To maintain a high-quality, concentrated approach, ongoing monitoring, and consistent dialogue between management, and our portfolio managers and analysts is required. Since Coronavirus came onto the scene in March, we have connected with all of our holdings to better understand the strength and depth of their investment moat during these unprecedented times, and we’ve only made slight weight changes to the portfolio after analyzing risk/return profiles with a new lens. For example, we’ve added to our multi-residential REIT exposure, such as Killam Apartment Real Estate, because we think these stocks have been unduly punished by the crisis due to fear of unemployment resulting in residents not being able to pay rent. However, taking a long-term perspective, we know that the economy will inevitably recover, while immigration is another strong tailwind for these properties over the next 5-10 years, despite the current, temporary slowdown. All of our holdings represent themes that we believe are relevant going forward, from renewable energy and global infrastructure to a cashless society and the mobile consumer. For us, it’s not about what’s performing now, or even over the next 1-2 years; while gold stocks may be rising, we will still not invest because of their inability to differentiate themselves from the competition, and the volatility of the commodity price. They simply do not fit our investment criteria, and as a result, we’re comfortable avoiding these low-quality rallies in favour of long-term success. Similarly, despite the negative rhetoric on Canadian banks, we’re bullish on these stocks because they’re well-capitalized assets proven to provide income stability, growth and resilient dividends, which they did even during the 2008 Financial Crisis. Focusing on the bigger picture, they offer predictability of earnings in an oligopoly environment, which is attractive, especially in light of where they’re valued currently.
As diligent as we are in our purchases, we exert the same skill and expertise in our sale decisions. We’re constantly reassessing our portfolio and determining whether companies have that critical ability to protect their business from the competition, and by doing so, are able to grow at above-market rates. If we believe there is permanent structural impairment, we will make changes to assure our portfolios are positioned for long-term value creation. Case in point: we invested in Cineplex at its IPO in 2003, and held our position until 3 years ago because the company had a long-standing monopoly of Canada’s theatres, which we thought secured its economic moat even through the advent of home entertainment and surround sound speakers in the early 2000s. When Netflix and other streaming services appeared, however, the story quickly changed with the production of high-quality, direct-to-consumer content, and the competition began to reflect in theatre attendance. That’s when we decided we were no longer confident in the sustainability of the business model, and by extension, its value proposition. It’s an ideal example of how a company can offer differentiated products and services for a long period of time only to have new competition quickly alter its moat.
In a concentrated portfolio – like our BMO Dividend Strategy – all of the holdings are at risk of being replaced by a new, and better idea, and that is the opportunity cost of owning a smaller group of 35-40 high-quality names, with high returns on capital. That is why we continually review our assumptions, ensuring only the best investment opportunities reside in our portfolio. While there are many mediocre, or even good, businesses, there aren’t many great businesses that inspire the highest conviction.