2020 Canadian Equity Portfolio - January Report
Hello fellow investors!
With the exception of a rough January 31, the TSX had a fairly strong start to the year with the S&P/TSX Composite Total Return Index and my chosen benchmark, the iShares Core S&P/TSX Capped Composite Index ETF (Symbol: XIC) returning 1.81%. My 2020 Canadian Equity Portfolio returned 3.99%, for a total outperformance of 2.19%. Let’s break it down and see what happened this month.
Overview
If you haven’t yet checked out my methods and philosophy for creating equity portfolios, here are the Coles Notes:
have a healthy balance of low-volatile stocks and growth stocks
choose stocks with low or negative correlations with each other
focus on free cash flow and return on equity
less emphasis is placed on valuation ratios such as price-earnings and price-book
calculate historical risk and return using data which includes the last major recession (i.e. 2008)
With this philosophy in mind, I came up with a 30 stock portfolio which looks a lot different than the S&P/TSX Composite index, which is market-capitalization weighted. Energy stocks play a small role, and I hold none of the big Canadian banks. While the big banks have undoubtedly been great investments in the past, I believe my approach is safer and the portfolio risk is better captured by including not just the last 10 years’ worth of returns as regulations dictate, but by returns dating back to January, 2008.
THE INDEX
A return of 1.81% is nothing to sneeze at, and if every month could be this way then we’ll be on track for a repeat of 2019, which most investors would take in a heartbeat. Without diving into how each and every TSX Composite Index stock performed, let’s just take a look at the top 10 instead, which make up about 37% of the Index.
Financials (21%)
The biggest 4 Canadian banks (Royal, TD, Bank of Nova Scotia, Bank of Montreal) returned an average of 1.34% this month, while Brookfield Asset Management significantly outperformed with a 7.93% return.
Energy (10%)
Enbridge, TC Energy and Suncor returned an average loss of 0.82%. These companies historically have had lower volatility than their smaller peers which make them attractive investments in an otherwise unattractive energy sector.
Industrials (3.7%)
Canadian National Railway is the sole top 10 stock in the Industrials sector. Year-to-date, it has returned 5.28%.
Technology (2.7%)
Shopify, the tech darling which gained 173% in 2019, was quickly put at #9 of the market-capitalization list. Year-to-date, the stock has returned an impressive 19.37%.
The median return of these stocks was 2.12%, which interestingly is higher than the index’s return of 1.81%. This is another data point in favour of smaller, concentrated portfolios of established stocks as opposed to investing in an entire index.
MY PORTFOLIO
I went about things differently and instead invested heavier in consumer stocks, technology and real estate at the expense of heavy weightings in the Financials and Energy sectors. For a broad overview, please see the chart below:
Core Holdings
My top 10 “core” holdings make up 58% of my portfolio, which coincidentally happens to be my lucky number. They include the following holdings (respective YTD returns in brackets):
Metro (0.67%)
Canadian Apartments REIT (6.99%)
Boyd Group (2.97%)
Morneau Shepell (2.71%)
Alimentation Couche-Tard (7.33%)
Fortis (7.13%)
Constellation Software (10.30%)
Empire Company (1.18%)
Premium Brand Holdings (7.14%)
Franco-Nevada (12.19%)
The median return for this group of stocks was 7.06% (mean was 5.86%) and every stock was in the green - likely an anomaly I’m not expecting to continue.
Metro reported earnings which unimpressed investors, missing earnings expectations but still announcing an increase in dividends. Franco-Nevada enjoyed a $65 increase in the price of gold so far this year as this defensive stock ended up being my best core holding of the month. Perhaps that is a sign of things to come.
Mid-Tier Stocks
To say I’ve been disappointed with this group of stocks so far would be a massive understatement. Together, these stocks comprise about 30% of my portfolio but they contributed just 0.08% of the portfolio’s 3.99% gain in January. Of course, you can’t win them all and this is a good time to remind you all, as well as myself, that portfolios work in harmony together and as tempting as it is to focus on the performance of one or a group of stocks, it’s not the way to do it. In fact, this is spelled out clearly as one of the investor personality types you don’t want to have (framer vs. integrator). So while these stocks under-performed for me this month, there’s still a solid chance they will outperform in other months.
It’s not as if there aren’t good reasons for the under-performance. For example, not many people saw the impact the coronavirus would have on demand-sensitive stocks, including Air Canada which was the worst performing Industrials sector stock last week. CGI Group, down 6.75% on the year, slightly missed earnings and revenue estimates. And Parex Resources, off 13.25%, missed due to the significant drop in the price of crude oil this year - also linked, in part, to less demand from China from the coronavirus outbreak.
There were good stories to offset the bad ones though, particularly from Element Fleet Management (up 14.61%). No news though other than some analysts boosting their price targets, but I don’t treat analyst ratings as gospel so I’ll chalk it up to good fortune.
Speculative Stocks
Only making up 11% of my portfolio, these stocks are considered speculative because they have little to no trading history during the last recession of 2008, somewhat weak free cash flow or return on equity, or some combination of the three. Aritzia, of course, is the winner to date, up 31% on a strong earnings report. My wife loves their clothing, and whenever I take the kids to go pick up an order we are always greeted with friendly staff and good music. With a 1.75% weight, I don’t feel I’m risking too much here.
On the other end, Whitecap Resources disappointed with a 12.64% move to the downside. Again, this is due to the price of oil and the widening differential between WTI Crude and the Canadian Crude Basket, which is sitting near $20. One has to wonder if the Canadian government will move again to prop up prices, as otherwise we may see a further consolidation of Canadian oil producers in the near future.
Summary
I’m pleased the portfolio was able to outperform the index during a month of gains. Every time this happens, it’s a nice surprise as the goal is to stay close to the index during up months and significantly outperform it during down months. Protection of capital is the focus, and I try and accomplish that by having a higher concentration of defensive and low-volatile stocks (e.g. Consumer Staples) and cut back on the big bank stocks which do not provide many diversification benefits. Energy stocks have reduced influence as well, as I’ve grown tired of waiting for an oil price rally.
When explaining the concept of lower risk equals higher returns to people, I often get either blank stares or a lot of pushback. But looking at the performance of the S&P/TSX Capped Sector Indices over time, you’ll find strong evidence that this is indeed the case. Consumer Staples stocks have the lowest volatility and highest returns of all the sectors. I wrote about it back in July, and suspect it still holds true today. If you’re a Canadian investor, you’ve gotten paid for taking less risk.
I will look to February now, when a number of my key holdings are due to report earnings. I’ll also keep a close eye on the Index’s top 10 holdings as well, as they are the ones which will provide the direction for the overall market. If things turn south, I’ll be counting on Consumer Staples, Utilities and my gold stock (Franco-Nevada) to bail me out.
Good luck this year! Thanks for reading.