As 2021 begins, what should investors keep top of mind? While recognizing opportunities is essential to success, identifying potential risks is just as important. We asked five members of our investment team what to keep an eye on at the dawn of the new year.
Greg Taylor, CFA, Chief Investment Officer of Purpose Investments
What were the biggest hurdles you faced in 2020, as a result of the pandemic and US election? How did this shape your positioning going into the new year?
The biggest thing about 2020 was how fast the central banks and governments responded to the pandemic. Anyone that stuck with the roadmap of the 2008 financial crisis missed a large chunk of returns. In 2008, it took over a year for the banks to provide relief and it was too small. Investors had to quickly get their heads around that this time it was different and to look over the valley of bad news to see that markets had priced in too much of the negative headlines.
What is the best advice you can share with investors at the beginning of 2021?
Starting 2021, the biggest risk I see is that everyone is very complacent. All the outlook notes are universally bullish. The market often does what makes the most people wrong, eventually, and it will be important to be prepared for some more volatility in the new year.
Where do you feel there are opportunities that have come to light as a result of last year? How can investors take advantage of these?
Active management is finally coming back into focus. Rotations within the market and dislocations in specific areas are making researched ideas more powerful than in recent years. We may finally get to a market where small-cap and value stocks can outperform. This should lead to more funds outperforming the passive benchmarks. I also expect mergers and acquisitions (M&A) to be a major theme in 2021, which should benefit smaller companies, a tailwind of sorts which puts more power behind active strategies.
Sandy Liang, CFA, MBA, Lead Portfolio Manager of Purpose Credit Opportunities Fund
What were the biggest hurdles you faced in 2020, as a result of the pandemic and US election? How did this shape your positioning going into the new year?
First off, it’s about understanding the real drivers of drawdowns from companies during the crisis. Is the drawdown caused by short-term liquidity concerns, has there been a fundamental decline in credit quality, are there options on the table to rectify any liquidity or credit concerns, or is the market just incorrectly pricing the securities out of fear? These are all questions we ask ourselves daily as we conduct our due diligence and skate to where the puck is going.
Secondly, it’s key to have the patience in conviction names for the investment thesis to play out. There were many cases in our portfolio where our top holdings have been “boring” until key events happen that drive investors back in droves. Our most recent example is Curo Group Holdings. The stock doubled following its Katapult IPO announcement, despite the share price going sideways for nine months prior. Earlier in fourth quarter, SL Green Realty also traded up 35% in one day on positive vaccination news after treading water since March.
What is the best advice you can share with investors at the beginning of 2021?
Having a well-researched investment thesis will be increasingly crucial in 2021. The passive/beta trade is looking frothier every day with valuations in many sectors looking stretched by any traditional investment metrics. Investors need to look past the hype and differentiate the good companies from the bad with increasing focus on investments with asymmetrical upside-downside.
Where do you feel there are opportunities that have come to light as a result of last year? How can investors take advantage of these?
Increased exposure to US residential mortgage market and North American Homebuilding. House prices are soaring in both the US and Canada because of low mortgage rates. In the US, there are some other factors contributing, including demographics. This is a tailwind for companies involved in US mortgages, home sales and renovation/repair.
The key difference between the great lockdown and the financial crisis is that during the lockdown, homeowner equity is powering the economy, which is very different than during the crisis when homeowner equity actually went negative and caused the recession. We are taking advantage of this tailwind and have increased our positions in a number of mortgage and housing-related positions, including bonds from Redwood Trust, New Residential Investment Corp and Empire Communities.
The best time for high-yield debt historically is the period from December through April, with four of the top five months occurring in this window. There have been significant changes in high-yield indices in the past year as the BB-rated component has increased to over half of the asset class from around one-third to start 2019. This is due to so-called fallen angels or companies downgraded from investment grade.
It’s an interesting fact but doesn’t really change how we create alpha in the Fund – from credit research and acting as a lender to companies we like.January is especially a standout, with positive returns 86% of the time and the highest average return of 1.9%, the best of all 12 months. There are some reasons behind this, including dealer de-risking and tax-loss selling going into year end (US dealers have calendar year-ends), and the “January effect” of repositioning early in the year.
Nawan Butt, CFA Portfolio Manager of Purpose Marijuana Opportunities Fund (MJJ)
What were the biggest hurdles you faced in 2020, as a result of the pandemic and US election? How did this shape your positioning going into the new year?
After a few quiet years in financial markets, the ferocity with which volatility exploded in late February was shocking. Those who stood on the sidelines watched years of financial returns erased in days. Shock and fear can render investors powerless. However, early in this bout, I was advised to not be afraid and that only by actively trading this market will financial returns materialize and professional learning take place. Only once fear is taken out of the equation can professional investors make rational decisions.
We were bold in making decisions to put on risk while hedging the tails. We aimed to balance our portfolios by muting volatility while still maintaining returns. The age-old adage of diversification was key to portfolio success, and most importantly it was imperative to remain proactive rather than reactive. Going into the new year, we believe the formula to success is finding pockets of opportunity, identifying mis-valuations, diversifying and most importantly being bold and objective in our decision making.
What is the best advice you can share with investors at the beginning of 2021?
The “once in a generation” bouts of volatility might not be that uncommon. Risk management is key to value protection, but also you must be prepared to turn around and put risk on. Be ready to act quickly and decisively. Remember to diversify across asset classes and regions. Don’t fight the Fed. And remember to give back to your communities.
Where do you feel there are opportunities that have come to light as a result of last year? How can investors take advantage of these?
Our thesis is that cannabis will be one of the biggest trades of the 2020s. Proliferation is a hot topic south of the border and soon enough will become a global topic. The end of prohibition in Canada does not compare to the end of prohibition in the US. It is reported that sales of cannabis in Illinois alone topped US$1 billion in 2020, the first year of legalization. There are many more of these states to come and a nationwide illegal industry to be disrupted, by legislators of all people. Invest in this sector of non-correlated secular growth early, while the rest of the world catches up to our privilege as Canadians to hold US cannabis companies in our RRSPs and TFSAs.
Nicholas Mersch, CFA Investment Analyst for Purpose Global Innovators Fund (PINV)
What were the biggest hurdles you faced in 2020, as a result of the pandemic and US election? How did this shape your positioning going into the new year?
The largest hurdle in 2020 was timing. Both the magnitude and timeframe in which the recession and subsequent recovery occurred was astonishing. The average bear market throughout history has lasted 14 months, but this one only lasted five. There was no clearer example of “don’t fight the Fed” as a record amount of stimulus was injected into the system. This stimulus resulted in an environment in which rates will be persistently lower for longer, reinforcing the concept of a TINA (there is no alternative) market in growth assets which we believe will persist throughout the course of 2021. This has shaped our bullish view for growth equities and there are no growthier equities than tech stocks.
What is the best advice you can share with investors at the beginning of 2021?
Don’t underestimate the power of a category-killer. Generalist investors can get too focused on valuation multiples when it comes to technology. Although multiples can reach dizzying highs, when a company can grow revenue at 100%+ year-over-year, the EV/revenue multiple can get cut in half in quite short order. Category killers dominate the niche in which they operate and have excellent product market fit, causing them to win in the long term. Examples of this are Shopify, Square, Crowdstrike, Unity, Twilio and Atlassian.
Where do you feel there are opportunities that have come to light as a result of last year? How can investors take advantage of these?
Technology stocks had a remarkable year as nearly every aspect of life was shifted online. This has accelerated the timeline of digital transformation which will continue to evolve, ultimately to the benefit of enterprise software-as-a-service companies. In addition to this trend, there has been the “comeback of the consumer” as a buildup in consumer savings will likely get spent online in the second half of the year, which is why we like internet-based, direct-to-consumer companies.
Mike McNabb, Analyst and Trader for Purpose Real Estate Income Fund (PHR)
What were the biggest hurdles you faced in 2020, as a result of the pandemic and US election? How did this shape your positioning going into the new year?
The pandemic threw the real estate market on its head and then picked it up and drop-kicked it a few more times for good measure. Most major REIT indices were down over 40% in the heart of the COVID-19 March sell-off. It’s one sector that struggled to recover meaningfully. The US election just added more volatility to the mix, but the outcome was fairly agnostic for the sector. The pandemic and how we view and the use of retail, office, industrial, health care and hospitality were the major hurdles to deal with in 2020 and will be in 2021 as well.
Active geographic and subsector allocation was extremely important in 2020 and it will continue to be in the new year as highlighted by the following charts.
It’s clear that certain regions were better than others and interesting to see an over 42% return differential between subsectors within the REIT sector.
Our real estate fund ended the year with a 50/50 split between Canada and the US (more balanced than we initially thought) and overweight the industrial, multifamily, specialty (data centres and towers) and retail subsectors.
What is the best advice you can share with investors at the beginning of 2021?
We are watching the vaccine rollout closely and are bullish on some of the subsectors that have lagged during the pandemic. You can’t fight the demographics of our aging society and we feel that there is an opportunity in health care real estate. The same goes with hospitality. But we do have to ask how does the sector rebound from the pandemic? When are people going to start to travel again?
Another question that we still debate amongst ourselves is how will the office look when we return to normalcy. We feel that the office isn’t dead, but it could change and flex-work may become more common among businesses that occupied many towers in urban settings.
We are also constructive on the Canadian multifamily space. The pandemic slowed rent growth, but as mentioned before, it’s hard to fight demographics. When we return to normalcy and immigration picks back up, demand will once again outweigh supply. We will maintain our overweight industrial allocation as we feel that warehousing and distribution will continue to be in high demand as more and more consumers use ecommerce. Both industrial and multifamily are also on the radar of pension plans, which have to go outside of traditional fixed income investments to generate yield for their plan members.
Finally, we are watching retail closely. We like essential retail (grocery anchor and select big box plazas) and are more cautious on enclosed malls. The retail story in Canada has a redevelopment angle and we are starting to see some completed multifamily and storage projects boost retail REIT earnings.
Where do you feel there are opportunities that have come to light as a result of last year? How can investors take advantage of these?
We may be a bit biased as we run a REIT fund, but we feel there is a great opportunity for outsized returns from the sector this year. In our institutional equity income fund, REITs make up 35% of the portfolio. Canadian REITs have outperformed the TSX over a 10-year period, even after a tough 2020 where the TSX outperformed the REIT sector by over 18%.
The sector still trades at a significant discount to NAV (around 5% to 7%) and the spread between the implied cap rate of REITs and the 10-year government of Canada bond is still at a very wide margin (roughly 511 bps vs the long-term average of 390 bps). And we feel that getting the most out of the sector requires active management and in-depth analysis of the factors and subsectors we’ve mentioned above.
All data sourced to Bloomberg unless otherwise noted.The content of this document is for informational purposes only, and is not being provided in the context of an offering of any securities described herein, nor is it a recommendation or solicitation to buy, hold or sell any security. The information is not investment advice, nor is it tailored to the needs or circumstances of any investor. Information contained on this document is not, and under no circumstances is it to be construed as, an offering memorandum, prospectus, advertisement or public offering of securities. No securities commission or similar regulatory authority has reviewed this document and any representation to the contrary is an offence. Information contained in this document is believed to be accurate and reliable, however, we cannot guarantee that it is complete or current at all times. The information provided is subject to change without notice and neither Purpose Investments Inc. nor is affiliates will be held liable for inaccuracies in the information presented.Commissions, trailing commissions, management fees and expenses all may be associated with investment funds. Please read the prospectus before investing. If the securities are purchased or sold on a stock exchange, you may pay more or receive less than the current net asset value. The indicated rate of return is the historical annual compounded total return including changes in share/unit value and reinvestment of all distributions and does not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated.
