Leading Canadian fund manager is betting oil rally is just starting

Kevin Hall, manager of the best-performing large equity fund in Canada, says oil's rally is just getting started and will lead to as much as a 10-per-cent gain in the country's benchmark index this year.

Buying into crude's rebound helped Hall push total returns at the $1.26-billion BMO Monthly High Income Fund up 6.2 per cent this year through April 12. That's the most among more than 50 Canada-focused equity funds with at least $750-million in assets, according to data compiled by Bloomberg. He plans to add more energy stocks to his current holdings of Pembina Pipeline Corp., natural gas distributor AltaGas Ltd. and TransCanada Corp.

"Oil prices can again rise on a more sustainable basis as supply and demand balance out," Mr. Hall said in a phone interview from Toronto. Mr. Hall, fund manager at Guardian Capital Group Ltd., runs the BMO fund as a sub-adviser for Bank of Montreal. "Any short-term pullback in oil and gas stocks we'd look at that as a buying opportunity and look to add to some of our energy exposure."

For Canadian investors, deciding whether the commodity rally is for real is probably one of the toughest decisions they'll make this year. The benchmark S&P/TSX composite index is composed of 31 per cent natural resource stocks, the most of any Group of Seven advanced economy. That's been a millstone during a slump that's had the index lagging the S&P 500 for five years in a row.

With U.S. oil climbing above $40 (U.S.) a barrel, the S&P/TSX is up about 15 per cent from its Jan. 20 low, the sharpest rally since the market turned down in August 2014. Canadian stocks are the second-best performing among developed markets this year with a 5.1 per cent, behind only New Zealand's 7.2-per-cent advance.

For Mr. Hall it's all just a matter of supply and demand. The Energy Information Administration reported Wednesday that U.S. production fell to the lowest level since October 2014. Such reductions will help restore balance to the global supply glut that drove prices lower, he said. Producers, including Saudi Arabia and Russia will meet in Doha on April 17 to discuss freezing output at January levels. West Texas Intermediate, the U.S. crude benchmark, traded near $42 a barrel at 2:22 p.m. in New York.

Among Mr. Hall's energy holdings, Pembina returned 18 per cent including dividends in the first quarter and TransCanada returned 14 per cent. His positions in Bank of Nova Scotia, Toronto-Dominion Bank and Royal Bank of Canada also swelled as the nation's largest lenders bounced back with a 9.2-per-cent rally in March to snap a three-month slide.

Two other energy stocks he recommends are Vermilion Energy Inc. and Crescent Point Energy Corp. Vermilion is seen as a safer bet given its attractive 6.8-per-cent dividend yield. Crescent Point, which slumped 40 per cent last year, offers more upside in the stock, he said. He holds both.

"If our timing is a bit off, they give you some downside protection," he said, referring to Vermilion. "Their attractive dividend yield is sustainable, plus you can get some good upside participation."

For Bill Tilford, head of quantitative investments at RBC Global Asset Management, Canada's biggest asset manager with more than $380-billion in assets, the bet on energy has been more about seeking producers that are cheap with a track record of stable cash flow. This has led him to large-cap integrated producers including Suncor Energy Inc.

"You can almost think of the quarter as A Tale of Two Cities," said Mr. Tilford, who runs the RBC Qube Low Volatility Canadian Equity Fund, with about $1.5-billion in assets across all classes of the fund. "We had a straight line down then a straight line back up." Tilford said. "When we get market events that are volatile with huge downdrafts and sharp updrafts, those are the environments in which we excel."

The fund is up 4.6 per cent through April 12, among the best-performing equity funds in the group. The manager added Canadian energy producers including Suncor and Imperial Oil Ltd., joining an existing holding in TransCanada. He sold some positions in Dollarama Inc., up 29 per cent in the 12 months through the first quarter, to pocket gains while buying precious metals royalty company Franco-Nevada Corp.

"This is probably the first time we've put gold stocks back in the portfolio in several years," Mr. Tilford said. His fund targets about 25 percent turnover each year.

Investors jumping back into oil now may still get burned, Philip Petursson, chief investment strategist at Manulife Investments, said in a Toronto interview. He figures earnings among energy stocks won't materially improve until the first quarter of 2017, with some risk for earnings disappointments over the next two quarters.

"It's too early yet to see that oil has turned, although the sentiment towards oil is starting to improve," he said. Manulife's Asset Management unit oversees about $417-billion globally. "The main driver of the recovery off the lows we've seen in the price of oil is really short-covering. Is that sustainable? I don't think so."

This is in contrast to broader analysts' estimates, which project per-share earnings jumped 12 per cent in the first quarter from a year-ago for the biggest quarterly increase since the fourth quarter of 2014, according to data compiled by Bloomberg. That's after earnings contracted by 17 percent in 2015, the most since 2009.

Mr. Hall sees the rebound in crude prices as a bigger factor driving a rally. The 10-per-cent gain he predicts would be the biggest increase since 2010.