These are not easy times for nervous investors trying to decide if it’s finally safe to dip their singed toes back into equities, whose winning streak so far this year has to be enticing. At a time when yields on safety-net government bonds have plumbed record lows and it’s costing money to sit on idle cash, a rash of better than expected corporate earnings and relative calm in Brussels, Beijing and Washington have driven some solid stock market gains. The S&P 500 climbed above 1,500 Friday for the first time since 2007 and every major market around the world is in positive territory.
But the conservative buy-and-hold types of a certain age who watched their blue-chip holdings go up in smoke in the financial meltdown of 2008-09 remain firmly on the fence, still suffering from deep psychological scars. “Whenever you have a true trauma like that, it takes a long time for people to heal in terms of their risk appetite,” veteran fund manager Jeff Tory says, before addressing a gathering of about 100 clients in Toronto, many of them elderly.
In the four years since the market collapse, Mr. Tory has noticed a marked change in investor behaviour, including that of a particularly loyal, long-time client – his mother, Liz Tory. “What happened to a lot of our clients was they lost enough money that they felt if they didn’t get out of the stock market, there was a risk they might have to go back to work,” says Mr. Tory, the Montreal-based chairman of 45-year-old Pembroke Management Ltd. “Then a lot of people my mom’s vintage, from, let’s say, 65 to 80, were asking: ‘Will I ever see another bull market again?’”
His Pembroke colleague of 25 years, managing partner Ian Aitken, adds: “They won’t quickly forget that indices were down 40 per cent. That kind of loss and the fear that it put into people can stay around for a very long time. It will take an extended period where equities perform very well before people start to abandon that fear. And then, the fear of loss will be replaced by the fear of being left behind.”
Returns generated by equities over the past five years have been “incredibly low on an absolute basis. And people have a tendency of projecting forward the experience that they’ve had recently,” Mr. Aitken says. “Given the low returns and the amount of volatility that’s been present in most funds and equities, people think: ‘Why do I want that?’”
Those who don’t want to remain on the station platform when the train pulls out may want to join Mr. Tory and Mr. Aitken in their continuing hunt for a diversified bunch of Canadian and U.S. small and mid-size companies with sound balance sheets, plenty of free cash flow (to provide “insurance for the unknown”) and the ability to expand regardless of how macro-economic conditions unfold.
Their Canadian list includes a handful of metals and natural gas royalty companies, as well as the likes of Descartes Systems Group Inc., MacDonald Dettwiler and Associates Ltd., Constellation Software Inc., Home Capital Group Inc. and Paladin Labs Inc. In the U.S., they tend to play certain themes: cost containment (ICG Group Inc., which specializes in supply-chain management, and Liquidity Services Inc., which runs online auction marketplaces for surplus goods); financial services restructuring (Encore Capital Group, a new-age debt collector); the drive toward energy self-sufficiency (a money-losing bet last year, because of weak prices and rising costs); and what are known as disruptive technologies.
Along the way, they have lowered some of their expectations. “Historically, we used to look for 20 per cent earnings growth across the board,” Mr. Aitken says. In today’s slower-growth environment, “if we can find 15 per cent earnings growth, we’re quite happy with that.”
S&P 500 earnings have reached levels higher than in 2007, and can’t be expected to maintain that pace. “We’re not investing in the [S&P] average companies, so the fact that the average earnings are growing slowly isn’t much of a concern for us,” Mr. Aitken notes. “We’re looking for the particular opportunities that can grow faster. But obviously, it’s helpful if the backdrop is that over-all corporate profitability is increasing.”
What he and Mr. Tory have discovered is an encouraging optimism on the ground that contradicts the dismal prognostications of the more pessimistic economy watchers. “We like to juxtapose the big picture, which still seems gloomy and scary, with the bottom-up view that we get by meeting with the companies that we’re interested in,” Mr. Aitken says. “The more time we spend on the road, the more positive we become, because the companies are seeing opportunities to put their capital to work and to generate decent returns. We don’t know what the answer is to the big issues that people are concerned about. But at the company-specific level, a lot of groups are making good progress.”
As for Mr. Tory’s socially prominent mother, she remains “very supportive,” Mr. Tory assures me. “Good clients don’t measure [results] month to month.” Still, he once joked at another client meeting that he was forced to sit at the children’s table at the family Christmas gathering for a couple of years after the market debacle. “I’m back with the adults now.”