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The Canadian Essentials Portfolio is an affront to the concept of diversification.

Ten stocks in just four sectors – financial services, industrials, utilities and pipelines. Can you possibly achieve a decent return without exposure to sectors such as energy, materials, consumer staples, technology and health care? Looking over the past 18 years, the answer has been yes.

The annualized return since the beginning of 2000 for the Canadian Essentials Portfolio was 13.1 per cent, including dividends, while the S&P/TSX Composite Index made 7.6 per cent on a total return basis over the same time frame. These numbers were delivered recently by the man behind the CEP, a retired political science professor named Mike Henderson.

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I wrote about the CEP back in 2010, when it was coming off a decade in which it likewise beat the index. Mr. Henderson, who has a PhD from the London School of Economics, built the portfolio on the idea of investing in companies that are essential to the economy. The 10 holdings are: Canadian National Railway Co. (CNR), Canadian Pacific Railway Ltd. (CP), Enbridge Inc. (ENB), TransCanada Corp. (TRP), Royal Bank of Canada (RY), Toronto-Dominion Bank (TD), Bank of Nova Scotia (BNS), Canadian Utilities Ltd. (CU), Emera Corp. (EMA) and Fortis Inc. (FTS). With remarkable consistency, each of the 10 stocks delivered average annual total returns over the past 17.5 years between 10 per cent and 15 per cent. The outlier is CN, up just more than 18 per cent on average.

The CEP was an index-beater back in 2010, and it continued to power ahead in the ensuing years. But returns for many of the stocks in the portfolio have suffered in recent days, and therein lies a warning about the CEP. It’s lived most of its life in a world of falling interest rates. Many of the stocks in the portfolio don’t perform well in the kind of rising rate environment we’re in now.

Utilities stocks are a good example. Emera, TransCanada and Canadian Utilities were each down 15 per cent to 18 per cent for the past 52 weeks as of early this week. More losses could be in store if rates keep rising. Then again, depressed prices for many of the CEP might offer an opportunity to start building this undiversified portfolio on the cheap.

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