OB Report
April 2019
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Different Doesn't Always Make a Difference

Murray Leith By Murray Leith CFA, Executive Vice President & Director, Investment Research

Research Chart 1Equity markets have had a strong start to the year, with the Canadian and U.S. equity benchmarks up 13% and 11%, respectively through to mid-March. The positive shifts in investor sentiment and stock prices since the end of 2018 are remarkable. Fears of an economic recession have morphed into optimism that the global economic expansion will continue. We are at a loss to find material factors that explain the dramatic change in attitudes. From our perspective, we are neither overly excited, nor fearful about the outlook. With most stocks reasonably priced, and some deeply discounted, we believe prospective returns are attractive.

While the Odlum Brown Model Portfolio* has enjoyed the stock market’s rising tide, we haven’t kept pace with the S&P/TSX Total Return Index recently. Year-to-date, the Model has underperformed by more than three percentage points; and compared to last year, it has lagged by more than four percentage points.

Investing is a humbling affair at times, and we are at one of those junctures. Some stocks in our Model have performed very poorly. XPO Logistics, Kraft Heinz, Coty, ING Groep N.V. and Colfax are among the worst. Canadian energy investments have been a huge disappointment as well, with companies like Peyto and Cenovus well off their highs. Likewise, U.S. housing-related stocks, such as homebuilder TRI Pointe Group and timber owner Weyerhaeuser, have weighed on our results.

We wish we owned fewer of the stocks that have gone down and more stocks like Rogers Communications, Visa and Starbucks, which have performed very well. We know clients feel the same way.

However, we’ve owned frustrating stocks before, and our patience has yielded satisfying rewards. Not all of the recently disappointing companies will recover and do well, but if history is a guide, the odds are very good that many will be top performers down the road.

We would love to outperform all the time, but realistically, that will never be the case. We often challenge the crowd mentality and purposefully position our portfolio differently than the general market in order to achieve above-average, long-term results. Being different is a part of our philosophy and has yielded the expected rewards over time. Yet, a number of times along the way, periods of poor absolute and relative performance have rattled our nerves and tested our resolve. Most great money managers have shared similar experiences.

Warren Buffett is arguably one of the world’s best investors. Shares of his company, Berkshire Hathaway Inc. have underperformed the S&P 500 Index in 16 of the 53 years since he’s been at the helm. That’s 30% of the time, and is similar to our experience. As highlighted in the table below, our year-over-year return has been less than the Canadian benchmark in seven of the last 24 years, roughly 29% of the time.

Research Chart 2

Perspective is important when considering relative performance. Prior to 2018, we bettered the performance of our benchmark for seven consecutive years. That represented the longest winning streak in our Model’s 24-year history.

Over the last 10 years, the Model has risen 302% and more than quadrupled in value. The S&P/TSX Total Return Index is up only 161% over the same period. Nonetheless, a good long-term record doesn’t change the fact that it feels lousy when we are not keeping up. It’s hard on everyone when the investment winds aren’t blowing our way. As Director of Investment Research, I ask our analysts a lot more questions. Our advisors wonder if our research team has lost its mojo. The conversations clients have with their advisors are not as fun, and more time is spent talking about the equities that are not doing well rather than those that are. It’s natural to have doubts, and to feel nervous and uncomfortable when results fall short of the benchmark. It’s human nature to want more of what is going up and less of what is going down. Humans are instinctively wired to act on those emotions and make changes – to sell what is not working and buy what is popular and performing well. Unfortunately, doing so often sets the stage for poor performance and further disappointment down the road.

When we reflect on previous periods of poor relative performance, there are some common themes. It’s often late in the economic cycle and there’s usually a fairly clear delineation between what investors love and what they hate; between very expensive and very cheap stocks. We typically underperform when we hold on to our out-of-favour stocks.

In 2000, we didn’t keep pace with our benchmark because we were overweight in Canadian stocks, at a time when investors loved American stocks in general and technology stocks in particular. Before and after the 2008 Financial Crisis, we didn’t keep up because we favoured high-quality U.S. growth stocks, when Canadian resource stocks were popular and expensive. Our patience, along with the resolve to adhere to our discipline and stay focused on the long term is what set the stage for the solid recoveries we experienced following those periods of poor relative performance, and we are confident this strategy will yield rewards again. Nonetheless, we caution that it’s harder today to make a difference by being different. Investors are not manic like they were in other cycles, and consequently fewer equities are materially underpriced.

The high-quality growth businesses we own are popular and yet reasonably priced. While we don’t expect “reasonably priced” businesses to meaningfully beat the market over the long term, it seldom makes sense to sell great businesses unless they are excessively priced. We have selectively taken some profit and added to our out-of-fashion holdings, as we strongly believe that group will outshine the market over the next few years. Still, we think it would be a mistake to overemphasize today’s unloved equities, since most are lower-quality businesses.

We believe focusing on quality businesses and being patient with disappointing holdings during tough times (unlike the often emotionally driven crowd) makes us different, and will make a difference again.

Please read our Odlum Brown Limited Disclaimer and Disclosure - It is important!

The Odlum Brown Model Portfolio is an all-equity portfolio that was established by the Odlum Brown Equity Research Department on December 15, 1994, with a hypothetical investment of $250,000. It showcases how we believe individual security recommendations may be used within the context of a client portfolio. The Model also provides a basis with which to measure the quality of our advice and the effectiveness of our disciplined investment strategy. Trades are made using the closing price on the day a change is announced. Performance figures do not include any allowance for fees. Past performance is not indicative of future performance.

Odlum Brown Limited is an independent, full-service investment firm focused on providing professional investment advice and objective research. We respect your right to be informed of relationships with the issuers or strategies referred to in this report which might reasonably be expected to indicate potential conflicts of interest with respect to the securities or any investment strategies discussed or recommended in this report. We do not act as a market maker in any securities and do not provide investment banking or advisory services to, or hold positions in, the issuers covered by our research. Analysts and their associates may, from time to time, hold securities of issuers discussed or recommended in this report because they personally have the conviction to follow their own research, but we have implemented internal policies that impose restrictions on when and how an Analyst may buy or sell securities they cover and any such interest will be disclosed in our report in accordance with regulatory policy. Our Analysts receive no direct compensation based on revenue from investment banking services. We describe our research policies in greater detail, including a description of our rating system and how we disseminate our research here.

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