Canadian equities markets produced double-digit returns in 2010, and bonds also rallied as long-bond yields dropped and corporate spreads continued to narrow. Yet, managers of Canadian equity balanced funds are divided over strategy going into 2011; some see more upside in equities, while others are tempering their bets.

In the latter camp is Doug Warwick, managing director of Toronto-based TD Asset Management Inc. and lead manager of TD Monthly Income Fund. He shares fund-management duties with TDAM managing director Geoff Wilson and vice presidents Michael Lough and Greg Kocik.

“Our strategy continues to be to buy blue-chip companies that pay dividends that will grow over time,” he says. “But the market continues to be focused on energy and materials, so we’re lagging the market. But we are sticking to our mandate.”

The TD fund’s benchmark is a 60/40 split between stocks and bonds. Currently, it has 60% of assets under management in equities, 37.6% in fixed-income and 2.4% in cash. In mid-2009, the fund had almost 64% in equities and 34% in bonds. “In late July 2009, we decided to reduce the bet a bit and began to move very gradually out of equities,” says Warwick, noting that new cash was allocated to bonds. The fund has a 3.1% running yield.

About 80% of the fixed-income weighting is in investment-grade corporate bonds, with about 16% in government bonds and 4% in high-yield products. The average duration is 5.5 years vs six years for the benchmark DEX universe bond index.

“Our feeling is that interest rates will remain low for a long time. There is too much slack in the developed world economies,” says Warwick. “The population is aging. We have the demographics working in favour of interest rates remaining low. Even if rates do spike up one percentage point, pension funds will back up the truck to lock in those yields. They’re desperate for income and safety. We just don’t see interest rates jumping up to what we saw in the early 1980s.”

On the equities side, the TD fund holds about 35 blue-chip, dividend-paying names. About 32% of the fund’s total AUM is in financial services, with about 13.4% in energy and single-digit holdings in sectors such as utilities and consumer discretionary. One representative holding is Intact Financial Corp., the former subsidiary of the Netherlands-based ING NV spun off in the spring of 2009. “[Intact is] a debt-free casualty and property insurer and owns well-known brands such as Belair and Grey Power,” says Warwick. Acquired at $25 a share in 2009, Intact’s stock is trading at about $51.60, with a 2.7% dividend yield.

Looking at dividend-paying utilities, Warwick and his team have long favoured Enbridge Inc. “[It has] a steady business base,” says Warwick, noting that a large portion of the firm’s revenue is from returns set by regulators. “Over the next three to five years, you can see 12%-15% growth in the business.”



a little more cautious is Peter Frost, vice president with Toronto-based AGF Management Ltd. and co-manager of AGF Monthly High Income Fund. He believes that the coming year will be a stock-picker’s market in which security selection is more crucial than ever.

“It’s a bifurcated market,” says Frost. “There are some good opportunities, but other securities are stretched. You will have to be a very active manager — last year’s portfolio will look very different from this year’s.”

Largely a bottom-up inves-tor, Frost has already reduced equities to 58% of the AGF fund’s AUM and raised cash to 12% of AUM, with the remaining 30% in bonds. “Most of [the reductions have] been security-specific, not right across the board,” he says. “Many high-yielding securities, such as [real estate investment trusts] and energy trusts, had moved up significantly in the past few months. Their yields had declined. So, we thought it was prudent to take some profits.”

There has been a lot of liquidity, adds Frost, as many income trusts were in the process of converting to corporations by yearend. Frost took some profits in names such as Vermillion Energy Trust.

“Pension plans, especially foreign ones, were nervous about the trust structure and the limited liability,” he explains. “Now that these names are moving into the corporate structure, they’ve eliminated that impediment.”@page_break@Frost is looking to take advantage of the next bout of volatility, whenever it comes. He notes that the European markets are looking interesting. Currently, about 16% of the AGF fund’s AUM is in foreign assets, mostly in the U.S. (about 6%-7% is hedged back to the Canadian dollar).

Running a portfolio of 55 equities, Frost likes names such as TransAlta Corp. The utility has been hit by low natural gas prices and its share price has dropped to about $21.40 from a high of $37 in June 2008. “But the yield has gone to 5.4% from minus 3%,” he says. “It looks pretty attractive at this point in the cycle.”

On the fixed-income side, Tristan Sones, vice president with AGF and the fund’s co-manager, is running a bond portfolio whose average rating is BBB-, which is on the cusp of investment-grade. The average duration is three years.

In the future, says Sones, the trick will be “a lot more about finding relative value than finding names that are cheap in their own regard, with the hope that all high-yield bonds will go up.” He adds that he does not expect either a big backup in spreads or spread compression: “We’re finding more opportunities globally.”

With last autumn’s corporate debt rally, Sones took profits and trimmed some of the riskier names. However, he continues to like firms such as Zarlink Semiconductor Inc., which makes voice and data transmission products for the communications industry. Its bond is maturing in 2012 and yields about 2.9%.



Stephen Carlin, Senior Vice president with Toronto-based AEGON Capital Management Inc. and lead manager of imaxx Canadian Fixed Pay Fund, believes this year will be as challenging as 2010.

“We expect more of the sovereign debt issues to surface, settle down and surface again,” says Carlin. “A month ago, Ireland was not on the front page. But then it surfaced, and now that the International Monetary Fund and European Union stepped in, all eyes are on countries such as Spain. It’s like rolling blackouts. We will have rolling levels of volatility within [this] issue.”

As governments wrestle with heavy debt obligations, they are under mounting pressure to cut spending. “Unless they get their economic houses in order,” says Carlin, “the bond market will tell them how to do it.”

But Canada remains a beacon of light, thanks to its strong resources sector and a good supply/demand picture for iron ore, copper, gold and oil. Says Carlin: “Those are all prime investment attributes that we can see as positive for Canada.”

Unlike his peers, Carlin is more bullish on stocks — 79% of the i-maxx fund’s AUM is in equities and 21% in fixed-income. The latter is mostly composed of investment-grade corporate bonds. The equities component is heavily weighted (65%) in income trusts and REITs, while the balance is in common equities of banks and pipelines.

Running a concentrated equities portfolio, the imaxx fund owns about 30 dividend-paying names. “To use a baseball analogy, you’re operating off first base with a high dividend yield,” says Carlin, who anticipates total returns of 6%-8% in 2011.

One top holding is ARC Re-sources Ltd., formerly ARC Energy Trust. ARC converted to a corporation at the end of 2010 and is shifting more into crude oil production. The firm’s 5% distribution yield will be unchanged. “The attractiveness here is that ARC has enough tax-deferred writeoffs on [its] balance sheet that let [it] enjoy non-taxable status for several years.” The share price is $24.50. Carlin’s target is $27 in 12 months.

On the REIT side, Carlin likes RioCan REIT. The firm, which owns and manages office towers and shopping malls, has been criticized for paying out more than its cash flow, but Carlin believes the firm’s earnings will continue to grow: “As investors look at RioCan’s attractive acquisitions in the U.S. you can see room for capital appreciation over the next little while.” IE