Risk management is a top priority for Alan Wicks, portfolio manager of the award-winning Manulife Monthly High Income Fund. And he’s not content to measure his fund’s performance against market indexes or its peer group, the Canadian Neutral Balanced category. “When we’re talking about risk,” says Wicks, “it’s not relative to a benchmark. We’re trying to generate positive absolute returns.”
Wicks, senior managing director and head of the value-equity team at Toronto-based Manulife Asset Management Ltd., has been managing the portfolio since 1997. Currently closed to new purchases, the fund was the winner in the Canadian Balanced category of the Morningstar Awards in 2015.
Contributing to the five-star-rated fund’s success is the flexibility that Wicks and his teammates have to make shifts in the asset mix between equities, fixed income and cash. With the risk-reward relationship becoming more favourable for equities after the 2008-2009 financial crisis, the team raised its equity exposure.
The equity weighting reached a peak of 66% in December 2013, up from a low of about 50% before the financial crisis. At last report, the fund held about 60% in equities and 24% in fixed income, with the remainder in cash.
Viewed as a risk-management tool, cash has been in the range of 15% to 20% of fund assets over the last number of years. In the last year or two, says Wicks, it has become harder and harder to find great opportunities in the financial markets. “Interest rates are exceptionally low and valuations in quality companies are somewhat high.”
Wicks plans to take advantage of any stock-market downturns. “We’ll be out there with the rifle approach, picking out those high-quality names that have come back down into our range, adding back to them again,” he says. “We don’t mind holding cash until we can get a good risk-reward in either (long-term) asset class.”
In selecting stocks, diversification by the type of business is one of the team’s risk-management criteria. For example, says Wicks, energy is a very homogenous sector. “If energy prices are going down, then the entire sector is going to go down. And the telcos, the financials, utilities and materials are all also fairly homogenous in their risk.”
By contrast, Wicks adds, consumer discretionary, consumer staples, industrials, health care and technology are all sectors where the managers can invest in very good businesses that are doing very different things. An example is the fund’s recent top holding, Loblaw Cos. Ltd. (L), which is Canada’s largest food retailer and also owns the Shoppers Drug Mart chain.
The value team seeks to invest in businesses with high and stable earnings and cash flow, and whose shares are trading at a reasonable price. In addition to financial metrics, the team also looks at barriers to entry, competitors, the quality of management and corporate governance. Wicks and his colleagues meet with more than 500 companies a year.
Built into the investment discipline is a financial model for every holding with a buy-and-sell target price. Quality businesses that have been sold may be added back to the portfolio when valuations are more attractive.
For example, in the spring of 2014 the fund’s holding in Telus Corp. (T) was reaching the Manulife team’s sell target price, so the managers started to reduce the position in the telecommunications company. “There was a lot of noise about trying to attract a U.S. (telecom) name into Canada,” says Wicks, “and Telus equity went from $37, where we had been selling, down to $30 during the summer period. So we modelled that in to calculate the new price of Telus and we were in the market buying that security again.” Today the stock price is getting close to their sell target again.
Though Manulife Monthly High Income is a primarily domestic mandate, foreign diversification plays a significant role. About 21% of the fund’s assets are in U.S. equities, a weighting that Wicks says has been fairly consistent for about six years. He notes that because the U.S. is such a large and diverse market, it offers opportunities beyond what can be found in Canada.
Among them is Kraft Heinz Co. (KHC), a consumer packaging and beverage company, one of the fund’s top holdings. “Kraft is one where you have excellent brand awareness,” says Wicks. “The company has gone through a management transition, culling some names that aren’t as profitable, and we think going forward they will be successful.”
In the bond portion of the portfolio, the Manulife team doesn’t make unduly risky bets on credit quality. Bond holdings must be investment grade, with no holding having a credit rating lower than BBB. Currently, the holdings are all corporate bonds, yielding just over 3.5%, and the weighted average duration is less than six years.
In August 2015, Manulife capped the $9.2-billion fund to all new purchases. Wicks says that once a Canadian balanced fund reaches about $10 billion in assets, it’s not as easy to make shifts in asset classes or trades in individual securities. “A high priority is that we continue to deliver the returns that our clients expect,” he says. The decision to cap the fund will be reviewed at least annually.