Everyone wishes they had a crystal ball to know exactly what the market is going to do next. The unfortunate reality is that no such foresight exists.
But here’s the good news: By diversifying your portfolio, you can optimize returns and, just as importantly, position yourself to weather pullbacks in the market. And we’re feeling confident, after last learning from Vivian Lo of Aston Hill Asset Management about conducting the proper due diligence when assessing a company for investment.
But there’s a fine line between being diversified and being spread too thin. To find out just where that line sits, we talked to Vivian again - and she didn’t need a crystal ball to tell us how to diversity like a pro.
Ensure your eggs aren't all in one basket. Vivian explains...
- Q: We know geography plays a huge role in diversifying one’s portfolio. But what does that really mean?
It’s a big world and there are opportunities everywhere, so it’s important to look outside of our borders in search of the best investment ideas. Right now I continue to see value in the U.S., so I’m focusing more of my research there; however that doesn’t mean I’m ignoring Canadian companies - or even those outside of North America, such as in Europe - when making my investment decisions.
- Q: That makes a lot of sense. But aren’t you worried about spreading yourself too thin? Is there a right “eggs to basket” ratio?
Of course, but that’s why it’s important to always keep your eye on the bigger picture. My macro-economic outlook - meaning what my current and longer-term views are regarding the economic environment - is what drives my decision as to whether or not to invest in a certain sector or industry. At any given time I could be invested in around 8 to 10 different sectors, but in order not to spread the portfolio too thin, most of my investments will be concentrated within 3 or 4 sectors that are consistent with my macro view. Right now that includes a mix of U.S. Financials, Consumer Discretionary (think Starbucks!), Industrials, and REITs.
- Q: What major factors do you see playing into the positive outlook for U.S.-based investments?
The economy is on the mend and we are somewhere in the mid-stages of the recovery. Continued improving economic data should help drive earnings growth now that we are past Q1 weather-related disruptions. Compared with a very tough Q1, second quarter earnings season has been better, with most companies beating analyst estimates albeit off of lowered expectations. However, for those companies that have either missed or reduced forward guidance, stocks have been driven down sharply. As we near the end of reporting, we remain constructive in our longer term view, although Fed induced short-term volatility remains possible as the market grapples with the timing of when interest rates will be hiked. From an international perspective, accelerating and improving global growth should help U.S. companies with international exposure as consumer and business spending eventually turns around.
Despite the rally in the S&P 500, good investment opportunities still exist - pullbacks in the market provide good buying opportunities. On average, stocks are relatively fairly valued - meaning that they are no longer trading at bargain basement cheap prices but neither are they overly expensive and out-of-reach. I tend to look for catalyst-rich companies that have performed well despite the lack of growth in the economy. These companies typically have streamlined operations and have strong balance sheets that translate to attractive future earnings growth (and dividend growth) especially when economic activity eventually picks up.
- Q: What about Canadian-based investment opportunities? Is it profitable to be patriotic?
Yes, it can absolutely be profitable to invest in our own backyard. For example, the energy sector as a whole has had a strong recovery this year; the Canadian Energy Index outperformed at 17.75% as of July 17 compared to the US Energy Index, which returned a lower but still attractive 12.6%. To me, the key is to remain nimble and opportunistic, which is why I keep my fund flexible and not beholden to any one geography.
Generally speaking, Canada is a market where many investors look for commodity exposure - things like precious metals, agricultural products and, especially, energy. There are a lot of good investment opportunities in Canada, but the U.S. market offers more breadth of securities. In other words, there is simply more selection because the U.S. market has broader representation of companies in any one given sector (such as in the healthcare and technology sectors). When identifying similar companies in the US and Canada, I look at relative valuation levels, and compare the growth opportunities available in the different countries to determine which country offers the better investment.
- Q: What about asset classes? Is it better to look at equities or bonds?
Likely both! Luckily, they’re not mutually exclusive. When I’m investing, I look for good opportunities in every asset class - i.e. equities, bonds, preferred shares, convertible bonds and options. And when I find a company I fundamentally like, I’ll look across its entire capital structure to see what facet I think has the best risk-adjusted return. If I really have strong conviction in a company, I’ll sometimes invest in both their equity and their debt. Options can also be used to generate more yield and/or add protection in the portfolio
Also, investors need to remember not to be afraid of cash. I view cash as an asset class just like equities or bonds, and hold a certain percentage of it as a part of my fund because it provides a cushion during times of market weakness. Cash also gives me flexibility as ‘dry powder’ (slang for cash reserves kept for easy liquidity) so I can take advantage of buying good companies when there is a market sell-off. This is especially the case now, since we have had such a strong rally in the markets and are currently in the slower summer months. I am locking in some profits and have increased my cash position.
- Q: That’s fair! But if we have strong conviction in a company, is it ever okay to put all your eggs in one basket, so to speak?
As damaging as spreading yourself too thin can be, putting all your eggs in one basket by going ‘all in’ on a company could be harmful too, as not every investment opportunity works out. However, within most industries there is a lot of competition, meaning there could be more than just one good company to invest in. My strategy is to focus on picking high quality, undervalued companies that have the highest potential for cash flow and dividend growth. But what if my research leads me to two - or more! - great investment opportunities within the same industry? I could buy both, but usually for different reasons. For example, right now I’m invested in several companies in the U.S. Financials industry: BlackRock Inc., the world’s largest asset manager; and BankUnited, a regional bank in Florida and New York.
- Q: What is it you like about those companies specifically?
BlackRock pays a 2.5 percent yield and offers ongoing share buyback programs. Its iShares ETF platform is the largest in the world and should continue to benefit shareholders as ETF penetration keeps increasing in equity and fixed income funds. On the other hand, BankUnited should perform well as loan growth continues to increase and interest rises over time. It brims with a solid balance sheet and strong management team whose focus lies on improving margins and good expense discipline. It also pays a favourable yield - 2.6 percent.
- Q: Are there other specific companies that you think will be big growth players for your fund?
You’re probably familiar with Gildan Activewear? It’s a vertically-integrated manufacturer of basic activewear, socks and underwear, and benefits from being the lowest cost producer in the industry from its high volume production facilities in Central America. It has a strong balance sheet and growth opportunities from expanding into branded apparel and international markets. Further, it’s run by an excellent management team, and for the investor, pays a small dividend of 0.75% while trading at a cheap valuation level.
I also like Boeing Aerospace, which offers products and services in the aerospace and defense industries. It pays a 2.3% dividend and gives the investor exposure to the global recovery in airline demand through higher aircraft deliveries and with a significant visible backlog. The main driver of valuation is the commercial aircraft business. Expect improvement in their FCF, or free cash flow, as well as continued share repurchases and dividend increases.
- Q: So, activewear and airplanes – got it! To conclude, there are four areas in total we should look at when diversifying?
Yes - geography, sectors, asset classes, and companies.
- Q: Excellent. Thanks for talking to us, Viv!