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Buy & Sell: Market conditions call for extra vigilance, portfolio manager says

MEDA-2014-06-27- Buy & Sell Market conditions call for extra vigilance, portfolio manager says

By Jonathan Ratner

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Central banks are coercing investors out on the risk curve again since many short-term fixed-income investments have negative real yields, so Sean Oye of Nicola Wealth Management thinks extra vigilance is needed.

“Investors aren’t really being compensated for the risks they’re taking,” he said.

Oye noted that U.S. 10-year treasuries currently yield about 2.6%, whereas Japanese 10-year government bonds yield less than 60 basis points as Prime Minister Shinz? Abe’s inflation dream is coming true, borne out by April CPI print of 3.4%.

“Why would any investor want to buy a 10 year JGB when you are virtually guaranteed a negative real yield?” the manager asked.

The co-portfolio manager of the NWM Canadian Tactical High Income Fund sees risk creeping up in all asset classes, particularly as the “zeal for yield” continues.

He points out the market’s low volatility and complacency, as evidenced by the VIX recently hitting a seven-year low, show people are starting to forget about the disruptions of 2008.

“This reduction in volatility has had the effect of reducing the premiums on put and call-option writing strategies,” he said.

As a result, the manager is writing options a little closer to the money or at the money to generate annualized double-digit rates of return on those investments. In some cases, he isn’t writing options on names at all.

“It’s getting more challenging, but being benchmark agnostic has advantages,” he said.

Oye’s goal is to generate tax-efficient cash flow through both long-only investments and income-generating strategies such as call and put options.

The manager has been increasing the fund’s exposure to industrials, which now represents nearly 30% of the portfolio versus about 8% for the S&P/TSX composite index.

“Many of the industrial names we own have the majority of their revenue outside of Canada,” Oye said, highlighting his positive outlook on the U.S. economy.


Guardian Capital Group Ltd. (GCG.A/TSX)

The position: 3.9% of fund, purchased in Oct. 2013

Why do you like it? Oye is seeing positive developments with this wealth manager’s capital allocation as it deploys some of its war chest to fund acquisitions and seed new products.

Guardian Capital also still has roughly $360-million in Bank of Montreal shares after selling some of its stake in recent quarters and 87% of its current share price is backed by BMO stock, cash and other securities.

“Very little value is being given to the asset management business,” Oye said, noting it is one of the cheapest asset managers on an enterprise-value-to-AUM basis.

Biggest risks: Equity markets sell off; BMO shares decline.

Heroux-Devtek Inc. (HRX/TSE)

The position: 3.4% of fund, purchased in Oct. 2013

Why do you like it? Oye believes the aerospace industry is in the early stages of a secular growth story, particularly airline OEMs and their suppliers, noting that Heroux-Devtek signed a significant contract with Boeing Co. in December 2013.

“It’s the world’s third-largest landing gear manufacturer and still doesn’t hit the radar of many fund managers because it has a small market cap and share float,” he said. “This company could also become attractive to other majors as it nears its $500-million sales goal for 2019, which the Boeing deal will help them achieve.”

Biggest risks: Higher-than-expected capex for Boeing 777 contract; a global economic slowdown.

Progressive Waste Solutions Ltd (BIN/TSX)

The position: 4%, purchases in Jan. 2012 via put options

Why do you like it? Oye sees tremendous revenue and earnings growth over the next five years for this fully integrated waste management company.

“It is a highly fragmented market and Progressive can become a consolidator,” the manager said, noting 60% of the $63-billion market is serviced by local companies.He also pointed out that it is highly leveraged to the U.S. economy and there is significant operational efficiency upside if it wins a contract for New York City that it is up for.

Biggest risk: A U.S. economic slowdown.


Westshore Terminals Investment Corp (WTE.UN/TSX)

The position: Recently exited

Why don’t you like it? Oye had owned Westshore, which operates a coal storage and loading terminal in British Columbia, since April 2012. He recently sold the position primarily due to its valuation, coupled with low top-line growth prospects and reduced return of capital to shareholders.

“There is a low probability that they will increase the dividend over the next few years, as a large portion of free cash flow is being allocated to new equipment and buildings,” the manager said.

Potential positives: Company raises dividend prior to 2018; purchases or receives management contract for Ridley Terminals.