David Taylor, president, chief investment officer and founder of Toronto-based Taylor Asset Management Inc., owes his winning investment performance in 2016 to his willingness to recognize and embrace opportunities at home. In contrast, many of his peers had cut their domestic exposure and foreign investors fled.
Taylor manages IA Clarington Focused Canadian Equity Fund, which finished 2016 with a gain of 36.9% – placing the fund first in the “Canadian focused” category as measured by Toronto-based Morningstar Canada. That performance is three times better than the category’s average one-year gain of 11.4% and was solidly ahead of the 21% gain of the S&P/TSX composite index.
“I felt like a salmon swimming upstream,” says Taylor of his move a year ago to increase the IA fund’s Canadian exposure to 75% of assets under management (AUM) from about 55%. The fund’s mandate as a “Canadian focused” fund requires Taylor to have at least 51% of AUM in Canada.
“In early 2016, everyone was doing whatever they could do to reduce exposure to Canada. But I believed that with valuations lower, there was lower risk,” says Taylor. “The underperformance of the Canadian market relative to the U.S. had been staggering for the few years prior to that, and people were talking about a Canadian recession.”
As a value investor, Taylor looks for temporarily unpopular stocks. Not only did he increase the IA fund’s weighting in Canadian stocks last year, he increased his exposure to energy companies, focusing on oil producers that were suffering from the severe drop in oil prices.
The popular view last year was that rock-bottom oil prices would be a continuing disaster for oil producers and also could spill over to the big banks that were huge lenders to the industry.
“When oil is at a price at which 90% of the world producers can’t make money, that’s not sustainable,” Taylor says. “The lower the price goes relative to the cost of production, the more potential [the price] has to snap back. We saw the opportunity to buy companies below net asset value – companies with good plants, infrastructure and hard assets.”
One of the IA fund’s largest positions was Paramount Resources Ltd. Taylor began buying Paramount stock at $4 a share and watched the share price rise to the $19 range. Paramount stock, now trading closer to $16, is still one of the IA fund’s largest holdings.
But energy isn’t the only arrow in Taylor’s quiver. His portfolio holds other overlooked stocks, including Labrador Iron Ore Royalty Corp. and lesser known U.S.-based financial stocks such as regional bank Regions Financial Corp. and bond insurer Assured Guaranty Ltd.
“[The IA] fund has benefited from large, overweighted positions in the two hottest sectors in the Canadian market – resources and materials,” says Rudy Luukko, investment funds and personal finance editor at Morningstar. “[Taylor] has never been shy about crafting a portfolio that looks different from the market index, and that’s proven to be favourable for the IA fund.”
To be No. 1, your fund portfolio can’t look like those of other funds or like an index, according to Taylor: “These days, advisors need a fund that adds value. Otherwise, they can just go out and buy an ETF for their clients. To justify our fees, we need to build a portfolio that doesn’t look like a low-cost index alternative – we must have names that are different.”
Although Taylor’s strategy can pay off when the value of undiscovered or unpopular companies is recognized, he also must be patient and wait for the market to turn. The IA fund’s portfolio dropped by 3.4% in 2015, when expensive stocks such as Facebook Inc. and Google Inc. continued to rise as investors were willing to pay up for growth.
“In 2015, no one wanted value,” Taylor says. “We stuck to our knitting and, in 2016, made up for it in spades. There always are periods in which value underperforms growth, but I’ve never seen a period in which value was on sale to that degree.”
In recent years, cautious investors have turned to low-volatility, dividend-focused stocks such as telecoms, utilities and pipelines, Taylor says, but he hasn’t focused on those defensive stocks: “Those kinds of securities don’t do well when the economy strengthens. Value stocks began outperforming growth in late 2016, and a lot of investors are behind in this trade. In the late stages of a growth cycle – at which I believe we are now – cyclicals outperform defensive stocks and staples.”
Taylor describes his economic outlook for 2017 as “positive,” and expects Europe and emerging markets will join North America in showing a pickup in growth rates: “The outlook is good for late-cycle performers, which is what Canada is about.”
About 65% of the IA fund’s AUM is in Canada and the balance is in the U.S. Taylor runs a concentrated portfolio of 20 to 25 names, but tends to turn it over about once a year on average as he seeks the next generation of winners.
He’s looking forward to picking up some bargains when 2017 earnings are released, and companies that temporarily disappoint are “buy” opportunities.
He expects that U.S. President Donald Trump will be a tax- cutter, which will be positive for corporate earnings and consumer spending. As well, the new administration is likely to spend on infrastructure, which will be positive for machinery and industrial products. And Trump’s pro-pipeline stance is likely to boost energy shares.
Taylor also is watching for trade protectionist policies in the U.S., and will adjust the IA fund’s investing strategy to take advantage of this policy shift.
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