For many investors, the sinking feeling that accompanies an investment statement littered with losses has been less common over the past decade. But as the economic cycle winds down, it’s only a matter of time before the feeling returns.
“We’ve passed peak economic growth for this cycle, which was in 2017,” says Andrew Zimcik, portfolio manager at Connor, Clark and Lunn Investment Management.
Not only is the cycle in its late stages, he said in a June 19 interview, but politics are affecting the global economy. “This creates very high levels of uncertainty, and one reason why market volatility has picked up substantially in the last 18 months or so.”
Uncertainty was cited by the Bank of Canada last week when it held its key rate. The central bank downgraded its global growth outlook for this year to 3% from 3.2%, based on escalating trade conflicts and geopolitical tensions.
As a result of uncertainty, market volatility is expected to continue, Zimcik said. So, what’s an investor to do?
Zimcik, who manages the Renaissance High Income Fund, described the game plan he helped put into play over the last year: “Investors will continue to favour stable, consistent and high-quality companies, as these are the characteristics that are scarce when the economy is more volatile.”
Across sectors, he targets companies with strong balance sheets that aren’t suffering under heavy debt burdens as interest rates move higher relative to recent years. An example is telecom BCE, which Zimcik described as “defensive,” with “very low” financial leverage.
Such companies are further attractive because they’re often large or have greater trading liquidity. Larger companies are typically diversified across their businesses so are more stable, he said, and greater liquidity instils in investors the confidence of knowing they can get in or out of a holding quickly.
For example, the team recently added Coca-Cola to the fund. The U.S. mega-cap consumer staple has “very defensive characteristics, including its exceptionally high trading liquidity,” Zimcik said.
Another positive characteristic Zimcik looks for is strong, stable earnings growth as economic growth moderates. For example, the team increased the fund’s weight in Empire Company, the large-cap Canadian grocer.
Similarly, Zimcik said he looks for high, stable margins or consistent free cash-flow generation. An example is Element Fleet Management, a global fleet leasing business. The company has “high levels of recurring revenue and is less exposed to the economic cycle than many of its peers in the financial sector in Canada,” he said. “This leads to more stable margins.” The name has been one of the best performers in the fund over the last year.
In conjunction with these positive characteristics, Zimcik said the price must be right. “Companies that have these characteristics are more likely to stand out based on [our] target prices and, as a result, will have attractive risk-return or risk-reward opportunities.”
The focus on high-quality companies served the fund well as markets sold off in the last quarter of 2018 and again in May. These included Microsoft, another name with high levels of recurring revenue, and insurance company Intact Financial, which has a consistent business model relative to its peers, Zimcik said.
“With this backdrop of heightened volatility and, at a minimum, increased uncertainty, we believe this high-quality bias is the most prudent way to position the fund on a go-forward basis,” Zimcik said.
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