Analyst’s Report: RBC Canadian Dividend

Following the departures of John Varao and Shane Jones in April 2007, RBC Asset Management named Stuart Kedwell and Doug Raymond as the co-managers of RBC Canadian Dividend in August 2007. While the transition of the fund to new management has been fairly smooth, we are concerned with the turnover within the firm’s Canadian equity team. Also, the team’s added focus on high-growth names in non-financial businesses may marginally alter the portfolio’s texture. Nevertheless, we think that its continued focus on dividend-paying stocks, combined with the fund’s low fees, will continue to yield decent results.

RBC’s Canadian equity team has seen its fair share of manager departures over the past five years. The loss of Varao and Jones followed the retirement of successful manager John Kellett and the departure of precious metals veteran John Embry in 2004. Then at the end of February 2008, Warner Sulz, who had been co-manager on RBC Canadian Equity with Varao and then its lead manager, also left. These departures are significant, but the firm has been developing its stable of managers and analysts to keep things on track.

Although we don’t expect their strategy to deviate significantly from that of previous management, the new managers have started to look for higher-growth names in resources, albeit at the margin. They have initiated positions in some high-octane resource names such as Potash, Agrium and Fording Coal. While these names are susceptible to the wild price fluctuations of the underlying commodity, the team’s emphasis on long reserve lives of the assets along with significant cash generation potential should help maintain the dividend yield offered by the portfolio. We think this strategy should boost overall returns during rallies in the resource sector, but it may also make the fund slightly more volatile.

But the team will continue to position the portfolio’s core around large-cap dividend-paying companies that have demonstrated the ability to grow both dividends and earnings. And the fund will remain heavily tilted toward financial services; currently at 39%, the fund’s position in the sector is overweight by 15 percentage points versus the S&P/TSX Composite Index. We don’t hold this allocation decision against management because there are generally fewer established dividend-paying stocks in the materials sector than in financial services.

While it is not immune to losses if financials continue to face trouble, the fund has fared better than its peers in the Canadian Dividend Income category over the past year. Interestingly, its one-year loss of 2.3% is less than half that of its median peer even with a significantly higher allocation to financials. Also offsetting some of the fund’s relative underperformance is its managementexpense ratio, which at 1.71% is lower than that of 81% of its category peers. This should be particularly beneficial in a low-return environment since it translates into a lower hurdle for the fund.

OF NOTE Over 10 years the fund’s annualized return beats the index and the median by 60 and 160 basis points, respectively, with median-like volatility.

Historically, this fund has had low portfolio turnover, with the average holding period being close to six years. We don’t expect this to change going forward.

The managers run a fairly concentrated portfolio where roughly three-quarters of the assets are in the top 25 holdings.

The fund is generally underweight in energy and materials since most of these businesses don’t meet the team’s investment criteria for this mandate.

Bhavna Hinduja is a fund analyst with Morningstar Canada.