We are thankful over the positive feedback we received on the release of our Canadian High Dividend Equity Strategy (CAD). Recently, a client asked us to explain how the ranking system of this new model portfolio strategy is different from the ranking system of the Canadian Equity Strategy (CAN). To ease the reading of this article, please keep the above acronyms in mind.
Dividend Yield Requirement
The CAN doesn’t have any requirement when it comes to dividend yield. This allows the inclusion of companies like CGI Group (GIB.A), which doesn’t give back to shareholders but provide strong capital appreciation. However, this becomes a requirement in the CAD.
The 2.5% threshold seems arbitrary but not entirely. If we set the bar too low, we are going to include companies that don’t necessarily fit with the mandate of the CAD. On another hand, if we set the bar too high, we don’t have enough companies to choose from in our universe.
Low Volatility Weight is Much Larger
Investors attracted to fixed income are more risk averse than those looking for capital appreciation. For this reason, we have to focus on companies that are suitable with such low risk profile, which is why we gave a significant weight of 30% for this factor alone.
Low Volatility Calculation is Different
In the CAD, we are using the Average True Range Normalized (ATRN) formula to calculate the LVOL factor instead of the 3-Year Beta. Why? Because the ATRN, is overall a better gauge of volatility as it takes into consideration the highs and the lows of a stock for a given period.
Cash Flows Are More important
As you may have noticed, valuation metrics such as PERA (Price to Earnings) and OPIV (Operating Income to Enterprise Value) are absent in the CAD. The only thing that matters, valuation wise, is to assess relative to free cash flows and cash flows for a CAD strategy.
Simply put, if a company doesn’t generate sufficient cash then the dividend will be unsustainable. Many investors are looking at factors such as dividend coverage or payout ratio. but they are from the income statement. Instead, we focus all on the level of cash flows.
Maximum Correlation Limit
As seen in our sector allocation, our holdings are concentrated in a few sectors such as Real Estate, Financials and Utilities. In order to mitigate the concentration risk, we are taking into consideration the correlation of stocks between each other at portfolio inclusion, if possible.
Which Ranking Should I Use?
It depends on the purpose behind your investment. If you have capital appreciation in mind, then use the CAN ranking and disregard the CAD ranking for the same company. The same applies in the reverse scenario. We separated the CAN and CAD tabs so you don’t make the mistake of looking at the wrong ranking. If you have any questions regarding these ranking systems, please feel free to send us a message and we will reply promptly.