Finding investment opportunities when the economy isn’t handing them out

iStock 000014863867Medium priv eq banner 300x94 Finding investment opportunities when the economy isnt handing them outLast week, we organized a lunchtime panel with four outstanding financial minds that are part of the pool of talent we have to draw on for the management of client investment portfolios:

  • Maureen Farrow, (economist), President, Economap
  • Tye Bousada, (global equities), President & Co-CEO, Edgepoint Investment Group Inc.
  • Rick Grafton, (energy), CEO, Grafton Asset Management
  • Corrado Russo, (real estate), Managing Director, Global Securities and Investments, Timbercreek Asset Management Inc.

It was a lengthy and meaty conversation about the state of the global economy, how Canada is faring and what it all means for clients of Newport Private Wealth. This summary won’t fully do justice to the depth and scope of the presentations, but we will try to boil a 90 minute discussion down to a readable blog post for you.

Another five years of muddling through?

Our independent economist, Maureen Farrow, President of Economap, kicked off the discussion with a macro-overview of the key global economic issues. Her main point is unchanged. Governments and consumers are still paying down debt and will do so for some time to come.  We are currently in year five of a de-leveraging cycle and it will likely be another several years of sub-par economic growth. Progress is being made in repairing economies, but at the price of very slow growth and job creation.

Look to EU, U.S. and China for everything you need to know about the global economic picture

Europe is back in recession – take Germany out of GDP numbers and Europe’s been in recession for five quarters!  The way out appears to be ill defined with ‘bailout fatigue’ setting in within Germany and France. Europe will remain the most serious risk to the global economy for some time to come.

The U.S. recovery has some traction, helped by a turnaround in the housing market.  Housing starts are now at 750,000 per year versus 350,000 at market bottom – but still a far cry from the 1.2 million at the peak. The impending fiscal cliff looms large, but Maureen was optimistic there will be a resolution.

China’s economy appears to be growing again, but at a reduced and safer growth rate of 7 – 8% per year. China’s leaders are working to shift the country’s economic balance, encouraging domestic spending and ultimately reducing its heavy dependence on exports.  The expectation is that going forward China will grow at a slower percentage rate than the past, but on a much larger economic base. This change will increase demand for energy and services needed to support an operating economy and moderate demand for those commodities (e.g. iron ore, steel) required for capital spending on infrastructure that is now effectively built.

Canada’s economy slows

While the trends in the U.S. and China are positive for Canada, our growth rate has slowed and, Maureen predicts, GDP percentage growth will be less than the U.S. in 2013.  Canadians have high levels of consumer debt and lower spending will be the result as they work to pay it down. The residential real estate market is cooling, especially in the overbuilt condo markets of Vancouver and Toronto, though pockets of hot markets still exist, as in Regina and Calgary for example.

Can investors learn to love volatility?

Never in the history of the world has macro-economic news driven the performance of capital market so much and for so long. Expect volatility to continue. Investors with a long-term investment horizon may be rewarded with buying opportunities at times when fear is heightened and well-run businesses are mispriced (read undervalued). Opportunities can be found in countries and sectors linked to growth in Asia, and in areas of the U.S. housing market, which has turned.  Investors should exercise caution, favour investments that generate a portion of their return in cash (e.g. real estate, infrastructure, dividend-paying equities, bonds, etc.).  Yet be mindful that as interest rates eventually rise, a secular bear market in bonds should be expected – so not the obvious safe harbour they once were.

Canada’s energy sector a beneficiary of China’s growth

Rick Grafton, CEO of Grafton Asset Management, was our next speaker. Rick is an asset category specialist in high-growth energy companies.  We have a small allocation to a private energy fund he manages through our Newport Canadian Equity Fund and Rick gave us a terrific overview of the opportunities he is seeing in his industry.  He opened by reminding us that the industry is and always has been cyclical.  He reported that the cycle looks to have turned up in June with natural gas prices increasing from approximately $2/mcf to $3.75/mcf. In his view, the opportunities remain immense.

According to Rick, the industry needs to spend $650 billion annually for the next ten years to meet the demand from Asia and to add more pipeline capacity in North America.  All this potential has the full attention of our federal government which has its eye on the prospect of an additional $25 billion of tax revenue.  It is a safe bet that this activity will translate into opportunities for investors.  Rick was particularly positive about some of the larger names like Tourmaline (TSX: TOU) and Paramount (TSX: POU), his current two favourites.  As an aside, we were early investors in Tourmaline and it is one of the largest positions in our Newport Canadian Equity Fund.

Profiting from other investors’ mistakes

Next, Tye Bousada, President of EdgePoint Investment Group Inc. and one of the asset class specialists managing a portion of our Newport Global Equity Fund, weighed in from the perspective of a portfolio manager of global stocks.

After warning us that we should expect more volatility, he added he hoped “volatility is here to stay.” He did an excellent job of explaining that volatility causes investors to make mistakes. For instance, a short term price decline always causes some investors to lose faith and sell a stock – because they never had a good “fix” on the true value to begin with. By contrast, Tye and his colleagues work hard to understand the real value of a business.  If there is a short term decline, they often will buy more.  Why all this volatility?  Financial markets are trading more on macro news rather than “fundamentals” like corporate earnings, and with no shortage of troubling news like Europe and the fiscal cliff, volatility remains high.  Tye’s ideal investment is a company that will grow even if the economy does not, and he does not want to pay for this growth today!

As an example, he talked about his holding in Pool Corp (Nasdaq:POOL).  Pool Corp is the world’s largest wholesale distributor of swimming pool supplies. In the aftermath of the 2008 crisis, its stock price fell almost 50% to $13 per share.  Investors were understandably worried about the company’s prospects in a tough economy and a collapse in new housing construction. However, Tye and his colleagues had developed their own “proprietary view” of Pool Corp and invested on the weakness at the time.  As Tye explained, “we aim to know the true value of companies and capitalize on others mistakes – when there is volatility, people make mistakes.”  Fast forward to 2012 and Tye is now selling the stock at $40 and above.

The appeal of apartment buildings

Our panel would not be complete without a real estate expert– a sector that represents approximately 12% of the assets under management at Newport Private Wealth. Real estate has been a favoured and strong performing area of ours for many years and much of this success has been through investment with experts like Timbercreek Asset Management Inc., a global real estate manager with $3 billion of assets under management.

Corrado Russo, Managing Director of Timbercreek updated us on the outlook for this sector, specifically multi-residential apartment buildings. It seems appetite for income and demand from foreign money has driven up the price of Canadian apartment buildings. Timbercreek is now selling some of its mature holdings into this frothy market and finding better buying  opportunities in properties where they can add value such as tired or mismanaged properties. Timbercreek has a large pool of capital, an expert team and a finely-tuned program that allows them to purchase a building and create value where others cannot, through suite and amenity renovations and operational improvements.  These enhancements increase the cash flow from the properties (from higher rents and operational efficiencies) and in turn the value.

In contrast to the Canadian market, the U.S. real estate sector has bottomed out after falling as much as 40%. This is creating tremendous opportunity for Timbercreek to apply their formula in that market by partnering with local experts.

A buying opportunity in southeastern US

The opportunities in the U.S. multi-family sector are particularly attractive in the “right to work” states of the southeast where manufacturing and employment levels are rising.  Across the U.S., home ownership is in decline and renting has become a favourable alternative. In addition, there has been little in the way of new apartment supply in recent years. In short, occupancy levels are high and rents are rising because demand exceeds supply.

We have touched on just three asset categories here – we have seven more to choose from in constructing portfolios to withstand turbulent times and deliver steady returns. As investors know too well, every percentage point of return in this low-growth environment is hard fought and you can’t take anything for granted. Yet, despite all the black clouds that are hovering overhead, there are smart investment specialists with proven strategies who can still capitalize on market volatility and pockets of opportunities – if you know where to look.

 

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