Mutual Fund Managers of the Year take the team approach

It turned out to be the right move for the RBC Life Science & Technology Fund.

With Cavallo taking the lead on the health-care side and Montanari heading up technology, the fund (Series A) is up 25.6% for the year to Oct. 31 — enough to earn them the title of Investment Executive’s Mutual Fund Managers of the Year.

By comparison, the fund’s Morningstar benchmark — the Morningstar US Market TR CAD index — was up 12.7% over the same period, and the fund has also vastly outperformed the U.S. equity category this year, placing it in Morningstar’s top quartile.

That’s a welcome rebound from a difficult 2022, when the RBC fund posted a return of –22.9% and was ranked in Morningstar’s bottom quartile. Over 10 years, its annual return of 16.1% is good enough for the top quartile.

The RBC fund straddles three S&P benchmarks: health care, information technology, and communication services minus the telecom names.

The fund’s top five holdings (which accounted for 39.6% of the portfolio on Oct. 31 — see below) are five of the so-called “Magnificent Seven” stocks. But Cavallo said the fund’s makeup is quite different from a Nasdaq 100 index fund.

“It’s something you can’t really replicate in any single benchmark, or, as far as I know, in any passive ETF either,” said Cavallo, portfolio manager, North American equities, with RBC GAM. “A tech benchmark is certainly not going to capture this fund exactly.”

He describes the fund’s approach as a “barbell” with tech and health care on either end. The health-care component fluctuates between 25% and 30%, while tech and communication services make up approximately 60% to 65%.

To capture the sometimes confusing moment we’re in, Cavallo and Montanari said they fine-tune weightings, take risk mitigation seriously, and operate with a growing conviction that the dispersion between winners and losers in these sectors will widen.

With regular input from RBC team members Matt Gowing (monitoring the technology and life sciences sectors), Kalvin Hon (media and internet) and David Tron (mid-cap tech), Cavallo and Montanari check and recheck their investment thesis, reviewing the metrics and key performance indicators that will make a difference for specific companies.

“For the launch of a new drug, the metric that is going to really matter is understanding what the trajectory of the launch curve might be,” Cavallo said. “On the technology side, it could be user acquisition growth. Once you kind of get past the traditional metrics, it really becomes a company- and stock-specific approach.”

“The process helps us focus in on what’s signal versus what’s noise,” Montanari added.

And above all, Cavallo said, it prioritizes the fund’s ultimate objective.

“This is not a high-flying ARK-type of fund,” he said. “We’re trying to provide a consistent, positive return experience for shareholders, as opposed to trying to pick all diamonds in the rough.”

The concept has proven popular with Canadian investors. The RBC fund topped $1.4 billion in assets under management, up 29% from its December 2022 total of $990 million.

“We just crossed over US$1 billion, which is a bit of a milestone for us,” Cavallo said in a mid-November interview. “So it’s been a good week.”

It’s been a pretty good year, too, thanks in large part to the payoff of two long-standing themes they were monitoring: artificial intelligence and obesity drugs.

“Technology has this tendency to go through hype cycles. And [AI] had all the makings of another hype cycle,” Montanari said. “But we decided to ensure that we were well represented on anything to do with AI, as long as it was real. You get a lot of pretenders who put up their hands in these types of situations. But we stuck to the ones that had a clear play.”

“Lots of stocks are going to trade up on the hype,” Cavallo admitted. “But we have the ability to pick and choose the stocks that are actually going to benefit versus the ones that are not.”

Montanari said databases turned out to be the rocket fuel for AI, propelling early leaders in the technology such as Microsoft Corp., Adobe Inc., Meta Platforms Inc. and Alphabet Inc.

Cavallo said the health-care sector may be one of the biggest beneficiaries of AI, thanks to the terabytes of data the sector has captured in developing drugs, diagnosing diseases, and monitoring patients. Even if that revenue potential takes years to play out, the sector is flush after launching new mass-market obesity and diabetes treatments.

“These are drugs we’ve been watching and monitoring for a long time,” Cavallo said.

For Indiana-based pharmaceutical giant Eli Lilly and Co., the reward was immediately clear. But the attention on potentially revolutionary drugs such as Zepbound and Mounjaro also caused dislocations downstream in the health-care industry. Certain companies have been affected as the market anticipated reduced need for surgeries and treatments related to diabetes, obesity and cardiac health.

“We think they were overly punished by the market, and we remain very confident in their return potential,” he said.

Other companies, such as New Jersey-based Merck & Co. Inc., have been impacted by investor money being diverted into the obesity play, creating opportunities.

On the tech side, Montanari said, there are growth drivers beyond AI, such as robotics and the energy transition.

Cavallo said prognosticating too far out is difficult and dangerous, but they remain positive on both health care and tech. They’ve adopted a philosophy of patience, steadily increasing the amount of time they’ll hold onto a stock, allowing extra time for conditions to ripen.

“We have an attitude of ‘get it right and sit tight,’” Montanari said. “We want to stick to the thesis, as long as the thesis is intact.”

Montanari came to RBC from Canadian Bond Rating Service, which was acquired by Standard & Poor’s in 2000. He was covering telecom and cable, “the perfect place to be because there was this new thing called the internet,” he said. “You could see it was going to change everything, but no one knew exactly how.”

Cable companies were over-leveraged, their stock prices tanking. “Nobody wanted to touch them,” he said. “But I said, ‘These guys are going to be carrying the internet because they have more bandwidth than the telephone companies.’ That kind of just launched me into all this.”

In 2016, after years of being a generalist, he was given the opportunity to take over the tech and growth mandates.

For his part, Cavallo was an equities researcher with a boutique investment firm in Toronto before joining RBC GAM in 2012.

“I’m a very curious person,” he said. “I love learning, and I love offering my opinion. There is no better avenue for being able to do research on something and then tell people all about it.”

One call he’s especially proud of was for Minnesota-based UnitedHealth Group. In 2012, with Obamacare being challenged in the U.S. Supreme Court, sector uncertainty led to health insurers trading low. Not only did Cavallo suspect the Affordable Care Act would remain in place, but he noticed signs that UnitedHealth was pivoting to take advantage of it.

“That’s been a home run over the past 11 or 12 years,” he said.

Over the years, Montanari and Cavallo have rolled with market fluctuations, widened the scope of their search for opportunities, and learned to sit tight when conditions allow.

Above all, they have come to trust each other’s judgment, running their observations past each other almost daily.

“Whenever I’m going through something tough, I remind myself that Marcello has probably gone through similar things,” Cavallo said. “There’s that ability to lean on each other. And that’s really special.”

This article appears in the December issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.