PARTICIPANTS
Mark Brisley
Managing Director and Head of Dynamic Funds
Oscar Belaiche
Senior Vice President & Portfolio Manager
PRESENTATION
Mark Brisley: You are tuning in to On The Money with Dynamic Funds, a podcast series that delivers access to some of the industry's most experienced active managers and thought leaders. We're sitting down to ask them the pertinent questions to find out their insights on the market environment, and navigating the investment landscape.
Hello, and welcome to another edition of On The Money. I'm Mark Brisley Head of Dynamic Funds. In the current investing landscape of low bond yields and a lower for longer interest rate environment, it's really no surprise that the conversation around equities that can provide income as an investment and asset class is attracting the attention it is. My guest today has been managing money in this area since 1997 and has fostered his views of equity income investing over a 38 plus year-career that has included asset management, property development, and corporate banking.
Oscar Belaiche is the head of the equity income team here at Dynamic. A team that now includes more than 18 investment professionals and manages more than $18 billion of assets for clients of Dynamic Funds. He's created a process that governs his team approach to managing money that focuses on investing in quality businesses at a reasonable price, which can be summed up in the acronym, QUARP. He is also a fan of the sports analogy that "Defense wins championships when it comes to investing," and has defined that as meaning that you are willing to forego some of the upside of the market to protect on the downside as well because as Oscar says, "Slow and steady and staying invested, wins the race over a whole market cycle."
Oscar, it's great to have you here today. Welcome, and thanks for joining us.
Oscar Belaiche: Thank you, Mark.
Mark Brisley: Oscar, I'll start off with asking you a question around a year like we've seen in 2020, which has really been like no other; the volatility in the market, one of the most dramatic falls we've seen not only in the market but economically. Also one of the most dramatic recoveries in history, economic forecast, and earnings forecasts are moving all over the place, and more supporting stimulus is unknown as well as the course of the pandemic. Can you talk in a little bit more detail, from your perspective, as to the reasons why this year has been so extraordinary?
Oscar Belaiche: The reason it's been a year like no other is there's some research I came across that showed that we have not had a situation like this going back to 1900. There are four events that have happened this year, and only in three other years, since 1900, have we had this situation occur. This year there were four such events. What are those four events? We've had, clearly, the COVID pandemic, which is the main event of the year, which has led to a recession, which is Event 2. At the same time, as a result of inequity, let's call it racial inequity, we've had mass protests, which is Event 3. We also have an intense election that is being fought over, that is happening within less than 50 days now, between the Republicans and the Democrats in the United States. Now, what that's led to is what I would call a scrambled chessboard because no one has had the experience of living and operating in this situation, since 1900, or potentially, pre-1900. That's how far back this data went. There have been a number of changes in our society, and people are looking to cope at it. There are varying degrees of coping, and varying degrees of distress and opportunity.
Mark Brisley: We continue to see a disconnect between valuations and the economy as well. How has this impacted equity markets?
Oscar Belaiche: What's happened is that price-earnings multiples, which is what the market is valued on simplistically, it can also be valued on net asset value or discounted cash flow. Price-earnings multiples have been expanding. There are some companies that are growing their earnings, particularly in technology, as a result of digitization, and some companies that have been adapting to this growth in digitization, and work from home. There are also a number of companies and sectors that have not been able to adapt well. They have negative growth, or no growth, or declining growth.
That's the disconnect. Why has that happened? The reason why it's happened is because there's been a significant fiscal and monetary infusion, so the fiscal infusion from governments that have provided a replacement for lost income in many cases, and monetary support to ensure there's liquidity in the market. When you put that together, the result has been that the discount rate that's used to discount cash flows has gone down, which means the cash flows that are available are more valuable. Particularly, in the growth sectors of the market, those cash flows have become extremely valuable.
We've also had a disconnect within the market between growth and value, between technology, and other sectors that are more traditional sectors such as cyclicals or defensives.
Mark Brisley: That certainly has raised this question from a lot of investors and ultimately people running money, explaining the differences between how the market is not the economy, and the economy is not the market. We've seen just unbelievable levels of stimulus, and fiscal, and monetary action that's been pumped into the system, especially year today.
What happens if this support, especially with regard to fiscal and monetary action, starts to wind down?
Oscar Belaiche: That's a great question. Absolutely critical has been this fiscal and monetary support, but as we've seen in the United States, they haven't been able to agree on the next level of support, the fiscal support, that many people believe the economy needs to keep functioning until such time as COVID is conquered, or its effects are minimized. What needs to happen for that is to get the appropriate treatment methods, which are emerging, as well as the vaccine so that we don't have to all wear masks and be distant from each other, which impacts many industries today, as we speak.
Like retail, restaurants, hotels, travel, tourism, office buildings, sports, stadiums. Any place where people gather is still needing support. The problem is, in the United States, right now, is that the support is breaking down on the fiscal side because the Republicans and the Democrats are not able to agree on what the appropriate level of support should be. Meanwhile, we have an election pending, we have a possible government shutdown, and we have recently had the death of Justice Ginsburg, which has other implications, for example, for Obamacare, which is another level of support in the economy.
It's a bit of a scrambled chessboard out there. The support, ideally, will wind down when the vaccine and treatments are stronger, and we can be more free in our ability to move around socially and economically.
Mark Brisley: Oscar, when we look at the market, you've spoken about what we're now seeing being described as a bifurcation between stocks that have benefited from the pandemic, and those that have not. I almost hate the expression COVID beneficiaries, but you've identified this concept really through a description of how it's impacted various sectors. Can you talk a little bit more about this?
Oscar Belaiche: The way you can look at is it's like a barbell. The barbell in that bifurcation is between one end, which are the COVID beneficiaries, which are, and have been the technology stocks and the growth stocks that thrive on this digitization; Pull Forward, the Cloud, the working from home, the e-commerce, the ability to deliver to home. All of these have been key factors for the COVID beneficiary sectors. Those sectors are primarily the technology sector. Amazon is in the consumer discretionary sector, so that's been a beneficiary. In the communication sector, where you have companies like Facebook and Google, and, I believe, Netflix as well, then those sectors have been the beneficiaries. The other end of the barbell, which are the vaccine beneficiaries have been lagging because we don't have the vaccine yet. We're still in this limbo-land that requires that fiscal and monetary support we spoke about. Those sectors, traditionally, I've got an acronym for them is FIREU, financials, industrials, real estate, energy, and utilities. Financials, part of what they do is obviously economy sensitive, and part of what they do is interest-rate sensitive. With rates having fallen, that puts pressure on their net interest margin. Industrials are cyclicals that are also dependent on GDP growth.
We've seen a recovery in industrials, but they've not been certainly as strong as the COVID beneficiaries on this FIREU spectrum on the other side of that barbell. Real estate has been impacted in many ways. Certainly, housing has been very supportive for real estate, as people are looking for a better accommodation and larger accommodation. Office, and retail shopping centers, and hotels have not fared well in this environment. Then energy demand has gone down because all these places aren't open compared to what they used to be. Utilities, which we believe continue to be very attractive, have just been sold off as part of a non-COVID beneficiary.
What I believe will happen is as we move towards more certainty on a vaccine, then we are going to get the FIREU sectors are going to be the beneficiaries of that as we look forward.
Mark Brisley: Oscar, one of the sectors that you talked about in your FIREU example, of course, is real estate. There's such a conversation around real estate, in particular, commercial property right now, based on, is the world ever going to return to a commercial real estate use that we've been used to? I would love to tap into your perspectives based on your background and to hear your thoughts on that looking forward.
Oscar Belaiche: Within the real estate industry, there are a number of sectors just like there are sectors within the stock market, the gig sectors. There are a number of sectors in the real estate industry. As a result of COVID, there have been a number of implications on each of the sectors. You could also frame that as to COVID beneficiary real estate, and COVID vaccine beneficiary, or non-COVID beneficiaries in light of our discussion. For example, office is definitely troubled because people have not returned to work, and even if they do today, they're only able to go back at maybe 25% or 50% of capacity. I haven't really heard much more than that. Office, if you were looking again on a one or two-year basis, then you would want to own office because it's become very, very inexpensive relative to what it's traded at historically. However, if you think that things have changed significantly, then you may want to shy away from office because what if some of the workforce will naturally no longer go to the office but continue to work from home? That would have implications on demand. When you look at retail, that's been the most hit. It was getting hit already by e-commerce, and Amazon, and shopping online, but that's accelerated.
Retail shopping centers have really been damaged as a result of people not willing to go out, and gather in crowds, and browse through goods and clothes, et cetera. They're shopping more online, and that's had huge implications on the retail sector, which was struggling already. If you look at industrial, industrial has done really well because you need warehouses. The Amazons of the world, the people who were shipping goods online, need warehouses to store the goods to have them picked up by truck, and shipped either to truck transportation, or truck to air, to truck transportation. The industrial sector has been very strong.
The other element is multifamily. Depending on the type of multifamily you have, if you have walkup garden multifamily, then that's very attractive. You can drive up to your place, and you don't have to get in an elevator. If you're in a high rise multifamily in an urban location, that's become a bit of a ghost town, then that's been more troubled. The other area has been the huge bifurcation between large and small in retail. All the small shops, the little dry cleaners, the little restaurants, the little retailers, the street fund retailers, their business is way down.
In some cases, they can't afford, or in many cases, they can't even afford to pay their rent. You're getting a lot of job loss and wealth destruction at that area. Whereas the big box retailers, that in a number of cases were deemed essential services through the lockdown, have done extremely well. There's an acronym for those companies called WATCH, which is Walmart, Amazon, Target, Costco, and Home Depot. Those type of companies, those type of businesses are absolutely going to survive and even thrive, regardless of the environment, whether it's COVID or a vaccine. That's a viewpoint in terms of how real estate has been impacted The other part of real estate is housing. Single-family housing, or single-family rental, has also become much more in demand as people prefer to have more space and are leaving their urban locations to more suburb in order to have more space. Now, interestingly, as I believe, there will eventually be a vaccine, and we are going to go back to what was normal pre-COVID. Then what happens when these people have a commute back into town to go to work if they are requested to go back to their offices? These are all things that will unfold as we look forward.
Mark Brisley: Thanks for sharing that view on real estate, Oscar. Those are really great insights,. There's so much to think about in that particular sector. You've also referred to the current environment in terms of an acronym you've coined as PEST, P-E-S-T. What is that? Walk us through what that represents.
Oscar Belaiche: What we try to do as investors is try to create frameworks for our thinking. Also, one of the frameworks is what are the themes that are taking place? In the themes, we've talked about the vaccine beneficiaries, work from home, Cloud digitization, as a big theme this year, and also that nesting theme. Related to trying to frame the environment, is this acronym called PEST, which is looking at the lens of what's going on from a political, economic, social, and technological viewpoint. On the political side, as we know, the biggest issue this year is the presidential election, and the implications of that, which could include taxing the rich and redistributing the wealth because of income inequity.
That leads into the economic issues, which the political issues we'll touch on, which include unemployment, modern monetary theory, which is the theory that governments can print money for nothing. That this income and equity worsens or has worsened, and the concept of universal basic income, where everybody should have the right to a minimum level of income to survive. That's really been brought forward this year, as millions of people have been put on the unemployment roles through no fault of their own, and literally through no fault to the businesses they work in, other than they just happen to be in sectors that have been the COVID non-beneficiaries.
As I mentioned before in that barbell, they would be vaccine beneficiaries, but right now, they've been non-COVID beneficiaries. The social aspects also come from the economic aspects. There's a question of socialism versus capitalism in our world now. One of the concepts that was recently tabled was a more social capitalism trying to deal with social inequity, which is the Black Lives Matter movement, the racial inequity, and also the implications for the vaccine and how we're going to get back to our social lives that we as humans thrive on. Then, of course, the technological changes that I've mentioned include the digitization, the e-commerce, the working from home, which are serious changes that have been pulled forward from where they were going, that's been accelerated and brought forward. Those are the PEST.
Mark Brisley: Oscar, on the assumption that regardless of vaccine, or how things evolve with respect to the pandemic itself, the world has probably changed forever. Virtual is probably realistic, how we gather will be changed. These themes that you talked about within PEST, do you see these as key investment themes for quite some time, as you look ahead?
Oscar Belaiche: Yes, absolutely. These are framing our society as we go forward, and have all kinds of implications on valuations, on interest rates, as we discussed with lower interest rates. It has implications on different sectors of the market, for example, on financials, on real estate.
Absolutely, there are all kinds of implications.
Mark Brisley: I wanted to ask you a specific question about a couple of the funds that you run. You have two significantly size-balanced funds in your portfolio, the Dynamic Strategic Yield Fund, and the Dynamic Dividend Income Fund. Given how you framed our discussion so far, can you talk us through a little bit how those particular balanced offerings are positioned right now?
Oscar Belaiche: The way we build our portfolios is we're diversified across sectors. There are 11 gig sectors, and so we would have exposure to pretty well all of those sectors, and the way we construct our portfolio. The current positioning in the two funds, Strategic Yield and Dividend Income Fund, these are balanced funds, and so they have a combination of equities, and fixed income, and cash. We're running about a 50-50 mix between equities, and cash, and fixed income today. That's what we would call down the fairway investing. It's not aggressive. 60-40 is what some would refer to as a normal allocation.
Aggressive would be 70 equities and 30% cash and fixed income, and defensive would be 40% equities and 60% cash and fixed income. We're sitting down the fairway, and we have used some option strategies to supplement our equity positions and generate income while we're waiting, so effectively getting paid to wait with downside protection by writing put options.
Mark Brisley: With that view towards the emphasis that you place on dividend-paying equities, I wanted to ask you just about how you see the landscape for those particular types of equities right now. Also, are companies maintaining, reducing, or outright cutting their dividends? What are you hearing from the management teams you talk to?
Oscar Belaiche: On the equity side, most companies have been maintaining their dividends that we invest in. That's not to say all companies are maintaining their dividends. There have been a number of dividend cuts across some of the more impacted sectors that are non-COVID beneficiaries. The companies we own, there have been very few dividend cuts because these are high quality, defensive, great balance sheet moats type companies. We're comfortable that these companies are going to survive and going to maintain their dividends. They're going to ideally, once we get past the stage of COVID, go back to being able to grow their dividends or distributions.
Mark Brisley: Oscar, something that we're constantly faced with as a question from investors and our conversations with advisors across Canada is, demographic that is changing and evolving quickly, and investing landscape where people are looking to hold a portfolio that can produce income. That's a goal that's becoming more challenging based on where we are today. It's covered broadly in the media and in articles that anyone can pick up quite easily. What would you say to investors that do need a income-producing portfolio, and as it relates to how you're managing your portfolios right now?
Oscar Belaiche: We would describe ourselves, we're the equity income investors. We invest in these high-quality companies that pay a dividend or a distribution, and we look for sustainability of that dividend. That's related to what we do, and that's what we've been doing for a long time. What happens is that the companies that can maintain their dividend yield today are trading at spreads between the yield and the risk-free rate, which is the 10-year treasury yield in the United States, or the 10-year Canada bond in Canada. In the United States that spread is now the highest it's been since around 1958.
That's over 60 years that we haven't seen spreads that are so attractive. In Canada, we've never seen spreads so attractive against the 10-year government of Canada bond yields. I think that when things stabilize-- They're still in that process of stabilizing. As I mentioned, this is the year of the super disruptors, so things are not stable, but there will be a time where things stabilize. There will be a time when the vaccine will be effective, and there won't be as many cases, and there won't be as many hospitalizations. Already, we're seeing less hospitalizations and less deaths. As I mentioned, the treatment is getting better. Once we get that vaccine, those dividend yields are going to be very attractive.
I think they're attractive today if you have the patience to look out a year or two and see that things will improve and stabilize. There is that continued need for income from those who are retired or plan to retire. That landscape today is actually more attractive than it's been, as I mentioned, for historically ever in Canada, and for over 60 years in the United States.
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Mark Brisley: Oscar, thank you for those insights. Of course, we want to remind everyone that the best way to access this experience is through the use of a qualified financial advisor. Thanks, everyone for joining us today. Oscar, thank you for your time.
Oscar Belaiche: Thank you, Mark.
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Mark Brisley: You've been listening to another edition of On the Money with Dynamic Funds. For more information on Dynamic and our complete fund lineup, contact your financial advisor or visit our website at dynamic.ca.
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