A Canadian team has not won the Stanley Cup in over 30 years. As a born-and-raised Edmontonian (living in Calgary), it’s been exciting to watch the Oilers clinch their seat in the Stanley Cup Final. While many will agree that Connor McDavid is an amazing player to watch, Oilers fans recognize that more than a few strong players are needed for Cup contention. The key was adding new players with different skill sets to play certain roles on the team.
We apply a similar philosophy when investing. Our portfolio enhancement criteria (one of the seven tests we use in security selection), requires us to evaluate how adding or removing a company can enhance the quality and performance of the portfolio. The analysis considers the portfolio’s existing qualities and exposures and the areas that could warrant improvement. It wouldn’t make sense for a hockey team to add a skilled centerman to the roster if it already had several proficient individuals in that position. However, attracting a defenceman with a unique set of skills might significantly bolster the team’s strength.
There are additional alternatives to weigh in portfolio management compared to trading hockey players. For example, we can increase the weight of an existing holding rather than introducing a new one with similar exposures. Or, like the defenceman mentioned above, we can look at companies that would bring a variance of characteristics to the portfolio, such as exposure to different parts of the economy and/or a different geography. The key is the variation in exposures so that we can achieve better defence in down markets (when not all businesses are impacted to the same degree) and participate on the upside (when some businesses have higher torque to certain factors). Our portfolio enhancement objective is to determine what will be additive to the portfolio while benefitting from diversification.
What Are Our Scouts Looking For?
We are always screening for companies and meeting with management teams to find potential additions for our portfolios. In our Canadian large cap strategy, we do not currently have holdings in either the healthcare or real estate sectors as defined by index providers. If we could find businesses in these sectors that met our tests, the portfolio could potentially benefit from the differentiated exposures and diversity in cash flows.
We have not owned a business in the healthcare sector in our Canadian large cap strategy for over 15 years because of high debt levels or, more recently, unproven business models (namely cannabis companies). We have owned real estate businesses over this same period; however, low interest rates have caused valuations for many real estate businesses to move up significantly. We determined that exiting would be best for the portfolio.
Real Estate – Why Now?
An increase in interest rates typically puts pressure on real estate prices due to the increase in interest costs. We have seen that this cycle, but also persistent impacts from COVID. Warehouses and logistics properties have experienced positive impacts, even with increased interest costs, with higher demand for online shopping that still continues above pre-pandemic levels today. However, on the opposite side, office towers have seen decreased occupancy, especially in older properties, as more people work at home or in a hybrid environment. This has led to a decline in the price of certain parts of the real estate market, which we feel has created some opportunity.
The Canadian large cap team has reviewed numerous real estate companies to identify which companies we would want to own and at what valuation levels. We feel two QV strengths will assist us in this process. Firstly, our long-term perspective allows us to look farther out than most investors, beyond the current dislocations. Secondly, we typically identify companies in advance and if they are not immediately introduced into the portfolio, we can be patient and wait for the business to reach the markers we would like to see. We’ve identified Colliers International Group as a business we would like to own at the right price.
What is Colliers International Group?
Colliers is a leading diversified commercial real estate business with operations in 68 countries. Colliers provides services such as leasing buildings for clients, helping to buy and sell properties, and providing property management services. A new and growing area of its business is managing real estate investment portfolios for clients.
Colliers is different from many traditional real estate companies that own properties and use debt to finance them. Its unique business model has provided a growing amount of recurring revenue, especially with its investment management operations. With revenue per share that has grown at a compounded annual rate of 9.1% over the last 10 years, the company boasts a strong track record for growth:
Source: S&P Capital IQ
While growing through a mix of acquisitions and organic growth, Colliers has not sacrificed its returns (averaging an after-tax return on capital of 11.6% over the last 10 years). This rate of return is much higher than the average company in the Canadian market. As well, Colliers has a well-financed balance sheet compared to many other real estate companies, which should limit its negative experience in difficult markets. This capital light business model provides strong cash flow and Colliers has displayed a strong ability to deploy it.
The Enhancement Factor
Part of our job is to ensure we are looking outside our respective portfolios for businesses we may want to own. In some cases, we may add them right away; in other times we may want to wait for a more appropriate valuation that will maximize its positive impact on the overall portfolio.
If you are looking at your portfolio and deciding whether to add a new holding, whether it be with a new stock, bond, mutual fund or investment manager, consider the question: Will this enhance what I already own? I know a new Stanley Cup banner at Rogers Place would enhance the rink. Go Oilers!
