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Steady and smooth – dividend fund paves the way

As lead portfolio manager of Fidelity Dividend Fund, Don Newman’s goal is to protect investors from market volatility

By: MARY GOODERHAM

Date: January 14,2015

Picking winning stocks and following successful investment strategies when markets are flying high is a skill. Doing it during volatility or when there are market downswings is a calling.

For Don Newman, a portfolio manager for Pyramis Global Advisors, a Fidelity Investments company, the goal is to protect investors from market gyrations and keep them earning healthy returns and dividends.

As manager of the Fidelity Dividend Fund over the past five years, Mr. Newman has seen both a strong, robust market and a turbulent, unpredictable one. Through it all, the fund’s investors have enjoyed a remarkably smooth ride.

“People are looking for a decent return without the risk of a significant downside,” says Mr. Newman, a member of Fidelity’s Canadian asset allocation team. (He is also lead portfolio manager of the Fidelity Dividend Plus Fund and manages equity portions of the Fidelity Income Allocation Fund, Fidelity Monthly Income Fund and Fidelity Canadian Asset Allocation Fund.)

Mr. Newman joined Fidelity in 2003 as a research analyst with the Canadian team, after four years in New York in the global investment research department at Goldman Sachs. At Fidelity he started by covering insurance, then he moved on to Canadian companies in integrated oil and gas as well as food, beverage and drug retailers.

Having broad exposure to the market is helpful, he notes. “You know the sectors, you know the stocks, you know the valuation metrics, you know the management teams, you know the company stories.”

The Fidelity Dividend Fund started in 2005 and Mr. Newman became co-manager in 2007. After he took over as lead portfolio manager in 2009, he says it returned a whopping 45 per cent, winning the Lipper Award for the best dividend fund in Canada.

With strong markets, the fund was mostly fully invested and had a good weighting in Canadian banks and the resource sector. “We invested in good companies at reasonable prices that can maintain and grow good dividends over time,” Mr. Newman recalls, adding that while the market and conditions have varied, this overall philosophy hasn’t. “When conditions change, we change what’s in the fund.”

The fund has especially benefited because its equities pay dividends. He points out that in Canada over the past 30 years, companies with dividends have compounded at 12 per cent annually, while those that don’t pay dividends have compounded at just 1.5 per cent.

He especially cautions against investing in companies that cut dividends. He says that cuts happen when companies get caught on the downside without strong balance sheets and business models. They become bloated with debt and cannot generate enough cash to pay dividends, and are often forced to raise equity at the bottom of the cycle, which dilutes their share count.

“You want to see companies that generate good cash flow and have steady business models, that are strong in the upturn and can weather downturns so their dividends are safe and don’t get cut,” he explains.

For example, oil companies today do not have enough cash flow to cover the drop in prices and continue to pay the dividends they have been generating. When dividends are cut, confidence in a company shrinks and stock prices trend downward, he says, and the company issues shares at a reduced price.

Mr. Newman has significantly cut back the Dividend Fund’s allocations to energy and other resources as well as to China, which he says is becoming more of a consumer economy and reducing its demand for commodities such as the copper, iron ore and steel previously used in its infrastructure build.

He has also reduced the fund’s weighting in Canadian banks, whose earnings “have slowed a lot,” as consumers are less able to take on more debt and credit losses approach cycle lows. While typical dividend funds can be as much as 45 or 50 per cent invested in Canadian banks, his fund currently holds just 15 per cent in the sector.

The fund has holdings “across the spectrum,” including U.S. utilities, REITs and U.S. health-care companies. “I’m a big believer in keeping things diversified,” he says, adding that Dividend Plus has some holdings in energy, mostly in pipelines, as well as decent holdings in REITs and just one per cent in Canadian banks.

Among his stock picks are Brookfield Property Corp., which has significant real estate development in New York and generates revenues in U.S. dollars, as well as Loblaw Cos. Ltd., which owns Shoppers Drug Mart Corp. and stands to benefit from increased prescription drug consumption among the aging population.

The fund has enjoyed better-than-market returns with half of the market’s volatility, he notes. He has now positioned it to avoid downside volatility in the market through a “decent weighting” of just under 20 per cent in cash.

Typical investors in the fund are people in their 40s, 50s and 60s who “can’t take a significant drawdown in their portfolios,” he says.

Mr. Newman, who calls himself a “bit of a student of history,” says that an analysis of returns going back to the 1930s shows that half come from price appreciation and the other half from dividends. “It’s remarkably consistent,” he says, therefore protecting dividends is key. “You want to make sure you understand the financial strength of the company and its ability to keep paying the yield and raising the dividend.”

Craig Strachan, vice-president and head of product at Fidelity Investments, says that Mr. Newman’s approach “especially pays off in corrections.”

With so much of its holdings in cash, in the interest of downside protection, the fund has still beaten the benchmark index, Mr. Strachan points out, adding that it’s important not to look at mutual funds superficially, by performance alone.

“I would think that people invested in a dividend fund are looking for a smoother ride than a pure equity ride,” Mr. Strachan says. “This is a great, long-term investment for them.”

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