PODCASTS

PARTICIPANTS

Mark Brisley
Managing Director and Head of Dynamic Funds

Oscar Belaiche
Senior Vice President and Portfolio Manager

PRESENTATION

Mark Brisley: Hello, and welcome to On the Money with Dynamic Funds.

I’m Mark Brisley, Managing Director here at Dynamic, and joining me for today’s conversation is Senior Vice President and Portfolio Manager, Oscar Belaiche. Our aim with On the Money is to provide access and insight into the investment management process and capabilities here at Dynamic Funds.

Oscar has been with Dynamic since 1997, and he is the Head of the Equity Income team that manages over $18 billion in assets. He has built a 20 member-plus team that focuses on investing in quality businesses at a reasonable price, and securities that pay a dividend or distribution. He brings over 38 years of business, operational and investment experience as a money manager, asset manager, developer, and corporate banker.

Oscar says often that defence wins championships. At the heart of this sentiment is his investment philosophy - searching for attractively valued, high quality businesses that are leaders in their industry, with strength in the following areas: management teams, returns on invested capital, free cash flow generation, and balance sheets.

Defence means also being willing to forego some of the upside of the market so that they can try to protect from some of the downside as well, because slow and steady, or staying invested, wins the race over a full market cycle.

Oscar, it’s a real pleasure to have you here today, and thank you for joining us.

Oscar Belaiche: I’m here and thank you very much, Mark. Pleasure to be here.

Mark Brisley: I wanted to tap in first to your 23-plus years of portfolio management experience. You’ve approached this COVID crisis by saying you’re going down the fairway. Can you explain what that means and how that impacts how you’re investing?

Oscar Belaiche: Sure. When COVID hit, there really wasn’t a lot of information about what might happen, and to this day there are a number of questions as to how this is all going to play out. If you think about it, there were two tails or two potential outcomes at the end of the probability spectrum.

The first tail would be, we enter into a Great Depression, we have high unemployment, massive job losses, and it’s not a pretty picture. That was one of the risks that we faced.

On the other hand, if we were able to find a solution to the COVID issue by science - i.e., a treatment or a vaccine - then we would then move towards a recovery scenario very quickly.

Given, at that time, we didn’t have the information that we do even today a couple of months later, the positioning of the portfolio was more, do you want to be exactly wrong by saying one of these tail events is going to happen, and/or exactly right; or do you want to go down the fairway or go down the middle and adopt more of a neutral positioning, so that whether one case or the other case goes, our primary mission is to protect capital.

We didn’t want to be in a position where we were positioned for the extreme good case and then the worst case happened. We would always err more towards protecting capital and protecting the downside. By going neutral, we’re going neutral and we’re going down the fairway with very high quality securities. That’s how we look at going down the fairway.

Mark Brisley: Oscar, one of the questions I’m sure is top of mind for everyone as we continue to go through a very challenging time, both with the virus and economically, is what does the recovery look like, and what are your expectations of a post-lockdown economy?

But maybe more specifically, could you share with us some of your more macro-secular views on a post-pandemic world?

Oscar Belaiche: As we’ve seen, everything has now come into question. We’re in a world where economic disparity, income disparity is coming to the fore. Most recently, as it relates to what I believe is a direct result of the riots and the protests that are taking place in America and somewhat in Canada as well. We have to look at it like everything’s changed and we don’t know when we’re going to get back to how we were, so people are calling this the new normal; how do we move towards the new normal.

Certain themes that were in place prior to COVID breaking out have been even more magnified. What do I mean by that? Well, in technology there was already a significant move towards digitalization - or the ability to work through Internet or email communications rather than physical communications. That has accelerated, such that Microsoft’s CEO said that 10 years’ advancement in that area has been compressed into two years. That’s one example.

Another example in terms of how we’re looking at how do you invest in the future economy is the theme that I’ve also talked about that is repeated more and more, which is the big get bigger, the strong get stronger, the rich get richer. Conversely, the poor get poorer, the small get smaller, and the weak get weaker. That theme has been accelerated, and I think that that’s why, in the stock market particularly, the companies that are in the public entities are very strong. They’ve been able to produce better returns than what you might expect when looking at what’s going on in the economy itself.

As we look at different themes—I call it rabbit holes, there are rabbit holes everywhere. For example, as we’ve seen in senior’s housing, there’s implications on the care that’s been provided, the health aspects, the safety aspects, and how that may change now to have cleaner facilities, better care, better oversight; that’s one area.

Another area is, are people going to want to live more urban or suburban, or what’s called exurban where they don’t want to necessarily live in a high-rise in a downtown setting. They may want to live in a home with some land and parking, more than living in a condo, as an example. Everywhere you look, those are some of the issues; those are in real estate, for example.

There’s issues about labour versus capital and if we’re going to be on-shoring or bringing back supply chains that have been pushed out to the rest of the world as part of globalization. We’re going the other way now, and as part of that you’re going to bring factories closer to homes, there’s going to be more automation, more robotics, more technology.

There’s the issue of universal basic income, as to how do you take care of these people. So that left tail that I talked about, the Depression scenario, that that was mitigated by fiscal and monetary stimulus coming from the government and the central banks. How long can that keep going? Again, what are the implications, because right now you need that medicine, so to speak, to keep people able to pay their rent or pay for their food or whatnot when they’re unemployed. The top up provisions have been very, very helpful in mitigating that Great Depression scenario and that left tail scenario.

Those are some of the things that we’re looking at as we look for an economic recovery. Certain areas of the market or of the economy are doing extremely well. As I mentioned, technology as an example. Vacation homes could be another example: instead of going on exotic vacations, maybe you want a second home or a vacation home or you want to rent a cottage and stay more local, than you’re going to fly off to some exotic place.

Again, everything can change if there’s a treatment, a vaccine, that eliminates the fear for the older people. These are all part of what the economic recovery and the post-pandemic economy’s going to look like. Every one of these rabbit holes requires real thought as to how to position your portfolio relative to the changes that are taking place before our eyes in our society, in our economy, and how companies and people are dealing with this pandemic and the results of the pandemic.

Mark Brisley: Since March, Oscar, and as we’ve watched this pandemic unfold and the situation evolve, central bank action has resulted in just a phenomenal amount of stimulus being put into the system. Do you believe that the central bank action has put in a bottom or a safety net for the equity markets? And how does this affect equity investors, and more specifically, equity investors in search of income?

Oscar Belaiche: Yes, there’s no doubt that what I call the bazooka - in other words what’s commonly referred to as the bazookas of central bank actions - and also the government or fiscal actions that have been taking place, both fiscal and monetary actions, have helped put in a safety net in the economy and for people.

Now, the concern is how long can that last, and how long will it take for people to get reemployed? It’s not, in my opinion, something that the reemployment levels are going to accelerate that quickly, as long as people are more reluctant to go out and do what they used to do, and as long as certain service areas of the economy and large gatherings in the economy are still curtailed. We’d all love to go to, say, a hockey game or an NBA basketball game, as an example, or a concert or a riding show, etc., whatever your hobbies were. But we can’t do that very easily, if at all, right now, and so there is a safety net. The question is, how long will the governments and the central banks be willing to put the safety net in place? And so far they basically said, it’s unlimited as to how long they’re willing to put that safety net in.

In terms of equity income investors, what we do is for us, the most important thing is the sustainability of the cash flow that we invest in and the income stream or the dividends that we receive from the companies, so that we can have companies that, over time, can continue to pay their dividends. We’re focused on the largest of the large, the best of the best, the strongest of the strong, as we look to position ourselves so that we will continue to be comfortable with the quality of our investments and the predictability and the security of those investments as we look forward into this uncertain future.

Mark Brisley: The notion that as an investor ages and becomes more in need of the income from the investment that they hold— does this lower for longer interest rate environment force investors that are in need of income - and as you said, sustainable income - into equity positions they might not otherwise have looked at?

Oscar Belaiche: Yes. The issue right now is that cash is incredibly low return: I think it’s 25 basis points or 0.25 percent you can get on your cash in a high interest savings account. It’s difficult to retire and have enough money to live off of 0.25 percent without eating into your principal, if you hopefully have enough principal to live off your principal. But if you don’t, the idea is to generate those income streams from your principal to create an income stream.

What we believe is that the value of those dividends, from companies that continue to pay them, has actually increased, because the difference between the dividend yields today and the what we call the risk-free rate or the cash rate that you may be able to get on your money, whether it’s a high interest savings account, short-term rate, or even a 10 year bond today in the U.S. is 0.66 percent, and in Canada a little bit less than that.

There’s really not enough income in those choices, but there is security of capital. How do you blend the cash and the fixed income components of your portfolio with the dividend component? I believe that that dividend component is going to be even more important as we look forward, particularly as you’re moving towards your retirement years, or in your retirement years.

Mark Brisley: That’s an interesting point, Oscar. Maybe I could ask you for your opinion then on just what is the landscape right now, in your investor view, for dividend-paying equities? What are you hearing about companies maintaining, reducing, or outright cutting their dividends? And now, how’s that shaping your approach to choosing dividend-paying securities?

Oscar Belaiche: The stock market, as I mentioned—whether for what primarily we concentrate on is the Canadian and the U.S. market, or the other concentration we have is the global or ex-North America market, but only the developed markets not the emerging markets; again, the best of the best, the strongest of the strong.

When we look at the landscape, there’s been very few dividend cuts. As long as things can sustain themselves, the market’s already anticipating a recovery and it’s already backed off from the worst case or that Depression scenario, as we’ve seen, in terms of how it’s been performing. What do you do? What we’re seeing is there’s very little reducing or cutting of dividends in the type of companies we’re in. Of course, if we were invested in a restaurant, a street-front restaurant that hasn’t been able to open, and when it opens, it opens at 25 percent or 50 percent capacity, it’s really hard for these businesses to make any money at anywhere near those levels. They need more like 65 percent to 75 percent occupancy just to break even.

We think that the capital markets, the equity markets, are very attractive for dividend-paying equities, and that we’ve seen very little dividend cut in the investments we’ve had. We’ve had one company suspend its distribution that we no longer own. And one company cut its dividend in half; it’s an energy company that’s still a high quality company but wanted to prudent, and so they cut their dividend in half. Other than that, we have not seen any dividend cuts.

As an example, in the banks, the banks have not had any dividend cuts, in the main banks, the major banks that we’ve invested in. We believe that their dividend is sustainable. Something we’re constantly watching for, and we will continue to monitor the dividends and the ability of those companies to continue to pay those dividends as we go forward.

Mark Brisley: Oscar, you’ve always had an insightful opinion on the impact of investing and demographics. As we look towards the future, do you see an impact on how this pandemic could potentially change investment behaviour or investor behaviour for different demographics? I’m thinking specifically of Millennials and Gen Z who are needing to focus more on savings, versus Boomers, who are obviously entering that retirement income phase of life.

Are there any secular themes among the demographics themselves that you’re seeing?

Oscar Belaiche: Yes, that’s a great question. In terms of demographics, I would say, what we’re looking at now is—there’s a saying, wounds heal and scars last. Again, as part of the rabbit holes, what will investor behaviour be, what will people’s behaviour be, demographically, as we move forward? I put the demographics into three buckets, from a financial perspective.

The first bucket is the younger people, the under 30 who are finishing University, or starting their first job, or have a few years’ work experience. For them, their financial position hasn’t really changed significantly unless they’ve lost their job, and then they’re just sort of hanging on, but they’re not investing because they don’t have that ability in a material way, either way you look at it.

Then you have, let’s say, the 30 to 50, 55 year olds. That would be those who have now gotten married, who have families, who have a mortgage to pay, have expenses. Their situation is where, I think, that there could be some scarring and that their approach is going to change as we go forward. If you were living your life well but had expensive leased cars or a big mortgage and now you’ve lost your job because it’s in an industry that’s been impacted then your life has completely changed. As you rebuild yourself and hopefully things get back to this new normal and we do find a cure - which I hope science prevails and I believe science will ultimately prevail - then as you get back you’re going to want to save more.

We’re already seeing that, even though there’s money that’s been put into the system, people are saving their money now. They’re not going out as much, they’re not spending as much, and they’re becoming bigger savers. For those who may have experience going back to the Great Depression, that really scarred the people who lived through it - that for the rest of their lives, they were frugal, they were careful of what they spent.

I think there’s going to be an element of that with those who maybe didn’t save enough and weren’t as careful as they could’ve in having money set aside for a rainy day that we’re just going through now.

Then the final group of people are those, they call it 55-plus, who are either pre-retirement or retirement. Financially, for the most part, if they’re in a retirement situation, they’re probably pretty well off. Their financial assets have not been destroyed in this market that we’ve seen to-date, but their concern more is, hey, I’ve got to be very careful if I go out because I’m older and I could be more at risk. I have a pre-existing condition.

They may just move into more of a sheltering in place environment of, say, wanting to make more local vacations, not necessarily wanting to be going too far from home. Second homes, maybe having more amenities in their homes; those are sort of the implications demographically that I see, as we go forward.

Mark Brisley: Oscar, you’ve been working for more than 23 years in portfolio management, and all along that time you’ve been working very closely with investment advisors. What would you say to investors today about working with an advisor to find and build a resilient portfolio that can produce income - a goal that, probably for many, seems more challenging based on where we are today.

Oscar Belaiche: Yes. As we look forward, I think one of the most important things is that you’ve got to make sure you’ve got proper diversification of your asset base. If you had all your money in a restaurant, let’s say, and you didn’t diversify, then you’d have some issues today. Whether it’s a restaurant, an airline company, a sporting event type of ownership, diversification is very important.

Secondly, you have to look at what’s called outcome-based investing. What is it you’re trying to achieve, what are your goals? This is where working with an advisor is really critical - because advisors can say, what are your goals, then tailor a financial plan to meet your goals.

For us, our outcome-based investing approach is that we’re going to invest in quality. We have an acronym called QAARP, quality at a reasonable price. We’re going to do everything we can to protect your capital. Rule one from Warren Buffett is protect your capital; rule two is never forget rule one. But then there are times that you can implement rule three, make hay when the sun shines. There are times to make money.

You always have to have a view in that area. For us, what’s more important is owning those companies that can continue to generate free cash flow, ideally, although certainly not today, can grow that free cash flow, although there are certain companies that are going to be able to maintain their cash flow a lot better than others, i.e. some of these tech companies that are pulling forward technology and digitization.

What Dynamic’s always done is we’ve always prided ourselves on making sure that people invest with advice, and that clients work with an advisor to come up with their plans. It’s very easy to get shaken up by the news and by events that are taking place. As we see today, even though there are all kinds of events going on out there, that the market’s actually been pretty resilient.

It’s important to stay the course in terms of the plan you have and how you’re going to try to achieve that, but obviously make adjustments or tack, to use a sailing term, if you need to shift around a bit and readjust.

These are all things that I believe are very, very important for an investor to consider, in terms of how they’re looking at building a resilient portfolio, and how they’re going to be positioned safely for the future.

Mark Brisley: Oscar, that’s great advice, and this has been a really insightful discussion given the current and unprecedented times we find ourselves in. I wanted to thank you for joining us today.

For more information on Dynamic Funds or anything that Oscar discussed on today’s podcast, please reach out to your financial advisor or feel free to visit us at dynamic.ca.

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