What are we looking for:
A concentrated low volatility portfolio for Canadian Markets.
For most retail investors and stock jockeys, the idea of finding “the next best stock” is often front of mind. However, disciplined and seasoned investors know that the portfolio that will ultimately help you reach your financial goals is not achieved by hitting one or two home runs, but rather getting onto first base consistently over time. With this in mind, I used Morningstar CPMS to create a low volatility portfolio by ranking stocks within the largest 200 companies in Canada by market float (excluding unit trusts) based on 3 factors:
- Yield on expected dividends (this is the yield calculated by taking the most recently announced, but not yet paid, distribution and dividing it by the most recent stock price)
- 5 year historic beta. Recall that Beta is a sensitivity measure. In falling markets, a stock with a beta lower than 1 well have fallen less than the index, while in rising markets a stock with Beta lower than one will rise less than the index. Here we use Beta as a defensive measure, preferring companies lower Beta.
- Earnings variability (this is a proprietary CPMS* metric that essentially measures how volatile a company’s earnings are over time, lower scores preferred).
The portfolio was designed to be very concentrated, holding only 10 positions, never owning more than three stocks per economic sector to ensure some diversification across the economy. (See the portfolio below)
What we found
I used Morningstar CPMS to back test this strategy from December 1985, to August 2017. During this process, 10 stocks were purchased and equally weighted with a maximum of three stocks per economic sector. Once a quarter, we used dividend proceeds to re-balance stocks back to their equally weighted target. Over this period, the strategy produced an annualized total return of 11.2% while the S&P/TSX Composite Total Return Index returned 8.1%.
The below table shows a clear picture of how such a strategy performed in trailing periods:
|Return %||Standard Deviation %||Downside Deviation %||Sharpe Ratio %|
|Strategy %||Benchmark %||Net %||Strategy||Benchmark||Strategy||Benchmark||Strategy||Benchmark||Alpha||Beta|
The stocks that qualify for purchase into the strategy today are listed in the table below. As always, it is advised that investors conduct their own independent research before buying or selling any security.
|Rank||Symbol||5Y Historic Beta||Earnings Variability||Expected Dividend Yield (%)|
|1||BCE Inc. (BCE)||0.26||2.65||4.92|
|2||AltaGas Ltd. (ALA)||0.77||10.68||7.28|
|3||IGM Financial Inc. (IGM)||1.31||3.17||5.36|
|4||Capital Power Corp (CPX)||0.84||8.82||6.63|
|5||Power Financial Corp. (PWF)||1.00||3.11||4.78|
|6||Cdn Imperial Bank (CM)||1.07||3.06||4.77|
|7||Enbridge IF Holdings (ENF)||0.79||9.66||6.4|
|8||North West Company Inc. (NWC)||-0.12||5.46||4.22|
|9||Emera Inc. (EMA)||-0.04||8.89||4.45|
|10||TELUS Corporation (T)||0.74||4.27||4.38|
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
Ian Tam is the Manager of the client services team at CPMS, a division of Morningstar that focuses on providing high quality equity fundamental data and disciplined rules-based investment processes to the institutional buyside and investment advisors across North America. Ian completed his Bachelor of Applied Sciences (Hons. Mechanical Engineering) from the University of Waterloo in 2007 and obtained the CFA Charter in 2013.