The leading financial advisory service for business owners and executives

Masters of the Markets, Q1 2014

Jon Williams: Jon Williams here with Manulife Securities and Williams financial group and today I have with me Duncan Anderson, a senior portfolio manager with Manulife Asset Management and today is our first interview ,that we’re calling the "Masters of the Market. Duncan’s team at Manulife manages over 12 billion dollars of which we use multiple mandates with our client portfolios. Today its early 2014, I just want to recap last year with Duncan as to some of the things that we saw happen in the markets and also what the opportunities are for 2014.

Just to start off with, last year it seem like it certainly paid to be invested outside Canada both from currency perspective as well as a market perspective. What where some of the big wins last year that you guys saw?

Duncan Anderson: All markets actually performed very well outside of Canada last year. The Canadian market had a good return with low teens but obviously the US market was very strong. It was a very broad rally across all of the US market and if you’re outside Canada you wanted to be certainly un-hedged - as the US dollar appreciate against Canadian dollar. But it wasn’t all bad in Canada, there are some very good performing securities if you’re outside of the energy and materials sector. There were a lot of Canadian stocks that actually did very well. Some of them were names like Gildan, Constellation software, Sokudo, Westjet, there was a lot Canadian companies that in fact did very well - that just weren't a larger presentation within the TSX.

Jon Williams: So the Canadian portfolios that you guys run, how would they differ compared to the Canadian index?

Duncan Anderson: They differ in a significant way, in fact, on our Canadian portfolios, about 95% of the portfolio is different than a TSX, so we have a portfolios that don’t own any banks or insurance companies, or gold stocks, no material stocks and in fact have a very small weight into energy - with one name being Imperial oil.

Jon Williams: So if I take a look at Canadian stock market and I exclude- resources, materials, banks and insurance companies, who do I have left?

Duncan Anderson: There’s a lot, in fact a lot of great Canadian companies - they are just are smaller market caps, so therefore they’re not a large representation within the index. So if you can create a portfolio to get exposure to those companies, without regard for a market cap weighting bias - then you can create portfolio that has great companies that just tend to be more than a cash base.

Jon Williams: So Canada has some of the best banks in the world globally according to many different sources, yet it doesn’t sounds like you have any Canadian banks or other banks in your portfolios, why would that be?

Duncan Anderson: It’s all due to the structure of a bank. The assets side of the balance sheet maybe very different I.E.: in the USA, they had a lot of subprime mortgages in, Eruope they owned a lot of Sovereign Deb,t in Canada our banks have a lot of mortgages that are insured by the Canadian government. So the assets of the bank can be very different. However, the structure of a bank is the same regardless of countries. So banks typically in need a lot of leverage in order to generate a good return for equity holders and so we’re creating our portfolios that are between 20 and 30 stocks - in all businesses that are doing very different things, we want to make sure that we don’t have a lot of financial leverage - that if we hit a credit crisis, our portfolio won't be impacted significantly and that’s why we prefer not to own banks in our portfolio.

Jon Williams: Without getting too technical, I’ve heard you talking about before the difference between return on equity and return on assets. That’s the sort of "return on assets" part that takes out the leverage of the balance sheet essentially?

Duncan Anderson: Exactly, "return on assets" would be the return a business can generate before any funding sources are taken into consideration. So if a business was fully funded with equity, so share holder’s money, and the return of assets would equal the return of equity. But soon as you start to add any liabilities, it can be interest bearing debt or bank deposits. As soon as you to add any liabilities into the equation, then you can actually amplify the return of equity holders - because they actually put in less money and so they get an amplified return.

Jon Williams: So going in looking forward into 2014 as you’ve mention the market sort of worldwide had a pretty nice run and whenever that happens, people do get nervous. They wonder are thing getting over valued? Are you still finding opportunities out there in the market place or are you guys starting to sort of pull back on the sidelines a little bit?

Duncan Anderson: No, we’re definitely still finding opportunities in the market place. Maybe the best example of this would be, we run a balance fund. The alternatives right now are between cash, fixed income and equities. Our balance fund is currently constructed with about 85% in equity because we see that as the best opportunity in the marketplace right now, given the returns that cash is offering and given the returns that fixed income is offering, we’d rather be owners of these great businesses that can compound for us - as opposed to being lenders in fixed income market and getting 3.5%.

Jon Williams: Speaking of fixed income, I know you own mainly equities, but you mentioned that in balance portfolio. What is your perspective on bonds? I am certainly, personally I am in fairly nervous of owning long bonds in any of my client’s portfolios at this time period. What’s your thoughts on bonds these days?

Duncan Anderson: We would agree with that and as obviously what’s reflected in that balance funds mandate is that, of that 15% we have allocated to cash and bonds - the bulk of it right now is in cash so we want to be on the short end of the curve, because we believe we’re not being compensated to go out long out on the curve and we’re also not being compensated to take on that credit risks that’s longer out on the curve. We would also agree with you that the long end of the long market is probably more risky, end of the market bond market right now - it’s probably the bond market that’s gonna to drive the FED to raise rates.

Jon Williams: Now, let’s look forward and hopefully we have some continued great markets and it seems that the FED has continued to slow down their stimulus programs. What happens to stocks when those programs eventually stop and they actually perhaps start to slowly raise interest rates in that scenario?

Duncan Anderson: It’s very hard to know what happens in the stocks in the future, but the math of it is such that although they’re slowing down, their interest rates are still very low. If the FED is tapering it’s a sign that they believe the economy is strengthened and that the economy is in fact getting better and some of those stocks that were saying under US would suggests that. Home prices in the US are now starting to increase, again we’re seeing very strong stock market. So we’re seeing assets prizes reflate again in the US, which is a good thing. So the economy continues to strengthen and you want to be an owner of the companies that gonna benefit from that. But on the other side of that eventually people will make a decision to get back in the fixed income, when those rates of return are higher and compensate them for the risks more appropriately.

Jon Williams: So in your balance portfolio it sounds like you’re still finding opportunities, things that you get excited about. Is there one or two different areas of the market or companies that you’re particularly excited about. Or are there any themes that you still see that there is a good value in, from maybe a sector or a theme or is it really you just or any companies in particular that you’re excited with that you can share with us.

Duncan Anderson: Yeah, lets maybe bringing to that under portfolio level. Like how excited we are about the portfolio that we’ve created of 25 different businesses, but each business is doing something unique and all are very interesting businesses in their own right. But we’ve been able to create a portfolio that has virtually no debt, it’s doing almost 30 % return to the equity holders and we’re paying about 14 times multiple for that business. So the way that we think about our portfolio is more of a company. Our company that we’ve created with these 25 stocks, all doing very different things, is a very high returns business without financial leverage that we think is attractively valued and for us we want to be owners of that as opposed to lenders in the bond market because we believe that that’s the best risk return opportunity.

Jon Williams: And when you use a number like 30 % return in equity and the PE was around 14. What does that mean to investor? What’s the impact of that to your portfolio, the business that you owned, if I have 30% ROE, what’s that mean? Where’s the company going next year? What’s the impact of that?

Duncan Anderson: The return of equity would simply mean the return of the business is generating for the amount of money that the equity holders have put into it. And you increase the likelihood or the odds of success if you can get higher profitability; you increase the odds that the future prices would be higher in the market, you increase the probabilities that you would do well if you buy cheap companies. So what we can combine high return with good evaluation, its multiplying the effect that the probability of success is much higher for our portfolio.

Jon Williams: Well Duncan, I’d like to thank you very much for your time today and for coming in and sharing some of your ideas with our clients and thanks so much again for coming

Duncan Anderson: Thank you.