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We’re in early stages of outperformance

Middlefield Canadian Income fund manager Dean Orrico notes that falling interest rates in Canada should boost his portfolio of cheap, dividend-paying stocks.

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  • We’re in early stages of outperformance
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Middlefield Canadian Income (MCT) believes it’s in the early stages of a sustained period of outperformance as challenges such as high interest rates dissipate. That’s good news for all shareholders, including US activist Saba Capital which has a 13% stake.

Fund manager Dean Orrico noted that the valuation gap between the trust’s Toronto Stock Exchange Composite index benchmark and the US S&P 500 was now the largest in 25 years, with the surge in AI technology stocks pushing the US index to a price-to-earnings multiple of 23 times versus 15 times for the energy-heavy Canadian index.

However, the earnings growth for both indices is closer, with the TSX expected to generate earnings growth of 13.8% in 2025 and 7.4% in 2026, while the S&P 500 is forecast to grow earnings of 13.5% and 8.2% respectively.

‘Canadian equities currently offer similar earnings growth versus US stocks while trading at an unprecedented valuation discount,’ Orrico (pictured below, at the Citywire Investment Trust Awards 2023) said, indicating plenty of upside for the portfolio of dividend-paying stocks.

The £124m portfolio of real estate, financials, energy and infrastructure, is already on the road to recovery and delivered underlying returns of 1.9% to beat the S&P/TSX composite high dividend index benchmark’s 0.3% gain, while the shares rose 4.6%, in sterling terms, interim results show.

The board paid out two dividends totalling 2.65p per share over the period, marking a 2% increase year-on-year, fully covered by earnings from the portfolio.

Orrico noted that the Bank of Canada has already made three interest rate cuts since early June, which will benefit several sectors in the 4.5%-yielding portfolio.

This includes financials, the largest sector weighting at a quarter of net assets, which was the top-performing sector over the period as Canada-centric banks outperformed those with significant US exposure.

Orrico has diversified exposure through insurance companies and asset managers, which are profitable segments given equity markets are reaching all-time highs, which should translate into further inflows.

An underweight to utilities, which make up 11% of the fund, was a contributor to performance over the period. However, Orrico said surging demand for electricity to power new data centres ‘is a trend that has caused us to take a more positive stand on the sector’ and remains ‘bullish’ on utilities.

He has an above-benchmark weighting to both energy and energy infrastructure and retains a positive outlook given energy producers should benefit from stabilising commodity prices in the second half, ‘supported by the attractive supply-demand fundamentals and geopolitical tailwinds’.

The largest private infrastructure project in Canada’s history, LNG Canada, is due to become operational next year and will provide a ‘material boost’ to gas production.

‘Oil producers are also getting a lift from the recently completed Trans Mountain Pipeline project, which added 590,000 barrels of crude oil capacity per day,’ he said. The Canada Energy Regulator estimates that the added capacity will add about $9 (£6.85) per barrel to what Canadian producers currently receive.

One overarching theme Orrico expects to play out to the benefit of his fund is a boom in the Canadian population, which has grown 8% since the pandemic.

He said many companies will benefit from the rapid increase in domestic demand, but the biggest winner will be real estate, where the supply has failed to keep up with demand, increasing apartment rents close to 10% year-on-year.

When investor focus shifts away from the headwind of rising interest rates, Orrico expects a swift rerating in real estate investment trust (Reit) unit prices.

Real estate is the largest active weight in the fund at 21% versus the benchmark’s near-5% exposure, with exposure to ‘necessity-based retail’, apartments, industrial and senior housing.

‘We believe the fund’s core exposures within real estate, financials and energy should benefit once capital flows out of high-multiple growth sectors and money market funds into more reasonably priced areas of the market.’

Over the period the share price discount narrowed from 16.8% to 15% and has come in further to 13% since.

US activist investor Saba Capital is one of the larger shareholders, increasing its stake to 13% in a fresh wave of buying at the end of September, stock exchange filings show.

The board rarely buys back stock, with only 40,000 shares acquired over the six-month period.

Over the past five years, the trust has delivered shareholder returns of 44%, beating the S&P/TSX composite high dividend index benchmark’s 29%, according to Morningstar data.

 

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  • We’re in early stages of outperformance
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