Manager Insight

Team seeks cheap stocks with margin of safety, Richard Wong says.
By Michael Ryval | 20/04/17

Richard Wong has been part of the team that overhauled the $2.6-billion Mackenzie Cundill Value starting in March 2016, when he and co-manager Jonathan Norwood took over the mandate. Yet Wong maintains that the deep-value principles used by previous managers are still very much intact.

About the Author
Michael Ryval, a regular contributor to Morningstar, is a Toronto-based freelance writer who specializes in business and investing.

"If you look at our portfolio, stocks are trading at an average 1.4 times price-to-book," says Wong, senior vice-president, investments at Toronto-based Mackenzie Investments. "The market, as measured by the MSCI World Index, is 2.3 times. That's a 40% discount to the global market. So the deep-value focus has not changed."

Take the financials, which account for about one-third of the portfolio. "They represent compelling value right now," says Wong, a 23-year industry veteran who previously managed U.S. and international portfolios at Mississauga, Ontario-based Lincluden Investment Management Ltd. "They are the arguably cheapest part of the market," says Wong, noting, for instance, that  Citigroup Inc. (C) is trading at 0.8 times book value. " American International Group Inc. (AIG), one of our large holdings, is also trading at 0.8 times book," adds Wong, who works alongside Norwood, who previously managed U.S. and international equity funds at Halifax-based Louisbourg Investment Management Inc.

Early in their tenure, the new team at Mackenzie Cundill is off to a strong start. The turnaround is particularly pronounced for Mackenzie Cundill Value. Though it has a dismal 1-star Morningstar Rating for its risk-adjusted historical returns, the fund's 22.7% return (for its C series) in the 12 months ended March 31 was 8.6 percentage points higher than its Global Equity peer group.

"We are committed to the deep value philosophy and style. And the portfolio continues to be a best-ideas, concentrated global portfolio," says Wong, who lays out three major parts to the team's process. First, they believe that buying cheap stocks is not enough, because there must also be a fundamental driver that has a high probability of delivering value within three to five years.

"The time value of money is important," says Wong. "If you buy a dollar for 50 cents, and it takes a decade to get to $1, your annualized return is 7%. If you get to $1 within five years, your annualized return is closer to 14%. That's a very different experience for the client."

Second, Wong and Norwood emphasize diversification within the portfolio and hold about 40 stocks. In practice, says Wong, this means ensuring that stocks are not closely correlated -- for instance, if they all depend on China's growth. "We think along the lines of, 'What are the drivers behind these companies? And how they are differentiated?'"

Third, there is a continuing focus on margin of safety. "But that factor should also vary with the quality of the business you are buying," says Wong. "It's not always the case that you want to buy 60 cents on the dollar. Some stocks could be going for 70 cents on the dollar."

The Mackenzie Cundill team maintains an in-house ranking of the qualities and risks of all the companies within its respective investment universes. "That tells us how much margin of safety we require," says Wong, adding that if an average company is a leader in a cyclical industry he is looking for a 40% discount to intrinsic value. "But if we find a company that has maybe more cyclicality, and a little more debt, and gets a score of 5, then we're looking for a 60% discount."

While Wong and Norwood are stock pickers, last fall they shifted the portfolios more heavily into the U.S. market on the basis of an expected upswing in the U.S. economy. U.S. stocks now account for about 66% of Mackenzie Cundill Value and about 39% of Mackenzie Cundill Canadian Security. "What Trump talks about in terms of his policies -- such as deregulation, infrastructure spending and tax reform -- is just icing on the cake," says Wong. "Trump is fortunate in inheriting an economy that is doing quite well."

One large holding that is representative of the fund is  Bank of America Corp. (BAC) "Five years ago, U.S, banks were weak. Now they have repaired and improved their capital ratios," says Wong, noting that the average so-called common equity Tier 1 capital ratio is about 12.1%. "Bank of America's valuation is still very attractive and trading at 1.07 times book value. And the underlying economy is improving so they will see better mortgage originations and demand for loans. They will see improved earnings from investment banking and asset management. And they've been cutting costs, so they are leaner and meaner."

Another favourite is  International Business Machines Corp. (IBM), which trades at 12.6 times earnings and is regarded by Wong as a "transformational" story. Its legacy business is making processing systems hardware and conventional consulting that accounts for more than half of its revenues, but has not grown.

"But their new businesses, such as its hybrid Cloud, is growing about 14% year over year," says Wong, noting that many clients prefer a hybrid version of the Cloud so they can manage some of their sensitive data in-house. "Watson, a business analytical tool, is also gaining traction among clients like Wal-Mart Stores. We believe that these new businesses will eventually become the majority of IBM's top-line and earnings."

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