2012 was another year of recovery with some scary moments along the way.
Globally, there continues to be many signs of improvement, but still a very slow recovery from a deep recession. The key from an investment point of view is not to get caught up in your current surroundings, but to focus on the direction. Today, that direction is positive. As a result, we are optimistic for the year ahead.
Even with a positive general outlook, we see a few red flags ahead of us this year which will likely see temporary pull backs in the market. We will try to use these pullbacks as buying opportunities. These might include:
- The United States will see meaningful government spending cuts take place which will slow their growth a little this year. It will come about as part of the negotiations to raise the debt ceiling. These cuts didn’t get done with the Fiscal Cliff negotiations, but look for them to happen around March – and will likely hurt markets in the
weeks leading to an announcement.
- The quiet in Europe is a little disconcerting. Expect some noise as new governments come in to power, continued austerity measures cause public uproar, and look for more standoffs between expectations of EU bailouts and countries that still don’t meet the criteria required to receive them.
- Asia and Emerging Markets seem to be moving in the right direction at the moment, but when it comes to China in particular, it is often hard to really know the whole picture. As a result, you always want to be wary about counting on China to lead markets forward. We will be looking for any government announcements that could
lead to a slowdown in growth.
- Canada faces some challenges around possible declines in real estate valuations and the increasing energy production out of the United States. Despite these concerns, we continue to see many positives in Canada, but in some cases there may be less room for growth here than in other recovering nations.
How did we do?
2012 was a positive year for TriDelta clients. While the TSX returned 4.0% and the DEX Bond Universe returned 3.6%, most TriDelta clients had a net return somewhere in the 4% to 10% range depending on their risk tolerance.
In addition to strong net returns, our clients had a much smoother ride than the Toronto stock index. Most clients never had a month with a loss of more than 1.3% during the year, while the TSX suffered a loss of 6.3% in May. This risk minimization is important for our clients as they are looking for peace of mind from their long term financial plan,
and from their month to month investment portfolio.
This combination of beating the stock market and bond market index with lower than average volatility is a fairly rare feat, and one that we are quite proud of.
What worked well
We remained significantly underweight precious metals and energy for most of the year. We added to our energy weight in the fall, and managed to capture much of the upside in the sector. Our stock weighting was 1/3 US based. With the US markets meaningfully outperforming Canada on the year, this was a value driver as well.
Our higher than average cash weightings (often 10% to 20%), didn’t slow us down much, helped to smooth out the bumps, and as discussed in the Q3 Investment commentary, we were able to buy in on a couple of pullbacks during the year – because the cash was available.
At TriDelta, we place the primary focus on capital preservation followed closely by a dividend growth approach to growing the assets. We seek risk adjusted returns, which means that at times of elevated market & economic risk we’re happy to give up some returns to ensure the safety of your hard earned capital.
On the fixed income side, we made the right call in terms of holding some longer term bonds. These bonds appreciated from the continuing decline in long term rates and stable short term rates.
Our best investments have been:
- Pason Systems up 45% on the year – a smaller Canadian company that provides instrumentation systems for the oil and gas industry. It was purchased because it has a very clean balance sheet, steady growth in earnings and dividend growth, and appears to be very well run. We were looking for some additional exposure to energy with a well-managed service provider.
- Southern Copper up 37% on the year – US headquartered Copper miner with very strong cash flow and dividend. Net profit margin over 35%. No debt issues and growth is currently powered by internal cash flow. We wanted some mining exposure but with good dividends and strong cash flow.
- Baxter International up 38% on the year – US health care firm that provides products
and services for hospitals and medical research. We saw similar fundamental strengths
as others here, and a good valuation for entry.
- Catamaran Corporation (formerly SXC Health Solutions) is up 63% on the year – Canadian based provider of pharmacy benefits management services and healthcare IT solutions to the healthcare benefits management industry. Great products, fast growing but managed growth. No dividend is paid here, so more of a growth name held by higher growth clients.
What did not work well
Sometimes our risk minimizing approach does keep us away from opportunities. One of those situations could be found in the second half of the year, as we saw strong gains in Europe and emerging markets that we did not participate in. These gains were not driven off economic strength as much as they were a bounce back from some of the significant declines over the past couple of years – and relative calm. We have started to add more non-North American exposure to portfolios.
Another investment that has hurt us in the short term was a Canaccord preferred share. We continue to hold the name as we see solid income, low valuations, and expect some recovery in 2013.
It can be difficult at times to hold poor performing investments, but we go back to the same numerical analysis that led us to own the investments originally. If there is no major change to the financials of the company, and it would pass our buy criteria today, then we won’t typically sell these investments. If something meaningful changes and the companies would no longer meet our original buy criteria, we will sell.
Our weak investments have been:
- Joy Global lost 33% – occasionally a company doesn’t do what it should do based on the numbers. It may require more time, but in this case, we bought Joy Global because it was a diversified drilling equipment supplier with a steady growth profile. While the stock has improved a little from where we sold it, we were able to reinvest funds into Tesoro and other companies that made solid gains. In this case, we felt that other companies in the sector were holding up better and could provide more upside than holding Joy.
- TransAlta lost 10% – we replaced it with Atco which is up 17%. In this case we made a relatively quick decision to move out of a company that had been underperforming its industry for a company that had been outperforming. Sometimes the best move you can make with an investment decision is to get out quickly. It requires an ability to be analytical and unemotional, something that many investment managers lack. In this case, the negative ended up a positive with Atco.
We are strong believers in the power of dividend growth, and look to hold stocks that, based on our analysis, are good bets to grow their dividends over time. This quarter was no exception, with 9 companies increasing dividends, and none decreasing.
Southern Copper paid out a special one-time dividend which accounts for its 1,046% dividend growth.
|Company||Dividend Increase (%)|
Our view of the past quarter and the year ahead
Prior to last quarter we said that we expected a 5% pullback due to one of a variety of factors, one of which being the Fiscal Cliff negotiations.
As it turned out, we did see this decline correctly after the US election in mid-November, and we took advantage over the past few weeks by buying McDonalds, Cisco, 3M, and Cognizant across various portfolios. All have seen gains of 3% to 10% since.
Another move we made late in December was an interesting approach to tax loss selling. As mentioned earlier, we had purchased a Canaccord preferred share which we believe in, but had experienced losses in 2012. This was a Series A preferred share. For those clients who held the security in a taxable account, we sold in late December to capture the tax loss. Because we believe in the company, and didn’t want to risk being out of the name for the required 30 days, we immediately purchased the Canaccord Series C preferred share. If we bought back the same stock, we would lose the benefit of the capital loss, but by purchasing a different (although very similar) security, we remained fully in the investment, but are still able to capture the capital loss for this tax year. As it turns out, this was a good move, as the investment is up 14% in the past 3 weeks.
Our general view of things is similar to that entering 2012. We see choppiness driven by the news cycle in the U.S. and Europe. We see things as generally positive, but not significantly so. We see short term rates remaining flat, and still see some room for long term rates to fall – leading to some opportunities for capital gains in bonds.
This general belief continues to support our core themes of dividend growth, large cap, long term bonds, and some increasing international exposure.
On the positive side, the US is indeed showing the classic signs of a solid recovery – increased manufacturing, improving employment and increasing housing prices. We expect that this will continue – along with a terrific investment environment of low interest rates and government stimulus.
China also looks to be showing meaningful signs of improvement. This bodes well for much of the global economy and in particular for Canada and its commodities.
Speaking of interest rates, we continue to see gains for long term bonds – at least for the first half of the year. Assuming declines in government spending, a strategy of easy monetary policy, modest job growth, and low inflation, we see these combining to keep higher interest rates at bay.
The U.S. Federal Reserve will keep overnight interest rates near zero, and continue with forcing a flatter yield curve until there is both a “sustainable” and “substantial” improvement in the employment situation. The Canadian bond market will essentially be dragged accordingly; however, the Bank of Canada may want to depart (like they did in early 2012) from the dovish stance, but on balance it is unlikely.
As a result, TriDelta will continue to hold longer term bonds for higher yield and capital gains. A great example of this strategy in action was our switch from a Manulife bond with a 2015 redemption date that had a current yield near 3.75% to one with a current yield of almost 6%, an $86 price and a redemption date of 2041. Since the 2041 bond was purchased in September, the bond has increased in price by 6% on top of the yield. The bond that was sold is up 1% over the same time period. We are unlikely to hold this 2041 Manulife bond long term, but will be happy to continue to receive the high income over the short term, and hopefully get a 5% to 10% capital gain when it does get sold.
We see low growth in North America, likely in the 1% to 2% range – certainly not significant growth rates.
We see continued strength in the Canadian dollar, possibly gaining a few cents during major Debt Ceiling debates. This strength in the Canadian dollar vs. the U.S. dollar will underpin the need for increasing Canadian partnerships with Asia across many industries, energy in particular.
At TriDelta we look forward to providing our current clients and new clients with three key deliverables:
- A financial plan that gives you a roadmap, financial peace of mind to do more with your wealth and smart tax planning.
- An investment plan that fits within your larger financial plan. An investment plan that will help you to achieve the long term life goals that you have set out.
- An investment approach that lowers volatility, delivers increasing income, and uses proven financial discipline and mathematics to underscore buy and sell decisions.
Our past year has been a great example of achieving above average risk adjusted returns. In a world of low interest rates and low growth, we strongly believe our investment approach and philosophy is well suited to outperform.
We look forward to a great year ahead.
|TriDelta Investment Management Committee|
VP, Fixed Income
President and CEO
VP, Business Development