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With Canadian and US stock markets enjoying a long and healthy run, many investors are savoring the fruits. Meanwhile, the team managing Dynamic Active Canadian Dividend ETF DXC is pondering where the next harvest will come from.
“There has been strength in the market that we didn’t expect a year ago, when we thought the easier returns were behind us,” says Don Simpson, vice president and senior portfolio manager at Toronto-based 1832 Asset Management LP. He manages the Dynamic Active ETF alongside vice presidents and portfolio managers Eric Mencke and Rory Ronan.
“Going into this year, we thought it would shift to more of a stock-pickers market, but the market has continued to move ahead and broaden out. It’s been a good time to make money, but once the euphoria goes away the question is how to protect the gains,” Simpson explains.
The C$319 million Dynamic Active Canadian Dividend ETF posts a top-decile track record over the last five years, gaining an average of 12% annualized. That is roughly 3 percentage points ahead of the Canadian Dividend and Income Equity category and the Morningstar Dividend Yield Focus Index each year. For the last three years, the ETF has landed in the top third of its category.
However, the Dynamic Active ETF hit a bit of a rough spell in 2024. Over the last 12 months, it ranks in the bottom quartile of its category. Still, the fund is up 17% this year.
Although the Dynamic Active ETF benefitted from its holdings in Royal Bank of Canada RY and Bank of Nova Scotia BNS, as well as strong gains in Manulife Financial MFC and Power Corporation of Canada POW, it was pulled down by negative investor sentiment in Toronto Dominion Bank TD.
As part of its diversification strategy, the ETF’s portfolio has exposure to gold through shares of Franco-Nevada FNV. But gold shares have not been as exciting as gold bullion this year, and Franco-Nevada has suffered setbacks like last year’s shutdown of its Panama operations. Both TD and Franco-Nevada lost ground in the last year, while gains have been less exciting in two other significant holdings, Canadian Pacific Kansas City CP and US-based diversified healthcare giant Johnson & Johnson JNJ.
Simpson focuses on profitable businesses with superior long-term growth potential, talented management teams, and dominant market shares. He’s been taking profits in frothy areas and redeploying them in stocks with room to rise. For example, the big Canadian banks are classic blue chip dividend stocks, but valuations have been less exciting than in some areas of the market during the past couple of years, as investors worried about rising loan losses due to high interest rates and a potential economic slowdown.
Simpson has been increasing the Dynamic Active ETF’s weight in Bank of Nova Scotia; it’s lagged the sector but he expects it to benefit from recent management changes and a stronger focus on customer relations. The largest bank holding in the ETF is Royal Bank of Canada, which Simpson says “hit a home run” with its recent acquisition of HSBC Bank Canada and is the “best-run bank in Canada.” He says, “There is a catch-up trade and good value in the banks.”
TD has a smaller weight in the ETF than before, due to the bank’s money-laundering scandal in the United States and the imposition of massive fines for criminal activity. Despite this year’s losses, Simpson says TD’s Canadian assets are undervalued at their current reduced stock price and new management can create better value. “The stock has been beaten down, but TD is still an attractive bank. There is a price for everything, and we look at the risk/reward relationship.”
A key prong in the Dynamic Active ETF’s methodology is diversifying in a way that spreads risk and isn’t just participation in various stock market sectors. The team examines in minute detail the business exposures of each of the roughly 40 companies in the portfolio to ensure their holdings are complementary rather than overlapping.
While financials are the top sector at 38% of the ETF’s assets, there is a wide selection of financial businesses. Beyond banks, Power Corporation of Canada, Manulife, and investment management firms Onex ONEX and Brookfield BN are among its top 10 holdings. “We look for 40 for so different ideas that work for 40 different reasons,” Simpson says. “That’s not always possible, but the more unique the ideas, the lower the correlation.”
Although the Dynamic Active ETF focuses on dividend stocks, Simpson says the size of individual holdings’ dividends isn’t the deciding factor when picking names. Rather, it’s their potential for total returns. “We target an overall yield for the ETF above the market yield, but it’s dangerous just to look at a company’s dividend,” he says. “The last thing you want is a company whose management can’t run the business properly because they’re worried about paying the dividend.” He says the best performers tend to be companies that also invest in growth and can increase their dividends over time
The Dynamic Active ETF currently has about 13% of its assets in US stocks, which provide exposure to areas with scarcer opportunities in Canada, such as healthcare and technology. Besides Johnson & Johnson, which Simpson says has proved a good acquirer and seller of businesses, key US holdings include software company Meditech, which develops healthcare information systems. The team has cut exposure to some red-hot tech behemoths dominating the US market. Still, the ETF continues to own software giant Microsoft MSFT and semiconductor maker Texas Instruments TXN.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.