The summer of 2006 was probably the worst possible time to be launching a fund for income trusts – legislation calling for the abolition of these entities was announced shortly afterward, and the great recession was just around the corner. While such was the lot of the RBC Diversified Income Trust Fund, though, it went on – under the new name of RBC Canadian Equity Income Fund – to become the best by miles among the 81 funds in the Canadian dividend and income equity category. The fund earned both the Fundata FundGrade® "A" grade for the past month, as well as the coveted Fundata FundGrade A+ Rating™ for 2011.
The RBC Canadian Equity Income Fund’s 5-year average annual compound return, at 12.0%, is almost double that of its closest peer, and its 3-year return of 21.3% also tops the field. In addition to its FundGrade “A” and “A+” ratings, in 2011 it garnered both the Lipper Award for best Canadian small/mid-cap equity fund (over 1, 3, and 5 years) and the Morningstar Canadian Investment Award for best Canadian dividend and equity income fund. And that’s just 2011 – there were other awards in previous years as well.
“It was pretty tumultuous from the start,” recalls fund manager Jennifer McClelland, vice-president and senior portfolio manager at RBC Global Asset Management in Toronto. “There was a period of high volatility, and the fund evolved into an equity income type of product.”
And of course, that volatility still remains. “It’s been a job to navigate in the markets right now,” she says. “Sometimes it seems like a different market every day. Some days everyone is locking into defensive stocks like utilities, and some days there’s more optimism in the market.”
One result has been a portfolio turnover as high as 200%, although McClelland doesn’t know whether it will stay that way indefinitely. “It’s an actively-managed portfolio, but I don’t know if we’ve hit a normal turnover yet,” she says.
Although the fund still owns some of those original income trusts (albeit in their new incarnation as dividend-paying corporations) the portfolio has always embraced other equity assets as well. “It’s always been an open mandate to invest in stocks or income trust units,” says McClelland. “There’s still a scattering of former trusts, but we’ve diversified into a balanced mix across all sectors. Our focus is more on the quality of the business and the underlying cash flow.
“We have a bias towards growing cash streams because that translates into a growing dividend stream,” McClelland adds. “With some companies we do look at absolute yield, but the quality of the underlying cash flow is more important. For the rest, we look at the same things as other fund managers – strong management with a good track record, a good sustainable business model with growth opportunities, and so on.”
McClelland also notes that rather than having yield requirements for each individual holding, her fund applies a minimum yield of 1 1/4 times the TSX yield – currently around 3 1/4% – to the total portfolio. And there are no sectoral targets, with two exceptions: “We do watch our allocations in energy and in finance, because these are both very important sectors in the Canadian economy,” she says.
“We’re cautious about energy right now, though, so we’re below the TSX weighting,” McClelland adds, adding that they’ve also started to reduce their exposure to defensive sectors like utilities and telecoms because “we’re concerned about the valuations getting pretty rich.”
The focus now is more on consumer discretionaries and staples, and industrial names – companies with strong balance sheets and with good growth prospects as the U.S. economy picks up some steam. When that will happen McClelland can’t say, but she is cautiously optimistic nonetheless. “Your guess is as good as mine, and I’m hedging, but I think we’re seeing a bit of a bottoming process now and we’ve seen the worst of [the recession],” she says.
In any event, with corporate balance sheets in great shape, McClelland is confident that strong companies will prevail. “When we talk to companies, there’s not as much concern as previously,” she says. “And again, I’m hedging, but I think that even if the recovery is drawn out, these companies will survive.”
Olev Edur is an experienced financial and business journalist and a frequent contributor to the Fund Library.
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