The RBC Canadian Equity Income Fund, which beat every peer in the past three years, is betting investors are too concerned about the economy by purchasing industrial stocks following their biggest decline since 2002.
Jennifer McClelland increased the fund’s investment in the group to 15 percent of assets from 10 percent on June 30. She bought Magna International Inc. (MG), Canada’s largest auto-parts maker, in August, and SNC-Lavalin Group Inc. (SNC), the country’s biggest construction and engineering company, in September. She said investors drove down industrial stocks because they expect a global recession, which McClelland doesn’t anticipate.
“The stocks were reflecting a pretty dire scenario,” said McClelland, 41, who runs the C$663.9 million ($654.9 million) fund in Toronto. “Based on what we see and people we talk to, it’s not nearly as bad as what people are worried about.”
The machinery group is producing double the gain this quarter as the Standard & Poor’s/TSX Composite Index, the benchmark measure of Canadian equities. The RBC Canadian Equity Income Fund returned 13 percent in the year ending Nov. 1, beating all 122 competitors, and produced gains averaging 13 percent annually since 2006, five times more than the S&P/TSX Composite Index, according to data compiled by Bloomberg. The fund beat the index 10 straight quarters between 2007 and 2010.
The S&P/TSX Industrials Index fell 19 percent last quarter, the most since 2002, as economists cut growth forecasts for developed countries and the European debt crisis intensified. The gauge of 19 stocks fell to a price-earnings ratio of 12.4 on Oct. 3, the cheapest in more than two years. Magna slipped to 7.1 times profit the same day, compared with an average of 8.6 in August, while SNC-Lavalin dropped to 15.4 times on Oct. 4 versus the average of 18.2 in September.
Phone, Pipeline Stocks
McClelland missed out on gains this year in telephone companies and Canada’s biggest pipeline operators, Enbridge Inc. (ENB) and TransCanada Corp. (TRP) Income funds such as hers augment returns by investing in dividend-paying companies. Phone companies have the second-highest yields among 10 S&P/TSX industries at 4.57 percent, while pipeline companies pay 3.83 percent.
The S&P/TSX Telecommunications Services Index has returned 16 percent this year, while Enbridge and TransCanada returned 26 percent and 14 percent, respectively.
Competition will hold back profits among Canadian phone companies, said McClelland, who sold all of her shares of companies in the industry by June 30. Smaller energy companies have the potential for faster energy growth than Enbridge and TransCanada, she said.
McClelland favors stocks that will benefit most from economic growth after speaking with corporate executives, who said business is fine.
“Talking to companies, they’re a little more optimistic,” McClelland said. “We’ve been adding to a lot of these names because we’ve been of the view the stock price did not reflect reality.”
Her fund also owned Badger Daylighting Ltd., an excavator, and Finning International Inc. (FTT), the world’s largest Caterpillar dealer, as of Sept. 30, according to RBC Global Asset Management’s website.
Of 78 economists in a Bloomberg survey, two forecast U.S. gross domestic product will fall for two straight quarters in the next year, which would meet a common definition of a recession. Investors have been acting as if the outlook was dimmer because “there may be a little post-traumatic stress” from the 2008-2009 bear market, said McClelland, who is also a co-manager of the C$7.74 billion RBC Monthly Income Fund.
Stocks that pay dividends have gained this year as low interest rates and bond yields make equities more attractive among investors seeking income. The S&P/TSX Dividend Aristocrats Index, which comprises companies that have increased dividends at least five straight years, has returned 1 percent this year, compared with a decline of 7 percent with dividends for the S&P/TSX Composite.
Should the market again fall at the rate it did earlier this year, investors may instead see dividend-producing companies as sources of cash, McClelland said. “When we came out of the big selloff in 2008, the market piled into low- quality, poor-balance sheet, cyclical small and mid-cap names,” she said. “I worry about that phenomenon happening again.”
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