A Q&A with Garey Aitken on Franklin Bissett Canadian Equity Fund

Garey – Can You Comment on Q3 and YTD as It Relates to the Canadian Equity Market and the Franklin Bissett Canadian Equity Fund?

It has been a great environment for the Canadian equity market, with the S&P/TSX Composite Index rising for six consecutive quarters, since the bottom in the first quarter of 2020.

The market’s advance did slow in the third quarter, with only a slight gain of less than 1%. I would attribute this to the gains made in prior quarters and accumulating worries, which include near term economic growth uncertainty in light of diminishing monetary and fiscal stimulus, ongoing concerns regarding COVID, inflation pressures and supply chain issues. Effectively, we are now at point where equity markets must climb the wall of worry. I would note though that October is off to a good start, with the S&P/TSX Composite Index reaching another all-time last Friday, October 15th.

The Fund has had a solid 2021, with a slight edge over the market YTD and during Q3. While it is still not an ideal environment for our strategy, it has been an improvement over recent years and we have benefitted from some strong security selection in a handful of sectors.

Could You Characterize the Market Dynamics over the past Year?

Equity markets experienced a sea change last November with the news of a successful COVID vaccine. With that, the reopening trade gained versus the stay-at-home trade, interest rates rose, and generally value outperformed growth for several months. While equity markets finished 2020 on a high note and started the year strongly, the bull market has lost some steam in recent months. During this period, the Value versus Growth trade has see-sawed back and forth, with no particular style or factor providing dominant leadership.

How Is the Fund Positioned?

We stay true to our investment style and the long-standing investment parameters of the Fund. We never lose sight of our goal to deliver strong absolute returns as well as risk-adjusted relative returns.

We can quickly pivot if the risk-reward opportunity presents itself. For example, over the past year, we have reduced cash by almost 500 basis points, to just a few percent, and added significantly to Financials and Energy. At the same time, we have reduced Utilities, Industrials and Consumer Staples exposure. This is reflective of the disproportionate opportunities we are continuing to find in names that are often “best-in-class” with valuations that we do not believe appropriately reflect the free cash flow profile of the businesses.

Overall, we are near fully invested. We like our mix of defensive/non-cyclical equities as well as value/cyclical equities, given their valuations, and remain leery of the valuations of the growth/concept stock segment of the market. At the aggregate level, we have been able to construct a diversified portfolio of high-quality businesses with strong fundamental profiles at a valuation competitive to the Canadian equity market.

SNC-Lavalin Was Recently Reintroduced in the Fund. What Changed since You Eliminated the Position Couple of Years Ago?

Despite SNC’s past legal challenges, we think the company has comfortably turned the corner and is well positioned to grow its core services business. We like the company’s strategic focus and are hopeful that it will start generating consistent free cash flow.

What make makes the equity particularly attractive is the current valuation. While the stock has performed well this year, we expect that as the company executes on its business plan that there remains significant rerating potential.

We don’t typically target turnaround situations, but in the case of SNC we like the risk-reward setup given our view of the improving business fundamentals.

In the past You’ve Discussed Your Investment Style Being out of Favour, Can You Elaborate on This?

I stated earlier that this has been a better year for our investment style, but it is by no means the ideal environment and the past several years have been challenging.

We’ve consistently employed a fundamentally-driven investment style that is based on assessing and valuing company’s free cash flows. Implicit in our approach is the belief that markets have a tendency to be inefficient in the short term but that the true worth of an equity will tend to get better recognized over time.

However, in recent years, we have not seen this play out as we have in the past. Effectively, many of the types of stocks that we gravitate to have stayed cheap whereas other stocks have only seen their valuations expand over time. We rely on mean reverting markets whereas equity markets for the past few years have, to varying degrees, been driven by momentum, and particularly as it relates to stocks with perceived high growth rates, or even the potential for high rates of growth in the future.

When Do You Think Market Leadership Will Change and Why May We Now Be in a Better Market Environment for Your Investment Style?

I’m not sure that anyone knows for sure what the catalyst might be for a change in market leadership, or when it may occur.

It is clear, however, that the outperformance for growth has been going on for a number of years and the valuation premium for growth stocks is getting extreme by historical standards.

Let me be clear, we too like growth, but more specifically we like visible, profitable growth and we are disciplined in what we will pay for this growth.

Regardless of the market leadership that prevails, we are continuing to find attractive valuations that should translate into strong multi-year absolute returns.

Fundamentals for our holdings are strong. The pandemic has caused, or allowed, management teams to drive efficiency gains, and we expect margins to impress as the economy recovers.

We are finding lots of opportunities where companies are furthering their alignment with shareholders in terms of returning capital via buybacks and dividend increases.

Eventually we do expect to see a return to an equity market that rewards solid fundamentals and valuations. A stronger global economy and higher interest rates could be the catalysts for our investment style to outperform. We expect a stronger global economy as COVID’s impact wanes over time. As well, the gradual reduction in unprecedented monetary stimulus unleased at the beginning of the pandemic, and now higher inflation, combined with a stronger economy could well translate into higher interest rates.

How Does the Canadian Equity Market Look Relative to the U.S. Equity Market?

The Canadian equity market has lagged its U.S. counterpart significantly over the past decade. Much of this is a function of the vastly different sector weightings in Canada versus the U.S., where the U.S. market is more heavily weighted in tech stocks while the Canadian market has a more economically cyclical orientation.

At this juncture, however, we think the set-up for Canada looks very good: the Canadian equity market is now better balanced across many sectors whereas it was quite concentrated in Energy, Materials and Financials a decade ago. The Canadian market now offers much better valuations, and remains positively leveraged to continental and global economic growth.

Why Should Someone Consider Franklin Bissett Canadian Equity Fund as a Long-term Canadian Equity Solution?

There are a few elements I would highlight:

• Proven long-term track record – we’ve demonstrated an ability to deliver on our performance objectives over long periods of time¹.
• Framework in place for long-term success – we have a time-tested investment process and a deep, experienced research team.
• Return potential is compelling – As I’ve said earlier, valuations are attractive, and we believe valuations drive returns in the long term.
• Risk Management – Risk management is integrated in our research, modelling, valuation work and portfolio construction.
• And finally, ESG – which is integrated and explicit in our approach. Our proprietary internal ESG evaluation results in portfolios with competitive ESG profiles, where we understand the risks and have identified the opportunities. As long-term investors, with strong relationships with issuers, our engagement activities allow us to make a positive impact on the ESG attributes of our portfolios.