PARTICIPANTS
Mark Brisley
Managing Director and Head of Dynamic Funds
David Fingold
Vice President and Senior Portfolio Manager
PRESENTATION
Mark Brisley: Hello and welcome to On The Money with Dynamic Funds. I’m Mark Brisley, Managing Director of Dynamic Funds, and joining me for today’s conversation is Portfolio Manager, David Fingold. Our aim today is to provide access and insights into the investment management process and capabilities here at Dynamic.
With over 30 years of business and investment experience, David has been a key member of the Dynamic investment team since joining the firm back in 2002. Over his career, he has held senior positions in corporate finance, sales, marketing, across industries that include manufacturing, transportation, distribution, and of course investment management.
Extensive travel professionally and personally has fostered David’s interest in foreign markets and helped develop his ability to effectively navigate cultural, economic and political differences. He is currently Lead Portfolio Manager for a number of global and U.S. strategies and has received numerous industry awards for strong fund performance.
David, welcome to the call today, and it’s a pleasure to discuss the current market environment with you as countries around the world look to recover from the COVID-19 pandemic.
David Fingold: Thank you for having me on.
Mark Brisley: David, I wanted to start first and foremost with, as an investment manager, how do you incorporate an unprecedented macroeconomic event or even a non-economic event like a pandemic into your investment process?
David Fingold: I think that people throw around the word unprecedented quite a bit today. I think the reason why is because very few people have studied history; in fact, Mr. Buffet said that the one thing we’ve learned from history is nobody learns from history. We have an economic disruption that’s been created perhaps by COVID-19 and also perhaps by the price war between Saudi Arabia and Russia and the price of oil. We also have a pandemic: now understand we also had H1N1 and SARS, we had Hong Kong flu. Pandemics happen from time to time and can have significant influences. We had a pretty serious earthquake in Japan in 2011 that disrupted global supply chains.
The way we deal with it is while we are mindful of the human cost of all these events, whether it be in the case of unemployment or health, we need to be emotionless when it comes to investing. These are all events that can cause disruptions in the economy, disruptions in credit markets. The way we address it, first of all, is to build a resilient portfolio, that is by owning high quality companies that will outperform when bad things happen, and secondly to have the liquidity and the intellectual flexibility to take advantage of any opportunities to buy good businesses when they go on sale because of these disruptions.
Mark Brisley: David, we saw no shortage of volatility when this pandemic started to first reach global proportions, and if we look back to early March, that was where it was at its most extreme.
We’ve now seen the U.S. and global equity markets move off of those lows in March. Do you believe we’re entering a new bull market, or are we just experiencing the signs of a bear market rally?
David Fingold: ell, from a technical point of view, we did fall more than 20 percent from the peak, so that started a bear market. As far as new bull markets are concerned, I am a believer that they start when the market takes out new highs. I don’t know when the market will take out new highs, but there is plenty of upside between now and when we get to that point in time. Nobody knows how long that’s going to take, and I think that these are all really important concerns if you’re buying an index fund or if your manager is a closet indexer.
But as active managers, we see things differently. There was an environment of risk that got created in late February and through the end of March. The risk came from what happened to interest rates and commodity prices, and also what happened to credit markets. Central bankers intervened to address the monetary aspects of this at the end of March, and that was able to improve credit markets, and that allowed the economy to stabilize.
That’s created an environment where businesses with healthy fundamentals are able to do well between now and when the market takes out new highs, and that’s the difference with active management. There are businesses that remain challenged today because of some of the policy responses, including social distancing. And this is not the only thing that’s going on. There is the natural resource sector that has been affected by a lack of demand, and again that is an area that perhaps we need to avoid.
What we like to do is we like to focus on the good things that are going on in the world and invest in them, and when we see things that concern us where we don’t see improvement, we simply avoid them. Again, that’s the power of active management. The averages are composed of hundreds of companies, in some cases thousands of companies, and we just need to come up with 25 or 30 companies where business is getting better for them in order to have an attractive investment opportunity.
Mark Brisley: David, a point you have been emphasizing is that the market is not the economy and the economy is not the market. Why is it important for investors to recognize that, given the often conflicting news about the economy and the performance of the stock market itself?
David Fingold: Yes, I understand the confusion because I think that the media is constantly telling people that the stock market is an indication of the economy. And the stock market doesn’t look remotely like the economy. The stock market, for instance, has a significant exposure to technology and healthcare, and the economy is very different. The economy has broader exposures to industries that simply are not publicly traded businesses.
People get confused when they see the unemployment numbers rising and the market going up, and what they miss is that the market is going up because of resilient - high quality global businesses that consumers and businesses need to work with and need to do business with are resilient and are continuing to be profitable.
The other thing that I think confuses people as well is that they want to look at the market as an absolute indicator of the state of the economy, and I think that that’s completely wrong. The stock market does not know good or bad, it only knows better or worse. Things were getting worse in late February and throughout the month of March, and things have been getting better since the end of the month of March. In fact, if you were to overlay jobless claims versus the stock market, you’ll see that as the number of people who are claiming unemployment has fallen, the stock market has moved up.
Again, that confuses people because they see a growing number of people who are unemployed, they just don’t understand that we actually seen green shoots. We see something that is less bad when several hundred thousand people claim unemployment this week than claimed last week. As long as less people are making claims, we see that as better, but it is clearly not good. But it doesn’t matter - the stock market only likes better.
Mark Brisley: That’s an interesting point, David, because you mentioned in your previous comment around an active management overlay to investment management versus indexing. Given that view and that you see some optimism in the markets and you’re constantly looking for opportunities, in your opinion, why is active management effective in the way you run your portfolios in this current environment? And I guess a bigger question: is index investing dead?
David Fingold: discussion about index investing, because it’s not a discussion that I enjoy having. But the mainstream media is constantly telling investors that active managers cannot outperform their benchmarks, and therefore they should index their money.
I think that what’s very frustrating about this is that there is a kernel of truth in that view, because it is the dirty secret of our industry that many people who call themselves active managers are not. I believe I am an active manager. You can see that in my active share that’s on our fund fact sheets every month. It allows investors to see that we are not hugging an index. Many of our competitors will not post their active shares. They own hundreds of companies, where we own 25, 30 companies tops and they’re highly correlated with indices.
I think that I can understand why people are moving away from closet indexing towards passive. We would like to see them consider some active within their portfolio, the issue is it needs to be legitimately active. That’s where the due diligence that an advisor provides is so important, because it’s necessary to make sure that managers are really doing what they say they’re going to do, and if we say we’re active, then we are.
Mark Brisley: David, based on the opportunities that you’re seeing right now and the mandates that you run here at Dynamic, I wanted to focus on three of your investment portfolios in particular. They cross U.S. and global equity positions, and I’m speaking of course to the Dynamic Global Dividend Fund, Dynamic Global Asset Allocation Fund, and the Dynamic U.S. Fund.
Could you walk us through how you are currently positioned, given the previous comments, in terms of your outlook?
David Fingold: Right. Well, what you’ll find is that we are presently near almost fully invested positions, and that is reflecting the current state of credit markets, which have repaired almost all the damage since the end of February. It’s also reflecting the incremental improvements in the economy from the position we were in at the end of March.
As far as the industries we focus on, they haven’t changed a whole heck of a lot simply because technology and healthcare are the two best performing industries of all time, and we really don’t know what’s going to change that. On top of that, healthcare is just coming out of a five-year period of underperformance that started with Hillary Clinton’s tweets about Valiance during the election campaign in 2015.
I particularly like healthcare because after taking a time-out for five years, one of the best performing industries of all time is reasserting itself; and frankly given the concerns about pandemic risk and broader concerns about health, healthcare seems quite timely.
The other thing I’d say is that the risk-reward is very interesting, because in prior bear markets - and that includes the bear market experienced during March or the near-bear market condition experienced in December 2018, for instance - healthcare outperformed. It has a record of outperforming bear markets. We are near fully invested. We are optimistic about the future, but if we’re wrong, it’s a very conservative investment proposition to have a significant exposure to healthcare because it has outperformed historically during bear markets.
As far as our country exposures are concerned, I believe we have a bit less exposure to the United States than we had before the volatility hit, but I would say that it still remains our largest country weight. Statistically, the United States and Switzerland and the United Kingdom are the three best performing stock markets of the last 100 years, so we like to look in those markets for opportunities simply because there is that historical tailwind. I don’t know if I need to justify that historical tailwind. Switzerland and the United States have very strong currencies. Britain is going through a challenge right now as it works through Brexit, but I do believe as that circumstance stabilizes, that Britain will be more prospective. We are still involved somewhat.
We also like Japan, but for very counterintuitive reasons. In every correction since 1970, the Japanese yen has gone up, and the same thing is true of the Swiss franc and the U.S. dollar. We like about Japan that you’re packing a parachute when you get exposure to the Japanese yen. It also happens that, notwithstanding all the concerns people have about Japanese demographics and the poor performance of the Japanese averages, some of the best quality companies in the world, some of the best global franchises just happen to be in Japan. Again, as an active manager, we can completely avoid the large Japanese companies that have dominated their indices and held back those averages, and invest in more moderately sized entrepreneurial companies that have shown a long-term record of growth.
Mark Brisley: David, based on that, I think it would be beneficial for our listeners to have you talk about a few examples of some of your longer-term holdings that will be survivors, or even winners during these times across your mandates.
David Fingold: Certainly. While we’re on the topic of Japan, I thought I’d mention Hoya. Camera buffs would be familiar with Hoya - there is a good probability that if they had a filter on their lens, that it was made by Hoya. Their expertise is working with glass, so for instance they’re the second largest producer in the world of endoscopes, their brand name is Pentax and, again, that helps facilitate minimally invasive surgery. Hospitals, as you know, are now reopening, so there’s some pent-up demand there.
They’re also the second largest producer in the world of eyeglass lenses and they’re the low-cost producer of eyeglass lenses, and again people are going to have the ability as social distancing backs off to be able to go to the ophthalmologist or the optician. As anybody with glasses knows, they wish their vision was getting better, but unfortunately over time they need to change their lenses, so there’s pent-up demand there. The aging of the world also speaks to the demand for eyeglass lenses.
They’re producers of lithography masks - that’s literally used for the photolithography to produce silicon chips, that is literally to put the markings in the wafer. There is really no alternative to them at the leading edge nodes, so when you hear about 10 nanometre, 7 nanometre, 4 nanometre, it’s getting facilitated by their lithography masks.
Finally there is their hard disc platter business where by moving from aluminum to glass platters and hard discs, you can put two more platters in, which is approximately a 10 percent or 15 percent increase in capacity. Certainly we’re all using more and more data, so everybody is looking for a method to increase storage capacity.
We think Hoya is very well positioned not only for current trends but also for some of the pent-up demand.
Mark Brisley: You—
David Fingold: On the topic—sorry?
Mark Brisley: No, that’s okay. You had another name of interest as well, but go ahead.
David Fingold: Yes, I was going to talk about Lonza in the healthcare space, because, again, it’s become very topical right now, the topic of treatments and the topic of vaccines. Lonza is a company based in Switzerland that is a contract producer of pharmaceuticals, so they don’t actually develop any drugs.
Pharmaceutical companies develop the drugs, but when they are—when a pharmaceutical company is seeking to produce a drug, they have two choices: they have to build a factory, or they have to hire somebody to make the drug for them. If they build a factory, they have a very big problem if the drug is not a success, so there’s a benefit to be a contract manufacturer because you can handle a multitude of different drugs for different drug companies and manage that risk for the drug company, and also allow pharmaceutical companies to avoid having to build their own factories. Lonza is actually the manufacturer of many of the best selling biotech drugs in the world and they’re also a strong manufacturer of vaccines.
Now, we’ve been also hearing a lot from governments about moving pharmaceutical production back to the western hemisphere and to Europe from Asia because of the reliability and the quality issues that we’ve seen. Lonza strongly stands to benefit from that because they really are the trusted partner of the pharmaceutical companies, and they’ve been gaining market share over the last five years as drug production has been moving back to the western world.
Mark Brisley: Great, thanks for those insights, David, on those names.
I wanted to ask as well, with the volatility that we’ve seen in the market since late February, early March, have you done anything differently from a risk management perspective on your mandates?
David Fingold: We haven’t done anything differently, we’ve simply followed our process. Our process is that when bad things start to happen, we will move to preserve capital.
To refresh everybody’s memory, at the end of February interest rates began plummeting, credit spreads began widening, commodity prices began plummeting. This isn’t my first rodeo - I’ve seen that happen before. It means that we have to shift to the defensive. We can’t make money on stocks that are going down, so we moved to raise cash. Some of our portfolios raised very significant amounts of cash, and then as we saw the situation begin to stabilize, as we saw commodity prices stabilize, credit spreads compress, some volatility start to fall within the stock market, we put the cash to work. To quote my mentor, David Goodman, he said, when you raise cash, you have to be right twice.
It’s not an enjoyable part of the job to have to manage risk on that basis, but when we tell our clients that a certain fund is low to moderate risk, or it’s moderate risk, there is an implication where we have to actually step up and try to take corrective action in order to mitigate risk.
We can’t promise to remain at a particular volatility level, but we can promise to try our hardest to maintain the risk profile that we’ve represented to our clients.
Mark Brisley: David, when you assess risk in your portfolios, you’ve often talked about the importance of looking at credit markets, and some investors may find it interesting that an equity manager spends that time looking at credit. Can you talk a little bit about that part of portfolio management for us? And as a follow-up to that question, in the management of risk, how does the addition of gold bullion in your funds address emerging risks in the marketplace?
David Fingold: Yes, let’s start with credit. I think it’s a very important point, and unfortunately we have to flash back a little bit to finance class. I think that what a lot of equity investors forget is that they’re at the bottom of the capital stack, and that’s a technical expression, as you know, that means that we can—it is that if a company sustains a loss, we have to sustain the first loss as the equity holder. Basically, until we are wiped out, none of the losses will go to the creditors, and that could be bond holders, banks, it could be trade creditors. We have to sustain the first loss because we own the equity.
Every time we look at a company we do very detailed credit analysis, and I’d say it’s actually quite a bit more rigorous than what a fixed income investor would do because, again, they have us standing in front of them, so because we have to be on the front lines, we have to set much higher standards.
Anyway, we require that the management teams of the companies we invest in disclose all their covenants to us and help us model their sources and uses of cash, so we can see that they can meet their obligations - that’s part of the process. If credit markets deteriorate, obviously any companies that we have that have a bit more debt than the other ones need to be kept on a shorter leash. It’s also an advantage for the companies that have no debt, so all things being equal, we would rather invest in companies that owe money to nobody.
It’s an important way of managing risk. Quality outperforms over time and quality outperforms in particular when volatility rises. Again, another refresher from the finance textbook, quality is a composite rating of the quality of a company’s balance sheet, and ideally they have no debt; its level of profitability, and ideally it should be as profitable as possible while still reinvesting in the business; and their consistency of profitability, although I think it’s very important that in a worst case scenario that they can at least break even. By incorporating that within our process, it helps us mitigate the risks we’re facing.
Now, you asked me about gold bullion. Gold bullion can reduce portfolio risk. Our retired chief economist, Dr. Martin Murenbeeld, did a study where he looked at adding gold bullion to a portfolio and what it would do over time to the portfolio’s risk characteristics. He identified a 5 percent target, and ideally one would rebalance if it hit 7 and would rebalance if it hit 3, and looking at a period of time beginning with when the gold price became freely traded in 1970 it appeared to reduce portfolio risk.
It’s a tool that we use from time to time. You will see it in the low to moderate risk portfolios - that is, global asset allocation and global dividends. It’s an additional risk mitigator there.
What I want to be clear about, though, is that when I say gold bullion, I literally mean 400-ounce bars of gold. We know we own our gold, we know where it is, compliance and accounting goes down to the vault and audits it to make sure that the inventory is there and that is the five-ninths fineness that we expect. It is literally the ultimate safety asset.
But one thing I’d warn people about on this is that Dr. Murenbeeld would always say, you don’t want your gold to be doing well because if your gold is doing well it means that risk is elevated. You actually don’t want it to be doing well because it means everything else you own is doing well, so I want people to understand that we do believe we’ll make money over time in our gold, but very frequently it’s going to underperform because the rest of the portfolio is doing well. It’s there as a diversifier, it’s there to mitigate risk.
Mark Brisley: You are fond of the expression, you have to be an optimist because you’ve never met a rich pessimist. What would you like to say to investors about investing in today’s climate and meeting your long-term investment goals, especially during the situation we find ourselves in now?
David Fingold: Yes, that quote from Ned Goodman, I’ve never met a rich pessimist, I think is one of the most powerful motivators I’ve ever heard in my life. Now, it doesn’t mean one should be a blind optimist and not care at all about risk - I think that’s completely crazy. What I tell people is that if we’re optimistic and we’re conservative, that if something bad happens, in the worst case scenario we’ll pick ourselves up, we’ll brush ourselves off, and we’ll move on. I believe that being optimistic and being conservative is an incredibly good combination.
As far as what investors should do in this environment, it has to do with their own risk tolerance, and obviously talking to a financial advisor, getting an unbiased professional assessment of one’s own risk profile, I think is very important. For some people, the low to moderate risk funds may be much more appropriate than the moderate risk funds. I think that also there may be individuals who are concerned about whether they should invest today or should it be six months from now, and if that really bothers them, we have the Dollar Cost Averaging Fund which allows investors to move their money in 1/52 increments, once a week for the next 52 weeks, and then they don’t have to be concerned about picking a particular point to get involved. Again, if they want to be all in, they can switch to the underlying fund.
Many of my funds are also wrapped in insurance contracts and the insurance contracts would come with creditor protection, principal protection, some mortality protection. Those are the features of an insurance contract, and that can also help some people deal with whatever their particular risk or concerns are.
What we are trying to do is to fit into all the possible ways an advisor may have of engaging a client - or, said differently, giving the advisor-client relationship the tools that are necessary to fit our strategies with what’s appropriate to the individual.
Mark Brisley: Well, David, thank you for joining us today. This has definitely been an insightful discussion given the current and unprecedented times that we find ourselves in.
For more information on Dynamic Funds, please reach out to your financial advisor, or visit us at dynamic.ca.
This has been On The Money with Dynamic Funds, and until next time, we all wish you good health and safety. Thank you for joining us.
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