A short-term approach to long-term returns

Helping him are 22 analysts and portfolio managers in Toronto and Montreal, and more than 800 in Europe, Asia and the Americas. His Canadian team covers more than 300 companies, with 40 to 50 stocks making it into his portfolios.

“With a smaller team, you wouldn’t be able to do this much analysis, so you might have to go toward more sector bets,” he says.

Building a portfolio on the merits of individual companies instead of using a single economic prediction means each decision carries less risk, he adds. “I would have to make at least 50 different decisions wrong to have the same outcome as being wrong on a China macro view.”

Q: How do you find strong Canadian investments?

We look from a bottom-up perspective. Sometimes companies benefit from growth outside of Canada, like Gildan Activewear. Most of its customers are in the U.S., and it’s the world’s lowest-cost producer of T-shirts. It has a high wholesale market share, and has started supplying shops like Walmart. It’s a big opportunity, and has led to a return on equity of nearly 20%.

I haven’t owned Gildan the whole time I’ve been a manager. Sometimes great companies aren’t great stocks because valuations are too high. In summer 2011, Gildan rose [to more than $35]. Working with portfolio managers and analysts who were looking at cotton prices, I found expectations on Bay and Wall Streets were too high.

The price of cotton was dropping, and when it falls aggressively, wholesalers hold back on buying T-shirts because they [want to wait until] prices fall. Since market expectations weren’t correctly pricing in the drop in cotton prices, I sold my position at the higher prices. When Gildan reported its earnings, the stock fell [to $17.32], I bought my position back and have held since.

Q: How do institutional portfolios vary from retail ones?

I approach them both similarly. It’s not about whether it’s institutional or retail, but, more importantly, what the client wants from us.

While many managers have clients with different time horizons, I regard the timelines as similar between the two classes. All my investors would like returns over multiple years, sometimes over a decade. They may like things to be strong over a decade [from now], but they are looking closely on a one-, three- and five-year basis.

Q: What stock is indicative of your bottom-up strategy?

Alimentation Couche-Tard: they do convenience stores globally. [It has the] three points we look for in any good company (see “Three things,” this page).

Recently, Statoil, a European oil and gas company, sold its stores to Alimentation Couche-Tard [for $2.8 billion]. Our global team had a model on those assets. The morning it was announced, we opened the financials and judged whether it was a good acquisition.

This one was, because it was in the core business—convenience stores. The valuation we had from our own work on the Statoil operations, and from the details that were in the press release, looked attractive. And the Statoil acquisition was done with a combination of debt and equity, and Alimentation Couche-Tard’s balance sheet was not stretched.

Q: How do you find a company like that?

Our Canadian investment team covers the fundamentals of more than 300 companies. Analysts come up with their best ideas, and then those 300-plus companies go down to about 100 stocks.

We have more than 1,250 CEO visits every year within the Canadian group. I meet with one CEO on average every business day. For one hour, we go over the business, including a strategy update, their competitive environment and capital allocation.

I ask myself, “What are they doing with it? How are they investing it? What are the returns?”

We will meet with companies we own, as well as companies we don’t own, assessing their potential. Or we’ll look at their competitors and suppliers.

Q: With a Canadian focus, how do you handle the risks of a concentrated portfolio?

I don’t take analysts’ picks at face value. I do my own analysis and double-check their work. I meet the company management; [look at] the income statement, balance sheet and cash flow; read reports and make my own judgments.

You also have to watch for unintended consequences. You might not have started with a macroeconomic or sector bet, but maybe the materials analyst likes lumber, so you think of buying some lumber stock. And the consumer discretionary analyst who covers automotives says, “I think the demand for autos is improving,” so you may buy an auto stock.

They’re in two different sectors but they’re both geared toward the U.S. economy. So even though your sector levels aren’t out of line as a whole, you’re depending on the success of the U.S. economy.

Q: Is there a limit to how much you buy in any sector?

It’s plus or minus 7.5%. So if a sector is 10% of the portfolio, I can only go up to 17.5% of the assets, or down to 2.5%. The sector weights are determined by bottom-up stock picking. A sector’s weighting is determined by the attractiveness of its individual stocks. If they’re not [attractive], we’ll own 0% in [that sector].

Q: Any other considerations?

We can own companies as small as $200-million market capitalization. The smaller companies historically total 5% of the portfolio, but there’s no hard minimum or maximum. It’s based on the individual security, and its risk and return potential.

Still, I don’t make major investments in small companies. It’s not appropriate for most of my clients. I was taught early on that many small companies never become big companies.