Franklin Bissett Dividend Income Update

After starting off the week with a historic 10.3% decline on Monday, March 9 (its second largest drop at the time), the S&P TSX Composite extended its weekly decline on Thursday, dropping 12.3%, a new all-time record daily decline for the Index and bringing the week-to-date return to -22.7%. The S&P 500 Composite Index also dropped sharply on Thursday as heavy selling forcing circuit breakers into effect five minutes into the trading session and stocks declined further after trading resumed, to close the day down 9.5% (-16.5% WTD, in USD). Markets continue to reflect heightened fears regarding global economic conditions, with 10- year Canadian and U.S. benchmark interest rates falling to new all-time lows in both jurisdictions, a concurrent blow-out in credit spreads, and the VIX (a measure of U.S. equity market volatility) spiking above 75 versus a 5-year average of 15. In addition to continuing fears related to the COVID-19 virus (which was officially declared a global pandemic by the WHO on Wednesday), a falling out between OPEC+ members and subsequent warning by Saudi Arabia has weighed heavily on oil prices, at a point declining to less than US$30 per barrel WTI. Monday, March 9, 2020, the first trading day following Saudi Arabia’s aggressive change in stance, ominously marked the eleventh anniversary of the start of the bull market phase which is now under threat.

Energy Sector

Recently, the energy sector has been the subject of significant volatility, reflecting the general virus-related anxiety of the market, and the resulting demand shock for transportation fuels. But within the last week, a disagreement within the OPEC+ cartel between Saudi Arabia and Russia threatens a supply shock, where additional crude is brought on the market above current demand. This spat has pressured crude oil prices and will have follow-on effects for oilfield service companies as producers limit capital spending. Although the entire Energy sector has seen downward pressure on share prices, and appears highly correlated at first glance, we believe there will be significant difference in forward returns between high quality, well capitalized companies and those with less operational and financial resiliency. Fortunately, Franklin Bissett’s Dividend mandates are well-positioned for this scenario. The sector weight is much lower going into this downturn, and our holdings are largely concentrated within Energy Infrastructure (pipelines, midstream) investments, which are much less exposed to the price of crude oil (or natural gas). Within this subgroup, it is our expectation that dividend levels will likely be maintained, although growth projects may likely be deferred. Elsewhere in the portfolio, we have no exposure to Oilfield Services, which we expect will take the hardest operational hit. Lastly, our E&P/Integrated holdings are smaller in weight in the portfolio, and consist of companies that have a number of defensive attributes (balance sheet, commodity mix, size, hedging, royalty ownership, etc.) and management teams that we believe have the experience and ability to shepherd their businesses through downcycles.

Portfolio Positioning

In recent years, we had grown increasingly cautious about equity valuations given increasing global economic risks and being mindful of the likelihood that we were likely somewhere in the late innings of the market cycle. Our concerns stemmed from the observation of widespread market complacency and pockets of speculation and extreme valuations. Over the past five years, the application of our bottom-up approach with a focus on strong fundamentals and valuations has resulted in a portfolio with a heavy emphasis on more defensive sectors such as Utilities, Telecommunications Services, Real Estate and Consumer Staples. As such, many of the largest weights in the portfolio are in businesses that are built around predictable cash flows and have strong capital positions that reflect a long term, disciplined approach to the balance sheet that would closely reflect our investment philosophy.

What we may have “left on the table” in terms of performance over the past five years by being on the outside of some of the more speculative investment themes, has resulted in a more insulated portfolio in the case of weakening economic backdrop, especially a sustained downturn. Although this positioning should prove relatively resilient in a weaker market, we will remain on the ready to take advantage of opportunities provided by emerging dislocations in valuation across various sectors. Granted at the current time we are facing a worldwide pandemic that is potentially in its nascent stage, an unprecedented interest rate environment, tumbling commodity prices and many other risks to the global economy, uncertainty prevails for the time being, validating our cautious stance.

The information is not a complete analysis of every aspect of any market, country, industry, security or portfolio. Statements of fact are from sources considered to be reliable, but no representation or warranty is made as to their completeness or accuracy. Because market and economic conditions are subject to rapid change, opinions provided are valid only as of the date indicated. The views expressed may not be relied upon as investment advice and are not share class specific