentals.”

Running a 60-name portfolio, Anstee favours telecom firms such as Telus Corp.: “Investors are afraid that increased competition will cause earnings to collapse. However, Telus has an entrenched position in Western Canada and should show reasonable growth.”

Telus’ stock is trading around $32.70 a share, about 10.5 times 2010 earnings. Anstee has a target of $40 a share within 12 months.

Another favourite is Shoppers Drug Mart Corp. This major drug and cosmetic retailer has been under pressure because of uncertainty surrounding Ontario government policy on reimbursing pharmacists for dispensing drugs. Although earnings could be hurt, that move could be offset if pharmacists are allowed to provide new services, such as vaccine injections.

“There could be a balance,” says Anstee. “It won’t be as harsh on pharmacists as the market is anticipating. The government will be reasonable.”

The stock is trading around $43 a share and yields 2%. Anstee’s 12-month target is $51.



Domenic Monteferrante, first vice president, Canadian equities, with CIBC Global Asset Management Inc. in Montreal and manager of CIBC Dividend Growth Fund, is taking a longer-term view of current volatility.

“We are at the early part of the business cycle recovery,” he says. “There will be bumps in the road. I characterize it as ‘two steps forward, one step back.’ Sometimes, it will feel like ‘three steps back, one step forward.’ But we will progress.”

@page_break@Although the recovery may take another nine or 12 months to take hold, Monteferrante is confident that the economy will rebound: “Inventories have been pared, jobs have been lost, and fiscal and monetary stimulus has been applied. So, through the normal course of economics, you do expect these inputs and stimuli to take effect. They just take time. I don’t expect that the laws of economics will be rewritten.”

Monteferrante admits the recovery is fragile, and there are concerns about rising short-term interest rates. Still, looking out by six to 18 months, he remains bullish on the economy. He says that many companies are in better financial shape, having bolstered their balance sheets and begun to replenish inventories. As well, many companies are starting to hire part-time workers and, based on past cycles, Monteferrante believes some of those jobs will become full-time.

From a strategic perspective, about 6% of the CIBC fund’s AUM is in cash, 73% in common equities, 15% in income trusts and 6% in preferred shares.

“We want to balance the opportunities with downside protection,” says Monteferrante. “We want some cyclicality in the portfolio, so we can participate in the rebound. At the same time, we want to maintain yield support.”

His target is a dividend stream that is 1.2 times the S&P/TSX composite index’s yield of 2.9%, or 3.5%.

On a sectoral basis, about 55% of the CIBC fund’s AUM is in the dividend-yielding financial services, pipelines and telecommunications sectors, as well as some real estate investment trusts. The remaining 39% is in cyclical names (energy and materials) and industrial sectors that have the potential to capture the rebound.

“We have a mix of defensive and offensive positions,” he says.

One top holding in the 65-name fund is Brookfield Properties Inc. This real estate firm has large holdings throughout North America, with a heavy exposure to Manhattan office properties.

“It has minimal rollovers of leases vs the rest of the industry. It’s not renewing a lot of the portfolio in a weak market,” says Monteferrante, noting that he has added to the holding on weakness.

As the economy is in recovery mode, he admits, it could take time for Brookfield’s net asset value to appreciate. “But in the meantime, you are being paid a 4.4% dividend yield.”

The stock is $13.90 a share, or about 0.9 times NAV. There is no stated target.

Another favourite is Canadian Natural Resources Ltd. The largest independent oil and gas firm in Canada, this company is heavily involved in the Horizon oilsands project, says Monteferrante: “It does not pay a big yield, but we see growth in production and cash flow. Over time, once it gets the Horizon project up and running, it will generate a lot of cash flow. It will pay down debt, and increase the dividend in due course. It won’t happen in the next six months, but we want to be positioned in ahead of time.”

The stock, which trades at $69.80 a share, yields 0.6%.



Also staying the course is Dun-can Anderson, associate vice president with Toronto-based MFC Global Investment Management (Canada) and co-manager of Manulife Dividend Fund.

“We focus on the companies in our portfolio — and getting the valuations and fundamentals right,” he says. “Last March, there were a lot of cheap stocks, and the opportunity set was very wide. Today, it’s getting harder to find cheap stocks. But we are still finding them.”

Anderson, who shares duties with Alan Wicks, vice president and senior portfolio manager, and Prakash Chaudhari, associate portfolio manager, notes that the Manulife fund’s “buy” list has about 240 of the 2,400 global stocks that the team tracks.

Value-oriented and fully invested, the team runs a 39-name portfolio that differs from most peer funds because there are no banks or pipelines among the Manulife fund’s top 10 holdings. It has an underweighted 22% in financial services and 16% in energy, but an overweighted 18% in consumer staples (vs 3% in the S&P/TSX composite index) plus smaller weightings in sectors such as utilities and industrials. The fund’s managers utilize a proprietary system that selects stocks on the basis of more than 30 factors. The fund’s running yield is about 3.5%.

“We price the risks for each individual security,” says Anderson, noting that stability of earnings and financial leverage are key factors. As a result, the team can develop an apples-to-apples comparison of each potential holding and, ultimately, determine the required rate of return to hold the stock. “I like to say that we are creating a ‘fishing net’ to screen stocks.”

One of the Manulife fund’s largest holdings is Empire Co. A leading grocery firm, it operates the Sobey’s supermarket chain, Anderson says: “It’s one of the most stable businesses in terms of return on equity and risks to ROE.”

Although Empire’s stock has been a laggard in the past year, Chaudhari argues, “We will earn our required rate of return, and it’s trading well below what we think the stock is worth. [As] it has very limited downside, it’s a top weighting in the fund.”

Its share price is $49, although the dividend yield is 1.5%. Based on the required rate of return of 6.8%, the stock remains a “buy” up to 1.4 times book value, or $57.72. The “sell” target, or fair value, is about $70 a share.

Another favourite is Wal-Mart Stores Inc. The U.S.-based giant retailer’s stock has been trading between US$43 and US$63 a share for the past 10 years, despite the fact its ROE has varied from 17% to 22% and forecast to be 23% this year.

“Few companies can generate high teens and 20%-plus ROEs,” says Anderson, adding that the price/book value multiple has consistently fallen and now stands at 2.8.“The price went sideways, but the book value grew by 200%.”

Although Wal-Mart’s share price is US$53.50 a share, Anderson believes fair value is about US$68. IE