“The idea behind the fund originated in our broader philosophy. We just want to own good quality businesses over the longer term,” says Paul MacDonald, chief investment officer at Oakville, ON-based Harvest Portfolios Group, which offers a suite of 11 ETFs, four structured products and two mutual funds and has about $654.5 million in assets under management. “The starting point of our universe is the top 100 leading global brands. We say, ‘let’s start with some good quality businesses,’ and then we narrow that down to a much smaller number by using financial data and metrics to select the best.”
Companies that have brand leadership benefit from consumer loyalty, proven long-term histories and pricing power. “Typically, they are global in nature and transcend cultural barriers. From our perspective, those are the type of firms we want to look at, although we don’t want to own all of them. But that’s our starting point,” says MacDonald, a 16-year industry veteran and native of Woodstock, NB, who traveled widely before graduating with a bachelor of international finance in 2001 from Australia’s Griffith University. “We use the financial data to determine the qualitative leadership status.”
The starting point, MacDonald admits, comes from lists of global firms created by Interbrand, a global research firm and subsidiary of NYSE-listed Omnicom Group. Working closely with portfolio manager James Learmonth, MacDonald also relies on lists from BrandZ Global Top 100 Most Valuable Brands generated by London-based Kantar Millward Brown.
MacDonald narrows the universe of 100 by screening firms with a minimum market capitalization of US$10 billion. This quickly reduces the list to 65 names. Because he prefers to deal with one currency and one market, he selects stocks that are listed in the U.S. and available as options. MacDonald employs a covered call strategy that is designed to generate an annual distribution of 6.99% (based on the July 31 net asset value).
Call options generate income in the form of the premium paid by the buyer of the call option. “We have a maximum of 33% written on each name so we will forgo some of the upside if the stock goes higher,” says MacDonald, adding that there is always a minimum 67% of the portfolio invested with a long bias.
“We marry the concept of leading brands with very specific financial metrics,” says MacDonald, who joined Harvest Portfolios in 2013 after working as a vice-president and portfolio manager at hedge fund manager Creststreet Asset Management.
In the end the team selects 20 companies that are equally weighted and rebalanced quarterly. “Twenty names provide us with some concentration within a portfolio. There is higher conviction in the names,” says MacDonald. “Second, it still allows us some subsector diversity. And, third, it relates to the options strategy. Twenty is a manageable number of companies for us to be tactical and active on the option strategy on a monthly basis.”
The 20 names that make the cut must meet specific criteria: the ability to generate a five-year return on equity growth that is higher than the average in the initial 65-name cut; a price-earnings multiple that is lower than the average in the universe and a dividend yield that is higher than the average in the universe.
Launched in July 2014, HBF is hedged back to the Canadian dollar and designed to be a call on volatility, and not a call on currency. It has a twin in the form of HBF.U, which is the U.S.-dollar version of the ETF.
From a sector standpoint, HBF has a bias to technology as it has a 33% weighting in that area. There is also 19% in consumer discretionary names, 14% financial services, 10% in industrials and lesser weights in areas such as consumer staples.
One representative name is Visa (V). “People see it as a credit card company and taking on consumer credit risk, but that’s not the case. It’s categorized as a technology company, but it is a direct beneficiary of the digital payments revolution driven by the structural change in the way consumers and businesses interact.”
The company is expected to see 31% earnings per share growth in 2018 and 16% in 2019. It does trade at a lofty 26 times forward earnings, “but they have beaten earnings estimates over 90% of the time over the last 42 quarters.”
Another favourite is Johnson & Johnson (JNJ). “We are huge believers in the positive structural dynamics in the global healthcare field: aging populations, developing markets and new technologies. It is a direct beneficiary of that shift and one of the few non-cyclical themes out there,” says MacDonald. “That being said, the sector is under pressure. Yet Johnson & Johnson is one of the most diversified healthcare companies with business lines across pharmaceuticals, medical devices and consumer products. It is truly a dominant player and has the ability to grow organically and make acquisitions and utilize their global infrastructure to extract value from those acquisitions.”
The stock trades at 15.2 times 2019 earnings. “There isn’t as much growth here [compared to a name like VISA], but you get healthy dividend yield of 2.7%.”
Going forward, MacDonald argues that the market may be transitioning from mid-cycle to late-cycle, but a number of factors augur well in the short term. “Earnings have been meeting expectations and in fact some firms have been exceeding expectations in this latest quarter. We are seeing strong economic data and it is synchronized globally.”
The big question is how long will this late phase of the market cycle last? MacDonald has no answer. “But this is the time to own quality businesses. And it’s time for a covered call strategy where will you forgo a little bit of the upside in order to generate current income. To me, it fits well within the market cycle, knowing we can’t predict its longevity.”
Link to Original Article: The Quest for Global Brands