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Recently, gold and tech stocks have driven the Canadian market. Scott Lysakowski, Head of Canadian Equities, Phillips, Hager & North Investment Management, discusses how he is managing portfolios in a top-heavy market, and what’s ahead for investors looking to break through the concentration. (Recorded July 30, 2020)


Hello and welcome to the Download. I’m your host, Dave Richardson, and I’m really pleased to be joined today by a newcomer to the podcast, Scott Lysakowski, Portfolio Manager at Phillips, Hager, and North Investment Management in Vancouver. Scott, one of the real bright young stars of the investment management business in Canada. Great to have you on.

Thanks, Dave. Thanks for having me on the podcast.

So we had a lot of conversations over the years, just one on one. One of the interesting conversations we’ve been having lately — and we’ve covered this a little bit with Stu Kedwell on Stu’s Days on the podcast — is the whole idea of the narrowness of the Canadian market. Particularly what’s driving the performance of the Canadian market right now. One of the numbers I have, if you go for the period from January 1, 2019 to January 30 of this year, TSX is up 13.7%. But if you strip out gold stocks and one great technology company in Canada, Shopify, the return goes down to 3.1% for the remaining stocks over that period. So Scott, it leads the conversation: as an active manager, with so much of that performance being concentrated in gold and one stock, and the Canadian market being fairly narrow to begin with, how do you go about managing that as an active investment manager? To drive the returns and manage risk, more importantly, at the right level for customers?

Yes, it’s a great question, Dave. It’s something we wrestle with on a continuous basis. You’re right, the Canadian market always had some unique aspects to it. In the past, it’s been the gold weight in the TSX that has always been somewhat unique relative to other sort of equity benchmarks. And then every once in a while you get these companies — whether it’s Shopify or Valeant or BlackBerry —, that become very dominant names in the index and drive a lot of the performance of the benchmark, which makes it very challenging for Canadian investors. If you don’t own those two components of the benchmark, it’s going to make it really hard to outperform. We’ve seen that year to date. You mentioned some numbers. If you did not own gold or Shopify, the rest of the market is a very different experience with the average stock actually being down around 10%. If you think about Shopify, on a year to date basis, I think it’s up about 150% or 160%, something like that. And Shopify now makes up about 6 or 7% of the index. Gold stocks are up 50 to 60%, and they contribute about 10% of the index. So right there, you’ve got a pretty significant return. And if you didn’t own those, you had something quite different. I was looking at the stats, and out of 250 stocks in the TSX, roughly about 100 are up or greater than zero on a year to date basis. And I think about 30 or 32 of those are gold stocks. So if you treated gold as one stock and Shopify as another, and you did not own them, that would lead to very, very different results than what the benchmark is showing.

So, Scott, given all that, what an investor might say, if you’re managing a Canadian equity portfolio for them is: “Well, why don’t you just load up on gold stocks and Shopify right now?” If that’s what’s going up, as an investment manager, why don’t you just load up on that, on the one stock and the one area?

I wish it was that easy. Maybe I’ll just separate the two and talk about gold and Shopify separately. Gold is something that we’ve sort of contended with as Canadian active managers for a long time. And it’s a bit tricky because gold as a commodity is very difficult to predict. I think all commodities are difficult to predict the direction of, but [gold] is very different than, say, other commodities like oil or copper. And so because it’s very hard to predict, you sort of need to think about the management of your exposure in your portfolio. One of the studies we did — this goes back a couple of years, so the numbers might be slightly out of date — but if you think about over the last 20 years, the TSX has returned on average about 7% a year with a standard deviation of 15%. So you’re either going to get on average 7, or you’re going to get plus 20 or minus 20. And gold has delivered over 20 years an average return of 5%. So you can make the conclusion that gold underperforms over long periods of time. That’s great and everything. But the standard deviation of gold returns is 40 or 45%. So the years in which it outperforms, it outperforms by a lot. And we’re in one of those periods right now. So when we think about our exposure to the gold sector, not only are we trying to buy good gold companies — profitable, generating free cash flow, etc. But if you believe that the gold stocks underperformed the broader market over long periods of time, you want to make sure that you’re managing that exposure such that in the years in which you get the plus 50% returns, you’re not getting wiped out by it. So that’s how we think about exposure in our portfolio. Shopify is a very unique situation. People talk about the lack of these innovative growth companies in Canada. And sometimes I say careful what you wish for, because it has been a spectacular growth story. It certainly came public a number of years ago, but it’s really grabbed the headlines this year as it surpassed Royal Bank as the biggest stock in the Canadian market. They just reported results yesterday. Just incredible results in terms of revenue growth. The revenue growth was up 100% in the quarter, as COVID-19 locked down and sort of shifted everybody into online mode. And it’s been a very spectacular growth story from a revenue point of view. I think the market thinks about the future of this company quite emphatically. It’s still very expensive in terms of profitability, because it’s not generating any profits. And that sort of brings us to this idea that what COVID-19 has done. This isn’t my line -- I’ve heard it several times, and actually one of which comes from the CEO of Shopify — it sort of brought the next 10 years forward to today. And so any sort of trends that were happening, it’s really accelerated them. E-commerce has been a trend that’s been in place for a number of years, but COVID-19 has really accelerated it. The traditional brick and mortar retailers have been forced to reposition their business model to be an online retailer. Shopify, that is their business models, to enable that to happen. So we just witnessed in the second quarter of this year perhaps some of the best conditions for Shopify to deliver results. And we always talk about the market as a forward-looking mechanism. It’s thinking about the future of e-commerce, and thinking about an accelerated future of e-commerce. It’s thinking about Shopify’s participation in those trends of accelerating e-commerce, and effectively bringing that back. And as we all know, interest rates are effectively zero right now. So you’re bringing back an accelerated trend, which is a huge runway of growth for this company, and bringing that back at a zero discount rate. So you think about this company 10 years from now, that’s basically what the stock market’s discounting: very strong execution and accelerating trends at a zero discount rate. That’s what we’re contending with, and that’s why the performance has been so strong in that stock.

Yes, and you think about it from a Canadian investor perspective. You mentioned some of the historical names that have risen up and become the lead stock in the TSX. You mentioned Valeant, BlackBerry, and now Shopify. And Nortel Networks is another one. It’s not a great history. And that is in no way, absolutely no way, to suggest that Shopify is going down that route. It just does mean, as you’re managing risk, that you need to consider that you’re paying an awful lot for this stock right now. And a lot of things need to continue to go right to maintain that valuation. And then as we’ve talked about on this podcast before, gold is one of those things where, typically, you’ve historically seen long stretches of a very limited performance in the sector. Then big spikes in performance for a short period, and then back down. So again, you’ve got to be very careful how you manage the risk around that as you’re managing a Canadian equity portfolio.

That’s totally right. And we go back to our basic principles of having a disciplined research process, and thinking a lot in scenarios. If anything, we’ve learned during this period that scenario analysis is an incredible tool. The future is highly uncertain. We’ve certainly thrown a curve ball into the future with COVID-19. There’s that saying that more things can happen than will happen. And so having a set of scenarios in place, do you understand what is being discounted in the share price? What is the scenario or a thought that the market is not considering? Then thinking about what are the likelihoods every day that the cards flip over and the probabilities change. So, managing that exposure is something that we focus on quite a bit here.

Well Scott, great to catch up with you today. Thanks for your insights. We’ll look forward to getting you on again in the future. Scott is one of the top coffee aficionados in Canada, too. So we’ll get some tips on places to go outside of Starbucks all across Canada in future visits. But, Scott, I’m glad to see you and your family are doing well, and we’ll talk to you soon.

Thanks, Dave.


Recorded July 30, 2020

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