The Canadian stock market isn't the easiest territory to navigate these days: Commodity producers are struggling with uncertainty over the health of the Chinese economy, while banks are flirting with record highs but face indebted consumers and a sputtering housing market.
For some guidance on what to do, we caught up with the lead managers of the Franklin Bissett Canadian Equity Fund, Garey Aitken and Tim Caulfield, last week. Under their leadership (Mr. Aitken is also chief investment officer of Franklin Bissett Investment Management), the fund has beaten its category average and the S&P/TSX composite index for the past five calendar years – giving their views some importance.
And what's their view now? They see a lot of opportunity for Canadian stocks, but prefer several names that may surprise you.
While some investors, including U.S. hedge funds, are either avoiding Canadian banks or short-selling them, Mr. Aitken and Mr. Caulfield have been active buyers this year. Like anyone, they can see Canadian consumer debt levels and the state of the country's real estate market, but are "less fussed about those things," as Mr. Aitken puts it.
"The nature of consumer debt is different in Canada than the United States," he said. "Our real estate market is completely different, and that's where we strongly disagree when people draw parallels between the Canadian real estate market in 2013 and the U.S. market in 2007 and 2008."
For example, mortgage insurance is different and mortgage interest isn't deductible in Canada, leaving the banks looking like solid franchises with attractive dividends. A slowdown in lending growth is already priced into stocks. And if growth is limited, banks will crank up their dividend payout ratios.
Curiously, their fund's top holding is the smallest (based on market capitalization) of the Big Five banks: Canadian Imperial Bank of Commerce. They applaud management for lowering the bank's risk profile and raising its focus on domestic operations. Yet, in terms of valuation, it continues to trade at a discount to other banks.
These stocks have been the biggest drag on the S&P/TSX composite index over the past two years, with gold and fertilizer producers in particular, driving down returns. The fund managers have been avoiding the sector, leading to a considerable "underweight" position in the fund – but their exposure to materials stocks is now on the rise.
Nope, they're not betting on beaten-up big-name gold producers, but rather five positions in: Agrium Inc., Potash Corp. of Saskatchewan Inc., Major Drilling Group International Inc., Silver Wheaton Corp. and Franco-Nevada Corp.
"They've all seen periods of weakness, and at times periods of extreme weakness, over the past 12 months or so – and we think that has been an opportunity," Mr. Aitken said.
"When people look at our fund and see us underweight materials for a long period of time, they are sometimes surprised to see us getting as aggressive as we have been."
Still, at the end of July their materials weighting was just 8.3 per cent, versus more than 13 per cent for the S&P/TSX composite index.
This area of the market has trended sideways for some time, buffeted by rising production costs and a move toward U.S.-energy independence. The fund managers aren't shying away, though, with close to a market-weight position.
The difference? They prefer smaller, service-oriented energy stocks over larger, integrated producers. In other words, Suncor Energy Inc. has a relatively small position in the fund, despite being one of the biggest companies in the index.
"What's interesting about the Canadian energy market place is the depth and breadth – the number of companies we have in capital markets that are associated with energy," he said.
It's tremendously deep – but the trick is to get past the usual suspects. Among their favourites: Tourmaline Oil Corp. and Savanna Energy Services Corp.
Tourmaline is crude oil and natural gas exploration and production company that the managers like for its management team and strong growth in production and reserves. Savanna is a drilling and well-service provider that should see ongoing improvements in operating and financial performance.