Canadian Equity Alpha: Overcoming the Headwinds

This month, we sat down with Kevin McSweeney, Senior Vice-President, Portfolio Manager & Lead for our Canadian Equity Alpha mandate. With over 25 years of financial services experience, including 17 years in asset management with CI, Kevin is an expert in both Canadian and global infrastructure equities.

Alfred Lam: Kevin, it's a pleasure to have you with us. Before we dive into investment topics, can you share how you got started in the industry and what led you to become a portfolio manager?

Kevin McSweeney:
I’d done an undergrad degree in Political Science and an MBA in Finance before joining Finance Canada as an economist. Government wasn’t my style, and I made my way down to Bay Street with Scotiabank, doing some regulatory and strategic matters for a bit, and then got into corporate lending risk management. I enjoyed this but wanted something more dynamic and thought that asset management – where I could buy and sell things, with lots of accountability – was a place where my curiosity would fit well. I then started as an investment analyst in the high yield bond group here at CI, moving over to equities in 2016. There’s nothing like asset management for one’s ability to combine a curious intellect, willingness to be accountable, and a good mix of high-level and company-specific analysts. It’s an infinite challenge to perform well, and that’s stimulating to me.

Alfred Lam: It's no secret that the Canadian economy and its stock markets have both underperformed compared to our neighbour, the United States. Can you walk us through some of the challenges Canada has faced over the past decade?

Kevin McSweeney:
From the economic and stock market perspective, the broad answer is that Canada has not been a place that has rewarded capital investment, and capital has gone places where it would be better treated. That was particularly the United States, which not only invested more and gained more productivity, but also attracted global investment flows that pushed up the valuation of its stocks in a virtuous cycle. While Canada has relatively fewer technology companies, this doesn’t fully explain the differential in performance. The well-publicized difficulties in getting infrastructure built, higher tax rates on savers, and higher exposure to natural resources (where productivity gains are lower than other sectors) saw fewer productivity gains in our economy. Additionally, high tax rates on income and capital have produced a disincentive for capital formation directly by reducing savers’ reinvestment, as well as in the culture of innovation within Canada, which saw wealth creators as “taking” rather than “creating” or “building.”

Alfred Lam: Has that dynamic shifted recently? Where do you currently see value and opportunity within Canada?

Kevin McSweeney:
I think the dynamic has shifted marginally. The pressure from the United States on tariffs has given Canada an impetus to invest smartly and not rely on trade/exports to drive economic growth. (The decline in the housing sector’s economic contribution has also created a need to drive more investment in the corporate sector.) While it is promising that the Carney government seems to recognize the consequences of underinvestment on Canadians’ well-being, and its rhetoric has been constructive, we need to see more. 

For where I see value, I’d say that we see a little less value in the market today than we did at the beginning of the year. Before the recent move higher in their stock values, I would have highlighted the Canadian banks as a place with opportunity and value, but I think much of the value has already been gained from them. I would say that the Canadian railway, CP, is currently trading at the same stock prices they were at 4-5 years ago, and so we’ve been adding to that name. CP has had its stock price beaten up on trade concerns, but this is an incredible business with bright long-term prospects. There are also some utilities and engineering companies that we think will benefit from increased industrial investment in Canada and around the world from macro trends such as electrification, decarbonisation, nearshoring, and AI.

Alfred Lam: Are you concerned about Canadian businesses that rely heavily on trade with the U.S.? How do you see those relationships impacting our economy over the next one to three years?

Kevin McSweeney:
Absolutely. There will be economic headwinds through lower investment by international/U.S. firms in Canada – preferring to set up shop in the U.S. – as well as lower exports and fewer jobs in impacted sectors. For me, the question will be: what is the response of the Canadian government? Not just in the short term for investment stimulus and sectoral tariffs, but how do USMCA negotiations proceed over the next year ahead of a potential sunsetting of that agreement? If Canada can negotiate a longer-term agreement with the Trump administration, even if that agreement is imperfect or involves some concessions, I think that we could see an acceleration of confidence and investment that could be very good for markets. This is far from certain, but I don’t think investors are even considering this potential positive scenario.

Alfred Lam: Turning to the Canadian Equity Alpha mandate—what sectors are you currently favouring? Could you highlight a few investments that you find particularly compelling?

Kevin McSweeney:
We’ve recently added to a few gold positions, including some mid-cap gold names that are completing their transformations into solid, cash-flow-generating businesses. IamGold and Equinox Gold have been added, each of which have done well, and we had one holding in this sector get acquired: Sandstorm Gold. We see more investors getting pulled into the space as higher levels of capital discipline and professional management help these companies with their “brand” within the investment community, somewhat like what happened in the energy sector a few years ago.

Within new positions in the Alpha Pool, I’m very constructive on Keyera, which we added to the portfolio back in June when they raised money to buy some energy infrastructure assets from Plains, a U.S. pipeline operator. Keyera has been executing well and using their asset base to nicely grow cash flows and dividends with a very solid balance sheet. I don’t think the market fully appreciates how much growth these new assets are likely to give Keyera. And when you think about how difficult it is and how long it takes to build things in Canada, the fact that they could grow their cash flows by almost a third, in one transaction with minimal execution risk, is a very strong move that the market isn’t yet recognizing.

Alfred Lam: Many of our investors also hold positions in your Global Infrastructure mandate. You've been an early advocate of this asset class. Are you still as excited about it today—and if so, why?

Kevin McSweeney:
I continue to like our Global Infrastructure mandate quite a bit. The companies in this fund are the ones that make the rest of the economy work: pipelines transporting oil and gas, utilities distributing power and water, telecommunications towers and fibre networks making sure we can use data, and toll roads or airports that get us around our cities and the globe. These are very consistent companies that everyone is going to always use – that makes them a bit less exciting as a story, but it has kept those companies steadily compounding value (our Infrastructure Fund has only delivered one negative return year in the last 10). That steadiness doesn’t always produce large increases in share prices, but we’ve returned more than 10% this year and we still trade at a lower valuation versus many major global stock indices. It’s easy to love the stability of the businesses, the resilient cash flows that those businesses create, and the ability to get those assets at a good price. When you put that package together, and if it’s not an oxymoron, it’s an exciting one for people that like boring returns.

Alfred Lam: Finally, what’s currently keeping you up at night?

Kevin McSweeney:
In the short term, it’s political stability. I grew up as a child of the 80s and 90s where the global backdrop was generally stable and improving over most of that time. These days, as the U.S. retreats from the Pax Americana role that so many people assumed would always be the case, it opens up a higher probability for chaos to occur.

Over the longer term, it’s demographics. The world is getting old, and while that’s a good news story overall from a longevity perspective, it is easier for economies and societies to flourish when there’s population growth with healthy, young demographics. Around the developed world and some emerging markets, it seems likely that many populations will decline. For example, China’s population is projected to decline from 1.4bn people to 800MM people by the end of the century. Can we really rely on China to be a driver of global economic growth when its population base will be almost 40% smaller? This matters for inflation, for commodities, for stability, and for any number of other factors. Aging puts a strain on societies through increased health care requirements, lower labour force participation, and higher expenditures put on the working age population for social services and pensions. Humanity has never been through this, so it’s a massive risk for economies and societies. 

Alfred Lam: Kevin, thank you so much for taking the time to share your insights with us.

Kevin McSweeney:
Thanks Alfred – always a pleasure chatting with you.

About the Author

Alfred Lam

Alfred Lam, Senior Vice President, Co-Head of Multi-Asset, joined CI GAM in 2004. He brings over 23 years of industry experience to his portfolio design, asset allocation, portfolio construction, and risk management responsibilities, which include chairing the multi-asset investment management committee and sizing investment bets to drive added value and manage risk. Alfred holds the CFA designation and an MBA from York University Schulich School of Business. He is a recognized leader in multi-asset investing in Canada. During his tenure, his team has won multiple investment awards, including the Morningstar Best Fund of Funds, and saw assets growing four-fold.