Real estate investment trusts and infrastructure stocks offer some of the better opportunities to weather a slowing global economy and the wild market swings, says fund manager Oscar Belaiche.
"I've become more defensive, but I am not pessimistic," says Mr. Belaiche, who oversees $8-billion in assets for Goodman & Co. Investment Counsel Ltd. "We are heavily invested in REITs and infrastructure stocks like pipelines and utilities, which are more stable and predictable parts of the market."
While stock markets have been rocked by euro zone debt woes and a tepid U.S. recovery, a continued retest of the August lows (1,120 on the S&P 500) is likely the worst downside scenario barring a "black-swan event" like a major European bank going bankrupt, he said. "We have and continue to be buyers at that level."
Over the summer, he reduced his exposure to economically sensitive companies such as railways and copper miners, and has virtually nothing in Europe. While he also owns certain bank and telecommunications stocks, he is avoiding insurers because they need rising interest rates and a rising stock market to make money, he said.
But Canadian REITs are compelling because their high yields are also attracting strong interest from U.S. and Japanese fund managers, said Mr. Belaiche, who focuses on companies with dividends and dividend growth.
The key to REITs and other dividend-paying stocks is that aging baby boomers need income in a low interest rate environment to fund retirement, and that will drive demand for companies with predictable cash flow regardless of whether there is fear in the market, he said.
REIT valuations are not expensive because they trade at only slightly above net asset value (private market value), he noted. And they are attractive when comparing their average yield (just below 6 per cent) to 2.2 per cent for a 10-year Government of Canada bond or other cash alternatives, he added.
Apartment REITS are stable, while office and shopping centre REITs are attractive because of income from long-term leases, he said. "Retail space in Canada is still expanding with Target and other U.S. companies expanding into Canada."
Mr. Belaiche likes REIT names such as Calloway, RioCan, Boardwalk, Dundee and H&R. The space has held up well this year with the S&P/TSX Capped REIT Index up 14.6 per cent versus a 11.4-per-cent loss for the Canadian market, he said. Interest rates should remain low so there is little concern about borrowing costs faced by REITs, or investors searching for alternative investments, he said.
He is also a fan of infrastructure stocks because of their earnings stability from long-term contracts that can be indexed to inflation. He owns pipeline operators such as Enbridge Inc. and TransCanada Corp. as well as utilities such as Northland Power Inc., Innergex Renewable Energy Inc. and Brookfield Renewable Power Fund.
One of his larger funds is Dynamic Equity Income, formerly an income trust fund, which has expanded its mandate to other dividend-paying securities. It has earned 12.5 per cent annually for the 10 years ended Aug. 31 versus 8.1 per cent for the S&P/TSX total return index.
Mr. Belaiche, who worked in the real estate sector before running money, is "a strong manager" with a concern for risk, said Dan Hallett, an analyst with HighView Financial Group. But the turnover in his funds tends to be on the high side because he also uses economic analysis for his investment decisions, Mr. Hallett said.
Despite his caution, Mr. Belaiche doesn't see a return to the lows of March, 2009, when the S&P 500 plunged to the 666-level after Lehman Brothers Holdings Inc. went bankrupt, the financial system froze and U.S. banks had to be recapitalized.
"In Europe, there is a road map, and government leaders are working to make sure their banks are backstopped" should they get into trouble from loans to the periphery countries like Greece, he said. "I am optimistic because I think the banking system will be preserved in Europe. If you don't think that, you don't want to be investing."
Belaiche's stock picks
Calloway Real Estate Investment Trust
The shopping centre operator is dominant in the "big-box space" with free-standing stores, Mr. Belaiche said. This REIT has very stable cash flow because of long-term leases and financially strong tenants such as Wal-Mart Stores Inc., he said. Calloway has a 6-per-cent dividend yield and trades at 16 times price to free cash flow, he added.
The telecommunications company has an "excellent management team," generates lots of cash flow and plans to raise its dividend by 10 per cent annually for the next three years, he said. It operates in a relatively stable business dominated by a few large firms, he added. Telus, which has a 4.25-per-cent dividend yield, trades at 12.5 times forward earnings.
The pipeline operator has an excellent management team, and is "one of the best energy infrastructure companies in North America," he said. "We expect about 10-per-cent earnings growth over the next few years, and dividends to grow in line with that." Enbridge trades at over 20 times forward earnings and has a 3-per-cent dividend yield.