Winning portfolios don't have to be volatile - MoneySense

Winning portfolios don’t have to be volatile

Outperform with lower volatility


In today’s investing world, there is no shortage of criteria to choose from when picking a stock. Investors can select to build portfolios based on a variety of factors from growth to momentum, or management quality to industry competitiveness. In particular, dividend portfolios are one type you may often see within investing media. Many of them have performed remarkably well, especially in Canada.

But performance should not be your only focus in building a portfolio. As you may well know, with the uncertainty and volatility in the stock market, investors should also be concerned with minimizing risk and preserving capital.

The Test

In an effort to produce a portfolio with potential for outperformance and lower volatility, I used Morningstar CPMS*, which comprises of about 98% of the investible market cap of stocks in Canada, to create an equity strategy that picks stocks with a history of increasing dividends and also have a low beta. Lower beta stocks are less sensitive to stock market movements.

The criteria:

  • Expected dividend growth (higher values scored better)
  • 5 year normalized dividend growth (higher values scored better)
  • Dividend yield of at least 1%
  • Beta of 0.75 or lower (a value below 1 would indicate the stock is less volatile than the market)

The results

To test the validity of this approach I back-tested the strategy from February, 2007, to April, 2017. During this process, a maximum of 15 stocks were purchased and equally weighted with a maximum of four stocks per sector to ensure a degree of diversification. Annually, the portfolio would be reselected based on the strategy’s criteria. Over this period, the strategy produced an annualized total return of 13.6% while the S&P/TSX composite total return index advanced 4.8%. Equally as noteworthy, downside deviation (a measure for volatility of negative returns) for the strategy was 5.5% vs. 9.8% for the S&P/TSX Composite. The lower the downside deviation indicates a lower history of “bad” volatility. You can find a list of the 15 stocks that meet our criteria below.

A Word of Warning

The results of this strategy are impressive, but I should remind you that they are based on a back-test, which comes with its own assumptions. For example, this test assumed trading with closing day prices and only at the last business day of the year. In reality you would likely trade at a different price and may transact at more frequent intervals. Also this strategy uses only quantitative data based on the factors above. I recommend that you should also regularly pay attention to news on stocks that you own and ensure that conditions of those companies are worthy for investment based on your own research.

As always, past performance (back-tested or real life) may not be indicative of future results. Nevertheless, I believe this strategy and the current list of stocks is a worthwhile consideration if you want to build a strong performing portfolio with reduced risk.

Dividend growing stocks with low beta

Rank Company Sector 5-yr. dividend growth rate Dividend yield Expected dividend growth BETA Market cap ($mil)
1 Gildan Activewear (GIL) Consumer Discretionary 28.7% 1.4% 18.3% 0.57 $8,601.1
2 Maple Leaf Foods Inc. (MFI) Consumer Staples 27.6% 1.3% 15.8% 0.60 $4,442.9
3 Enghouse Systems Ltd. (ENGH) Information Technology 24.8% 1.1% 18.5% 0.07 $1,632.4
4 Brookfield Inf Partner (BIP.UN) Utilities 21.7% 4.4% 15.9% 0.67 $14,378.2
5 Stella-Jones Inc. (SJ) Materials 32.7% 1.1% 10.0% 0.28 $2,890.7
6 Hardwoods Dist. Inc. (HWD) Industrials 30.4% 1.4% 9.9% 0.38 $371.7
7 Metro Inc. (MRU) Consumer Staples 18.9% 1.4% 11.6% -0.15 $10,600.3
8 Algonquin Power Corp. (AQN) Utilities 17.8% 4.7% 11.8% 0.44 $4,987.4
9 Brookfield Asset Mgmt (BAM.A) Financials 18.8% 1.5% 10.7% 0.52 $51,195.4
10 Exco Technologies Ltd. (XTC) Industrials 18.9% 2.7% 10.3% 0.59 $497.1
11 Agrium Inc. (AGU) Materials 59.8% 3.9% 2.9% 0.66 $17,161.5
12 Enbridge Inc. (ENB) Energy 18.6% 4.1% 10.0% 0.52 $93,157.3
13 Supremex Inc. (SXP) Materials 21.2% 4.8% 6.7% 0.20 $142.1
14 Jean Coutu Group, A (PJC.A) Consumer Staples 15.7% 2.3% 8.3% -0.13 $1,784.1
15 Brookfield Renewable (BEP.UN) Utilities 15.7% 6.1% 8.1% -0.07 $7,006.4

Source: Morningstar CPMS as of May 4, 2017

* Morningstar CPMS includes all stocks in the TSX Composite Index and the BMO Small Cap index. It also includes other stocks based on request with at least 3 analysts of coverage and 5 quarters of earnings. Currently the universe has 722 stocks in Canada.

Michael Pe, CFA is an Institutional Product Specialist at Morningstar Research Inc.