We try to pass along interesting market observations when we see them. Often, what we and others see from the top down jives with what we are finding from the bottoms up or company level. It can also help put performance of different portfolios or strategies into context.
Relative to even a few months ago, we are finding more “one-off” interesting opportunities as we go through our regular bottoms-up process. At the same time we are finding opportunities; there are a number of pockets of the market, some of which have been performing well. As our partners know, if we do not believe in the bottoms-up fundamentals of the business, we will not own it and are happy to let others participate. We stick to what we know because over the long term it works, it helps to reduce risk (which we view as permanently impairing capital), and it is how we want to invest our own capital (which is in the funds).
Interestingly, year-to-date when you compare United States “value” stocks to their “growth” counterparts in the S&P, you are seeing among the largest relative outperformance of growth vs. value since the peak of the US tech bubble. At nearly 1300 bps year-to-date, this is a dramatic difference and helps to explain why some of our more conservative portfolios will not have kept up to certain indices.
When you peel back the onion a little further (with the help of our friends at Kailash Capital – see first graph from Brandon’s July 21st blog), we see some other trends. If you group the S&P into quintiles by their economic durability and compare the top quintile (20%) to the bottom 20% you will see the following:
Economically Durable – Top 20% – These businesses overall have very robust balance sheets with almost no net debt (net debt to EBITDA < 0.2x) and strong return on assets (ROA >10%). These are the businesses which are more likely to be found in Cambridge portfolios, particularly among lower risk mandates.
The S&P 500 – Overall average – The overall business in the S&P 500 has leverage (net debt to EBITDA < 0.6x), but it is manageable. ROAs for the business are reasonably attractive at >8%.
Economically Fragile – Bottom 20% – These businesses in aggregate are the most highly levered (net debt to EBITDA > 5.5x) and have the lowest return on assets (ROA <2%).
It is interesting that today the more economically durable group is trading cheaper than the average (4.1% vs. 3.6%). What is even more interesting, however, is that the most economically fragile group is trading at a material premium the average (0.7% vs 3.6%) and their stronger peers – despite having lower returns and far greater financial leverage.
The economically fragile group has also recently had lower betas than Group 1, despite being riskier businesses (beta is supposed to be a measure of risk). This is the first time this has happened for a prolonged period in decades. We certainly live in very interesting times.
It is during these times, more than ever, that it is critical we carefully follow our rigorous bottoms-up fundamental approach, and we are appreciative to our many strong partners who allow us to do this. We are also fortunate to be finding some interesting business-specific opportunities out there, while also avoiding parts of the market that either carry too much risk or we believe are overvalued.
I would also like to briefly touch on the FX given the recent rapid change in the Canadian dollar. We have worked to be clear in how our funds should be thought about:
Canadian funds --> Canadian-dollar-based Cash held in Canadian dollars
US & global funds --> US-dollar-based Cash held in US dollars
With the rapid move higher in the Canadian dollar vs. the US dollar (12% since early May), those holding US and global funds will see their Canadian-dollar-based returns weaker as a result. As of right now, the S&P/TSX is up under 1% year-to-date with the S&P 500 up 13% in local currency, but only 2% in Canadian dollars. This is the mirror opposite to the benefit any US and global fund would have received when the Canadian dollar was weakening vs. the US dollar, such as during much of 2013, 2014 and 2015.
Interestingly, we are now seeing greater interest in Canadian investments vs. US and global investments because of the performance difference caused in large part by FX. Not too long ago (and when the Canadian dollar was weaker) the opposite was the case. If one rewinds the clock a few more years to when the Canadian dollar traded over par, Canadians investors in aggregate were redeeming US/global investments (priced in foreign currency and trading at much lower valuations) to invest in commodity businesses in Canadian dollars.
We appreciate that such a swift move in a currency can come as a surprise to some viewing their holdings in Canadian dollars. And while it is never enjoyable, it does create opportunities for those who can invest counter-cyclically or stick to a well-diversified portfolio. Investing against the crowd never feels great at the time, but is more lucrative. It also usually requires one to have a plan or asset mix that is followed through both good times and bad. A number of us at Cambridge have just added to our holdings in our US and global mandates.
This commentary is published by CI Investments Inc. It is provided as a general source of information and should not be considered personal investment advice or an offer or solicitation to buy or sell securities. Every effort has been made to ensure that the material contained in this commentary is accurate at the time of publication. However, CI Investments Inc. cannot guarantee its accuracy or completeness and accepts no responsibility for any loss arising from any use of or reliance on the information contained herein. This commentary may contain forward-looking statements about the fund, its future performance, strategies or prospects, and possible future fund action. These statements reflect the portfolio managers’ current beliefs and are based on information currently available to them. Forward-looking statements are not guarantees of future performance. We caution you not to place undue reliance on these statements as a number of factors could cause actual events or results to differ materially from those expressed in any forward-looking statement, including economic, political and market changes and other developments. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Cambridge Global Asset Management is a division of CI Investments Inc. Certain funds associated with Cambridge Global Asset Management are sub-advised by CI Global Investments Inc., a firm registered with the U.S. Securities and Exchange Commission and an affiliate of CI Investments Inc. Certain portfolio managers of CI Global Investments Inc. are associated with Cambridge Global Asset Management.