PARTICIPANTS
Mark Brisley
Managing Director and Head of Dynamic Funds
Don Simpson
Vice President and 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. Welcome to another edition of On the Money. I'm your host, Mark Brisley.
For a good chunk of the past two decades, Canadian investors have been captivated by the appeal of U.S., global, and international companies while really underappreciating the high-quality Canadian companies available to us at home. As a result, many of our best-in-class Canadian companies now trade at a discount to their global peers and offer attractive growth potential, solid dividends, and the familiarity of being companies well-recognized in the lens of most Canadians.
To dive a little deeper on this subject, I'm pleased to be joined by portfolio manager, Don Simpson, to discuss topics currently driving Canadian equity markets. Don and his team manage over $7.5 billion in primarily Canadian-focused assets. Over his nearly three decades of investing experience, he’s forged a reputation for constructing well-diversified, rigorously researched, and attractively valued portfolios in a potentially rewarding, but also sometimes turbulent, Canadian investing landscape.
Don, really appreciate you being here with us today. Look, you've been doing this a long time as a seasoned portfolio manager and you have managed funds globally. Why are you allocating and showing more interest in having your portfolios towards Canada and what factors are making Canada a compelling place to invest right now?
Don Simpson: I have to say having done this for over a couple of decades, what I've seen is Canada goes in and out of favour every once in a while, with international investors. What I've seen today is complete apathy for Canadian investments, not only international investors, but actually among Canadians themselves as people seem a little more excited about going outside the border.
For the first time I've seen in a long, long time, I'm able to buy extremely high-quality companies in Canada, but buy them at a valuation discount that normally you wouldn't see. Having done this for a while, what I found was you used to have to pay up for the higher-quality Canadian companies. Right now, I'm actually buying them cheaper.
I think what's happened is there was a dislocation, especially when the pandemic onset came on and you had financials and commodity companies as a big part of our index. I think people left and they still haven't come back. When they do come back, they'll see we've got the same great companies and we've got a recovering economy. We've got a great financial system. We have universal healthcare. We have all the things that make for a great economic recovery. I don't expect these discounts to last forever. I think it's a great time to get in now.
Mark Brisley: You're talking about Canada having high-quality business operating in favourable competitive environments. That's obviously core and fundamental to your process when screening businesses. What are some of the other investment criteria besides just quality that you look for when you're selecting these companies?
Don Simpson: The obvious one that most people would point to is valuation. You know what? I think everyone focuses on valuation. What I don't think investors focus on enough and it's probably harder to do is just the importance of management. We spend among our team probably the most time assessing management teams. What we want are management teams that are proven winners, that are ideally very aligned with shareholders, which means they own a lot of stock in the companies themselves.
One of the benefits in Canada is that we get to meet the management teams virtually as often as we want. That really means at least once a year. For some of these management teams, we've been meeting them for 20 years plus straight. What we can find are when there are changes in management, either for the better or for the worse. Some of the best investments I've made in my career have come from identifying when a management team of a good business has significantly improved, but the market hasn't yet identified how powerful that can be.
We spend a lot of time really drilling into these management teams and seeing if we can find something before the market does – good or bad. And we find because it doesn't show up in a spreadsheet and it's very hard to model, it's an area where we can make a lot of money over the long term. Some of the best investments over my career have come from not necessarily being first, but being early when you have a great management team take over a business.
Mark Brisley: Many of our listeners, I think, would understand as well that when you think about Canadian markets just in general, we certainly have a profile that would say it's dominated by only a few sectors. One of those would be the financial sector. I think they would also agree that Canada has a robust financial system. That's been proven over periods of volatility and Canada coming out of that quite strong with respect to financial companies. What are your current thoughts on that sector, specifically banks, insurance companies, and some of the world-class Canadian alternative asset managers that exist?
Don Simpson: There's no question, our financial companies are battle-tested and proven. We saw it in the financial crisis. Our banks were some of the only ones in the world not to have to cut their dividends; not to need a bailout. We have a very conservative regulator and I think it's done well for our economy over time. When I look at the banks and the insurance companies today, they were extremely conservative in the pandemic and it was partly due to the regulator.
They probably reserved too much. They were very prudent on their lending. What we've seen is they've emerged with great balance sheets that are way too strong. What we're seeing is they're now starting to release some of that capital. It's coming in the form of double-digit dividends and share buybacks. I think the earnings outlook for the Canadian banks and insurers looks extremely robust as we go forward. I feel very good about those.
Now, when we get onto the non-bank financials and some of these asset managers or non-traditional asset managers, over time, there's been some family-run companies that have done really well through the cycles, but they haven't always been transparent or investor-friendly and it's probably hurt their stock prices. What we've seen over the past five years is some of these companies; they've decided that they really care about their share prices.
I think the market hasn't noticed. They're doing things to simplify. They're being more investor-friendly, making their structures way less complicated. Those decisions are showing up in much better financial results, which has helped the stock price, but despite that, a lot of these companies are still trading at discounts because people still look at them as the way they used to be and not the way they are today. We can buy some of these high-quality asset managers at 20% to 30% discounts to their hard asset values.
I think as investors realize just how much more investor-friendly these companies are today, these discounts won't last. It's a great situation today where the asset values are rising and you're buying them at a discount to their asset values, but we now feel it's okay to share this secret with everyone else and let them in because we've got great investments. We're happy to let some other shareholders pay a little bit more for them, but we think we're really set up well with these businesses today.
Mark Brisley: Don, if we think about some of the things that are front and centre right now for a lot of investors, it's hard to open a newspaper and not hear about supply chain issues or labour shortages. I guess at the root of all that is people are concerned about what's the impact on all of those things in terms of inflation and inflation pressures. What are you hearing from your conversations with management teams and the businesses that you're dealing with? Are you concerned about inflation and how are the companies that you're invested in, in a position to handle a period of potentially higher than normal inflation?
Don Simpson: It's a concern for all businesses today and the ones we're meeting. What we don't know is how much is transitory and how much is permanent. At the end of the day, we don't really know this, but what we do know is there is a lot of inefficiency in the supply chain. There's a lot too many things that are trying to go through a place that doesn't have capacity for them.
Anytime you have that, you're definitely going to have spikes in prices. We have a lot of the labour market right now where people have been given money not to go to work. They're flush with cash. Now, companies are having to pay people to come back to work. I don't think all these situations with the government bailouts and everything else are going to be permanent, but they definitely could last longer than people think.
When we're talking with companies, what they're doing is they're taking price where they can. The higher-quality companies tend to be able to get price and as long as prices don't go up too much. That's one of the things we look for in our portfolio, are businesses with pricing power. The other thing we look for are businesses with higher margins. Higher margins are just a great buffer for when things go wrong. If you're operating at razor-thin margins and your costs go up, the impact on your earnings is really multiplied.
We're looking for businesses with higher margins, with some pricing power. Now, within Canada, we have a lot of businesses that will benefit from some inflation, either because interest rates rise a bit or because a little higher prices is good for their business. Businesses like the financials, they should stand to benefit. Brokers, they stand to benefit from a little inflation. In the commodity businesses, they tend to see the price of their commodities go up higher quicker than their costs do. It's benefit for them as well.
What we just make sure is that we have enough businesses in the portfolio that have offsets to balance off the ones that might not necessarily do well in an inflationary environment, but I think a lot of that's priced in. The other thing is we don't know when the supply chains will improve and just how much that'll change things. We never want to make a one-way bet on inflation, but it's definitely a concern for all the businesses we own and something that we are keeping on top of.
Mark Brisley: I think another area that's top of mind, Don, for a lot of Canadians is the issue around housing and, of course, affordable housing being one of the biggest issues, but it does seem appropriate to ask you about the Canadian real estate market with your background, having previously run a mortgage trading department. I guess the question is, are you concerned about a potential unwinding of prices, or this hot real estate market, if interest rates do rise in the near future and I guess everything from the word "bubble" to just people predicting that this is going to happen? What are some of the ripple effects that that could cause to other areas of the Canadian economy?
Don Simpson: Yes, I've been hearing about the bubble in the Canadian housing market for some time. I will say, the recent rise in house prices is; it's not healthy for the economy, it's not good. It's something that we are well aware of. Is it top of my worries? I wouldn't say that it's top of my worries, but it is a cause for concern. Why is it not the top of my worries? I'd say, well, one is with the rate of change they've gone up, it just can't keep going up like that forever.
A pullback is not necessarily a bad thing. Most people have significant equity in their homes. Yes, it'll hurt the last buyers that are in, in terms of their equity in the home. When we talk to the banks themselves, which are big investments for us, they're extremely well-reserved in this case and could probably withstand a 10% to 15% drop without having to go into the reserves. That's from one side what we've talked about.
The other is like lower prices will help affordability. I think at some point in time, supply has to catch up to demand. It is a big problem in Canada and we just haven't built enough houses or homes or apartments or whatever for all the demand. Long term, one that Canada has, is we just have a lot of immigration. We have a lot of people coming in the workforce. My biggest concern is not house prices but rather when you have a drop in house prices that coincides with a recession, that's when you have a problem.
Right now, I feel pretty good about the state of our economy and where we're going. We're later kind of getting our economy started than a lot of the world, but we have higher vaccination rates. We have a great medical system. I think as the world looks better ahead, for Canada in particular, it's probably something on the further horizon that I'd worry about. It's more something I worry about when I'm more worried about going into a recession than I am just particularly the price where we are.
Mark Brisley: Some interesting points in there. One of the things we've talked about a lot lately is things that were accelerated by COVID or COVID accelerants. One of those was people jumping into the secondary housing market or vacation properties and using equity in current homes. A lot of conversation right now that I'm hearing is, have people overextended themselves in terms of leveraging that equity and an interest rate rise create some turmoil? Is that on your mind or is that more a household balance sheet issue that you don't think is as broad as maybe it's being talked about?
Don Simpson: I think about who the people that you're probably talking with and these are, who is worried about spending that extra money on a cottage and who's upset that they're having to pay $2 million for a cottage in Muskoka that used to cost $1 million a few years ago? Part of it is just the amount of money that people have of equity in their homes and the inability to invest it in anything that feels like it has value. I think part of it is just the money supply has gone up so much. Yes, anytime you hear about bidding wars, it's not a healthy sign.
Again, where we really got in trouble in the past was when people were-- Speculation is never good. Really, the problems we had in the past had to do with the economy and what percentage of the economy was, particularly in the US where they had just too much money that was tied to housing. It's something I worry about in terms of any time prices go up. I think it's more of a problem of, I'd say, the people at the higher end of the market that are doing this.
The real people who you worry about are the people who have to get in their first houses. That's where the government and the private sector is going to have to find solutions to make affordable housing. I think that'll happen over time. It's easy for investors to be worried about because they can see it themselves. When you see it yourself, it's actually good. It's not something hidden in the system, but it is something I would worry more if the banks weren't in such great financial shape.
And the lending part – if we start hearing more about people getting money from weird sources, then I start to really worry. In the past housing crisis, it was really caused by a lot of money that was going into securitized vehicles that were being funded by people who didn't even know what they were doing. That just created a huge supply of money to the system. I don't think that's the case today, but it's something definitely to keep on watch for.
Mark Brisley: Another area that's emerging significantly across the investing landscape, not just in Canada but globally, is the aspect of ESG. Of course, I'm referring to environmental, social, and governance factors. This is becoming an increasing part of investment conversations at all levels, Don. I think you've mentioned in the past that greater emphasis on ESG factors will potentially provide outsized opportunities in the Canadian market. I just wanted to get to you to expand your thinking here on the importance of this and the impact it's going to have on portfolios.
Don Simpson: It's interesting, this ESG as it's called today. Anytime you have an acronym, you know it's a hot topic. Let's just call it good governance and that people should have been focused on this for-- When we talk about focusing on management teams and other things, it's really important not just what you make but how you make your profits. I think it's become a very hot topic and it feels good to invest in ethical and social and well-governed companies.
A lot of money has gone into that space. Anytime a lot of money goes into an area and you have a new sector, yes, opportunity is created because it changes how people look at businesses. On one side, you'll have businesses in extractive industries such as commodity producers and they're all viewed with one lens. When you have a situation like that, what you have is investors who, because of their investment committee or whatever, saying that, “We can’t invest in a dirty commodity or a company that pollutes the universe,” you have to sell.
It creates a lot of opportunity because anytime you have forced selling of what could be good businesses but are characterized as bad, there's an opportunity there. The discount rate goes extremely high and you get a chance to buy good businesses that may not be the bad actors people think, but they didn't have the time to do the homework. We think that's always a great opportunity for us.
On the flip side, what you have are businesses that get new capital simply because they're in a space, or they're deemed to be either great social, great for society in one way or the other. It could be green energy producers, or it could be some other thing. On that side, these companies have their discount rates go down more than they should. You have a pile of money go in. There's an opportunity to sell businesses that you thought were okay, but evaluations that don't make any sense other than because of a lower discount rate.
I think there are two sides to this. Anytime you know what you think a company's worth, and you know its long-term future, you can benefit from this. I don't think it's going to end. I think it's a great thing that more people are worried about, not just what the companies make but how they make it. I don't think it's going to end. From our side, it creates more opportunity and we've seized on that over the past couple of years.
Mark Brisley: Well, Don, we've unpacked a lot of key issues relative to the Canadian investing landscape. I guess my final question for you is just as you're looking forward and I think we can confidently say we're in a period of recovery coming out of a global pandemic, but it's probably a recovery like no other in a lot of ways with a lot of questions still to be answered. Final words of advice as you're looking ahead to 2022 for investors that are listening today.
Don Simpson: The most important thing investors can do is not get caught up in the day-to-day minutia, but rather have a long-term plan and think about what the world is going to look like – not just this year but look three to five years down the road and it allows you to look past a lot of the headlines, a lot of the things that are popular today that may not be in the future, and look past the things.
I think we're going to get to Z with the names of the variants we're going to see. I guess it's Omicron today. What's most important is to take a long-term approach and think, “Where can I get the best returns today with the most reasonable level of risk?” When I look at that today, I find Canada is still kind of in the penalty box. Maybe it's because of fears people have over reliance on our financial system.
People could be worried about the housing market because it is hot today. People might be worried about inflation. They could be worried about a whole bunch of things. I think when people look through things and they say, “Where's a great place to live? Where's a great place to work? Where's a good healthcare system, a great education system? Where am I getting businesses at attractive valuations?” they'll come to Canada.
I think they'll look back and say, “If you invest in Canada today, three to five years down the road, you'll be well-rewarded in the future.” That's how I'm pretty excited about Canada today. I've been talking about it for over a year. It's done well. Valuations are not as cheap as they were a year ago. That's definitely the case. Within the context of global investing, I feel Canada stacks up really well today.
Mark Brisley: To touch on what Don said as well that to take his points into consideration, all of us at Dynamic agree too that the best thing for investors is to seek the advice of a qualified investment professional. Don, appreciate all your comments today. We covered a lot of ground and appreciate you being with us.
Don Simpson: Thanks very much.
Mark Brisley: Thanks to all of our listeners for joining us. This has been another edition of On the Money. On behalf of all of us at Dynamic, we wish you continued good health and safety.
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