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Buy North American

Fidelity’s new North American fund is more flexible than its peers.


Date: October 29,2015

There are many similarities between Canada and our southern neighbours, but when it comes to investments the opportunities can be quite different. The U.S. market is much bigger, for instance, while macro-economic events can sharply pull one market ahead of another.

Knowing which region to overweight can be difficult at the best of times. In fact, over the last thirty years or so, there have been significant periods where one country has outperformed the other.

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To help Canadian investors find the best opportunities in both markets at any given time, Fidelity Investments Canada launched a North American Equity Class.

The fund, which launched on October 28, is being managed by Darren Lekkerkerker, a proven portfolio manager. He’s managed the equity portion of the $7 billion dollar Fidelity Canadian Balanced Fund and has helped it become a 5-star Morningstar rated fund.

While the company has Canadian and American-focused funds the difference with this one is that it’s North American, but that it also comes with flexibility — which is key in today’s increasingly more volatile market.

The Fidelity North American Equity Class allows portfolio manager Darren Lekkerkerker to hold as much as 90 per cent of the fund’s assets in U.S. stocks, or as little as 40 per cent. The range on Canadian equities is between zero per cent and 50 per cent, while up to 20 per cent of the fund can also consist of stocks from any other country.

“It offers more flexibility than just running a Canadian fund or U.S. fund,” he says. “I can put my best ideas for both countries in [it]. I’m not really restrained.”

Mr. Lekkerkerker is currently more bullish on the American market. He points out that the U.S. is growing faster than other developed nations and it has a more diversified economy than other locales.

Seeking consumer stocks

In terms of sectors, he sees value in U.S. consumer staples and consumer discretionary, as well as in railroad, healthcare and certain financial companies.

Some of the strong consumer companies are seeing good revenue growth and improvements to their profit margins, he said. At the same time, slower economic growth is forcing others to consolidate through mergers or acquisitions.

He does point out that railway stocks have performed poorly this year in response to fears about the weakening economy. These companies didn’t calibrate their costs at the start of the year to reflect lower shipping volumes and that’s hurt profitability and created negative sentiment among investors. But the railroads will rebound in 2016, says Mr. Lekkerkerker, as cost management improves.

The energy patch, however, will likely remain out of favour for some time, given that there is a surplus of oil in the market and stocks are valued for crude prices of between $60 (U.S.) and $80 a barrel (WTI crude traded recently at $43.83). But he said his role on the Fidelity’s Global Natural Resources fund – he’s a co-manager – gives him a good seat to spot the end of the trough.

A still uncertain continent

Fidelity is launching its latest equity fund into uncertain waters. Investor sentiment is volatile as the U.S. Federal Reserve prepares to begin raising interest rates and broad market valuations look high.

The S&P 500, for instance, is trading close to 26 times cyclically adjusted earnings – significantly greater than its historical average multiple of almost 17. At the same time, economists continue to ratchet down their forecasts for economic growth in North America and abroad.

This month, the International Monetary Fund again cut its forecasts for gross domestic product in Canada and the world as a whole. It predicts Canadian GDP will grow only one per cent this year and 1.7 per cent in 2016.

For his part, Mr. Lekkerkerker puts North American stocks in the “mid to late stages” of the broad equity cycle, and he thinks that earnings growth will drive prices of the best companies next year.

“This is a good opportunity for picking stocks,” he says, pointing out that a healthy stock market does not need to correlate with a strong economy. Prices stand to benefit from low investor expectations at the moment, he adds.

Going with GARP

Mr. Lekkerkerker uses three broad selection criteria in pursuing growth at a reasonable price (GARP). First, he looks for solid growth businesses that won’t see significant change to their market over the next five years. Second, he wants companies run by a team with a track record for being “shareholder-friendly,” which entails allocating capital effectively – be it reinvesting in the business or declaring dividends for the owners. Third, he wants to buy at a good price.

Among the financial metrics Mr. Lekkerkerker watches are strong free cash flow yields (ideally between four per cent and 10 per cent) and a good return on equity – which by his definition means a company that can finance the next several years of growth without needing to raise additional capital.

He also points out that the new Fidelity fund is not hedged to the Canadian dollar, which means returns will be affected by currency swings. While the loonie’s rocky ride this year is, Mr. Lekkerkerker view, probably now over, he says he will be paying close attention to macro economic variables in his stock selecting.

“This is my baby,” he says of the fund. “I’m highly motivated.”

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