Mackenzie Global Equity & Income Team
- During Q4 2016, Mackenzie Global Dividend Fund returned 2.4%. This compares with the MSCI World Total Return Index ($CDN) return of 4.3%. The portfolio benefited from stock selection in the United States and in information technology. Detractors included stock selection in financials and industrials, as well as overexposure to consumer staples.
- Mackenzie US Dividend Fund returned 3.7% during Q4 2016 and has now returned 16.4%, annualized, since inception. This compares with the S&P 500 Total Return Index ($CDN) Q4 return of 6.4% and 17.3%, annualized, since inception of the Fund. Stock selection in consumer discretionary and financials detracted from performance over the quarter.
- At the end of January 2017, the Mackenzie Global Dividend Fund will mark its three year anniversary since the current team took over management of the Fund. While we prefer to be judged through an entire economic cycle, we are pleased thus far by the results, as the Fund has returned 13.8% compounded after fees (as of Dec 30, 2016), ranking it in the top 4% of its Morningstar peer group. If one drills down into the attribution of returns you can see it was well balanced, which highlights the strength of the team and validates our global generalist approach to fundamental research. Case in point: over the three years, the Fund’s U.S. names outperformed the S&P 500 benchmark (20.8% vs. 17.8%, compounded), our European names outperformed the MSCI Europe composite (9.8% vs. 4.7%), and, taken as a whole, even our Asian and Brazilian names outperformed their benchmarks. From a sector standpoint, our companies outperformed their global GICS benchmarks in Consumer Staples (16.7% vs. 13.7%), Financials (16.7% vs. 12.5%), Healthcare (17.4% vs. 14.2%), Industrials (16.6% vs. 11.9%), Information Technology (23.8% vs. 19.7%...and all without any FANG stocks—Facebook, Apple, Netflix, Google), Materials (8.0% vs. 7.7%), and Real Estate (0.2% vs. -1.4%). We underperformed our benchmark in Consumer Discretionary (8.9% vs. 12.6%), Energy (2.1% vs. 3.0%), and Telecommunications (5.1% vs. 10.4%). The Fund owned zero utilities over the time period, which returned 13% per year for the benchmark. While we can always do better and strive to learn from our mistakes, we are confident that over the long term the Fund’s focus on paying a fair price for a broad selection of dividend paying companies that are market leaders in their respective industries will reward unitholders.
- While 2016 was the Fund’s worst absolute return year (+5.9%) and relative result (top 40%) since our team took over portfolio management responsibility, we are actually proud of this accomplishment, aside from the fact that we will always prefer a higher return number for our unitholders (obviously!). Why is that? Besides our focus on owning only the highest quality dividend paying stocks, we also have emphasized how our mandate differs from other dividend funds or passive products that focus on backward-looking factors that have shown recent market success (eg. low-volatility, high dividend yield ETFs). Namely, it is the flexibility of our mandate that sets it apart – we are not wedded to any specific yield threshold, sector exposure, or factor weighting. In short, valuation plays a role in our decision making and is an important overlay to our search to own great franchises. As the year wore on, we increasingly found our “bond proxy” holdings such as consumer staples to be increasingly expensive, whereas areas that had the opposite sensitivity to lower rates such as financials and industrials grew more attractive. By the time the election rolled around, the Fund had a lower (yet still healthy) exposure to consumer staples and a higher exposure to financials than any time in its history. The election of Donald Trump on November 8th saw an immediate and extreme change in market leadership that continued through the end of the year. From November 9th through December 30th the Fund returned +3.7%, which slightly outperformed its benchmark (+3.3%). In the context of our mandate and what had been driving performance up until that point, we were quite satisfied with this “average” result!
- As mentioned, post-election and almost overnight, the market pirouetted from an assumption of low-growth, nominal inflation, and the continued existence of a “new normal” where the world’s central banks maintained a policy of interest rates near zero , to a much clearer path to growth (and inflation) as a result of the world’s largest economy now in the hands of the Republicans, who have promised to open up the fiscal spigot (and expand the deficit). This stimulus is coming at time when U.S. unemployment rates are low, wage growth is picking up and households have largely exited the deleveraging phase. Of course, the political rhetoric has also increased the risk of protectionist measures, which on the whole would be a negative for global growth. Our guess is that this is classic Donald “Art of the Deal” Trump positioning – start at an extreme position and then move to the center. While tariffs on imports have been debated, aggressive unilateral actions are less likely, given the risk of retaliatory measures and in light of the interconnectedness of the world’s supply chain that many large U.S. companies rely heavily on. Thus far, while Trump’s top appointees have less government experience than most administrations since the 1960s, they have by far the most business experience. With President Trump at the helm, we expect the next four years to be volatile and unpredictable (to say the least), but with his administration likely pulling on a number of expansionary levers (tax reform/fiscal policy, financial and healthcare de-regulation, and infrastructure spending), we view the risks that GDP growth and by extension interest rates are higher 12-18 months from now. Of course, we are not macroeconomists and reserve the right to change our mind, as we can also make a case that Trump may disappoint investors in his ability to push policy through the house and senate. Or that European growth and inflation surprise on the upside, or that incoming Fed governors prove more dovish than the new U.S. Department of the Treasury plot suggests. While any of these new scenarios could challenge the pervading market assumptions, we do not wish to allocate large amounts of capital on the basis of one view or the other. Our day to day research will continue to focus on what it always has: identifying the best dividend paying companies in the world with the staying power to invest and compound value through cycles, and populating the portfolio with those leading companies that represent the best value.
What contributed positively to performance?
- JP Morgan (JPM), as well as being a new position to the Fund in Q4, was also one of the largest contributors to performance. We have been long-time admirers of Chairman and CEO Jamie Dimon and have been involved in Dimon-lead companies going back as far as 16 years ago when we owned shares of Bank One Corp, which was purchased by JP Morgan in 2004. Any investor who has even a passing interest in financial institutions (including Warren Buffett) knows that his year end Letter to Shareholders is “appointment reading”. We find that the reason to own JP Morgan relative to other banks is straightforward: besides having perhaps the strongest balance sheet in the industry (Dimon calls it a “fortress”), the company is in line with best-in-class peers across almost all efficiency and return measures. The question with JPM was not whether we wanted to own it, but whether we wanted additional banking exposure in a world of declining interest rates and substantial legal and regulatory costs. It became increasingly clear to us that while the cost burden was here to stay, we were probably past the worst of it. In addition, earlier in the year the Federal Reserve began to raise rates for the first time since 2006, so the path to higher rates at least directionally had been set. And finally, at 10x P/E with a 3% dividend yield, we viewed the shares cheap enough to bear the risk of a “lower for longer” rate scenario. The election of a Republican government was icing on the cake, as animal spirits were ignited in the hope that the regulatory burden would be significantly reduced and that fiscal stimulus would accelerate the rate path velocity.
- Other positions that contributed to returns include, not surprisingly, most of our financial holdings, including Wells Fargo, HSBC Holdings plc, Northern Trust Corporation and Cetip S.A. Maker of Cartier jewelry and some of the world’s most exclusive watch brands such as Piaget, IWC, and Panerai, Compagnie Financiere Richemont also rose as recent data suggested the hard luxury industry was finally rebounding from a slump that had started almost two years ago. At the very least, industry sell-through and wholesale trends were “less bad”. FLIR Corporation benefited from the post-election rally as investors presumed their business would be poised to benefit from the “build the wall” policy (thermal cameras are much cheaper monitoring solutions than thousands of border guards). While it remains to be seen whether the incoming administration will get such a wall built (paid by Mexico, no less), it is reasonable to assume border enforcement will increase. Air Liquide also contributed to positive performance as investors drew a direct line to a possible improvement to its core industrial customer base (and larger U.S. exposure with the closure of the Airgas acquisition) and future cash flows.
What detracted from performance?
- As indicated in the Market Review, most of our underperformance came from what had been working marvelously the previous three years, namely our consumer staples names. Heineken and almost all of our tobacco investments (British American Tobacco, Japan Tobacco, and Imperial Brands) were all down in the quarter. UK auto insurer Admiral Group has been weak due to concerns over a potential change in the regulated discount rate used to calculate compensation for injury claims, which would have the net impact of lowering future reserve releases, and thus, earnings gains.
- Moody’s Corp declined in the quarter when they announced federal officials were planning a civil lawsuit over its ratings of residential mortgage bonds in the years leading up to the financial crisis. The stock has since recovered (although not back to pre-announcement levels) when the company announced they had reached a settlement for US$864 million with the U.S. Department of Justice and 21 U.S. states over the matter. To put this in perspective, the $864m represents less than one year of after tax profits for the company.
What changes have we made to the Mackenzie Global Dividend Fund?
- The Fund initiated a position in Novo Nordisk A/S of Denmark. Novo Nordisk is the world’s leading healthcare company in the treatment of diabetes and obesity. With a market capitalization of approximately US$90 billion, Novo is solely focused on this therapeutic area. The company had one of the best 15 year track records in business. From 2000, when CEO Lars Sorensen took over, through 2015 the company generated extraordinary growth in sales (up 5-fold), profits (up 11-fold), and free cash flow (up 13-fold). Combined with intelligent capital allocation (the share count was reduced by over 25% through buybacks at low valuations), the stock returned 2,666% including dividends, or almost 25% per year for 15 years - even better than Vancouver real estate! For this performance, Sorensen was named one of the best CEO’s of his generation by Harvard Business Review. Needless to say, Novo Nordisk’s shares have always been too expensive for the team…until the price collapsed by 40% in November, from a price level of DKK400 to a low DKK220. The collapse was due to uncertainty created by a combination of factors. Novo’s traditional insulin portfolio came under threat of price pressure, especially from a bio-similar due to enter the market in 2018-2020, and expected to result in lower sales for Novo’s largest single franchise (Levimir) over the next four years. In the meantime, the growth from a new class of drugs known as GLP-1’s, both in market (Victoza) and in late stage development (Semaglutide), may not come in time to sustain the clockwork-like growth investors have become accustomed to over time. As a result, the long-term financial target for operating profit growth was reduced from 15% to 10% per annum in December 2015, and then down to 5% this September. The “Best in his Generation” CEO was fired, stepping down Jan 1, 2017. Growth investors, who made up most of the shareholder base, had seen enough and could not rationalize owning a business whose target is to achieve 5% CAGR over five years. The lack of visibility and catalysts until 2018 meant uncertainty which short-term investors hate; the stock was orphaned. However, such lack of “visibility” often provides an opportunity for long-term value oriented investors. Novo Nordisk usually trades for 20x EBIT or more, and the Fund initiated a position at <11x EBIT. At that valuation, very modest business performance will deliver a good investment return. We get the best platform in the diabetes market – an area of healthcare that is expected to grow mid- single digits well into the future - and all its pipeline optionality for next to nothing.
- Sherwin Williams (“SHW”) is the largest paint company in the U.S. distributing 80% of its architectural coatings through a captive distribution network of over 4000 paints stores. Geographically, U.S. architectural coatings make up 80% of the business and 95% of the company’s profits, which makes SHW a great vehicle to benefit from the incoming administration which promises to cut taxes and boost infrastructure spending. SHW has averaged over 20% return on invested capital for the last decade and has grown its dividend every year for 38 straight years. The company has managed to grow paint volumes at a rate of 2x the industry, by opening new stores at a rate of 2.5% per year. For the first time in several years the company has been able to push through price increases due to rising input prices, adding another leg to the corporate growth rate. The core drivers of growth for the company are housing starts and infrastructure spend in the U.S. Through its relentless focus on architectural coatings the global industrial business has been neglected. To fix this business the company made an all cash offer of $11 billion for Valspar. The two companies complement each other perfectly as each company’s strengths are where the other is weak. The cash structure of this deal makes the acquisition immediately accretive and gives the company a growth platform for the future. While the shares do not appear traditionally cheap on current estimates (~18x forward earnings), this is below SHW’s historical average and we believe an investment in this Dividend Dream Team company offers an attractive risk/reward scenario for investors.
- Allergan plc was owned in the Global Dividend fund as recently as 2014 when it was the target of a takeover. Three years later the successful acquirer Actavis, now rebranded Allergan, has sold off its generics business to allow us to buy the business again at less than the acquisition price. Allergan is the largest global medical aesthetics company. The company makes the consumer favorite Botox neurotoxin, Juvederm dermal fillers, breast implants and Restasis opthalmic drops for chronic dry-eye. Medical Aesthetics make up 40% of the company’s sales with the rest of the business made up of a diverse assortment of biotechnology drugs focused on Neuroscience, Ophthalmology, Urology and Gastroenterology. Medical aesthetics is arguably the best segment in healthcare with very little patent risk and mostly self-pay procedures that are isolated from drug pricing pressures. The rest of the business was carefully assembled to avoid any single molecule concentration, also quite rare in Big Pharma and Biotechnology companies, which usually have one drug that makes a up a disproportioned amount of the profits. Allergan’s largest drug is Botox with sales approaching $3 billion (20% of sales) with half of the sales related to cosmetic applications and half related to therapeutic applications such as chronic migraines, over-active bladders and lazy eye. The drug’s sales are growing in the high teens with no increases in pricing in the last five years. The drug is also protected with over 100 process and use patents for first generation Botox that run through at least 2030. Botox has 76% market share and makes up only 20% of cosmetic procedure cost giving physicians very little reason to switch. Despite the very high quality of Allergan’s franchises, we were able to buy the company at a discount to the market and most other healthcare companies due to a confluence of three factors. First, the company was created through a roll-up of smaller biotechnology companies and as a result was painted with the same brush as other roll-ups, most famously Valeant. After divesting $40 billion worth of generic drugs, the company had no debt versus the crushing debt load that buried Valeant. Secondly, the company’s merger with Pfizer was blocked by U.S. regulators. Finally, both Presidential candidates were very vocal about their discontent with drug pricing and while it certainly effects Allergan, the company is much more isolated than competitors due to its self-pay aesthetics business. The company has nearly 50% operating margins and has just initiated a large capital return program which included buying back 20% of the company’s shares in the month of November. Allergan is one of our highest conviction ideas.
- Companies we sold from the Fund this quarter include Hong Kong-listed conglomerate CK Hutchison Holdings, which had rebounded following a mid-year decline post-Brexit (it owns large assets in the UK, including mobile telecom operator “3”, water and sewage assets, and gas distribution networks). We sold a number of consumer staples companies including Danone SA, Proctor and Gamble, Hershey Company, and Imperial Brands PLC, as we were able to replace all four companies with more compelling ideas. We also sold long-term holding Walt Disney Company as we felt the long term economics of their cable business, namely ESPN, have become increasingly tough to model out in a world of declining subscribers and sky-rocketing sports rights costs. We look forward to revisiting this fantastic company when we have better clarity on these very tricky issues. And finally, we sold our remaining small position in chip licensor QUALCOMM Inc. when the stock rebounded following their offer to acquire NXP Semiconductors.