Checking in on the Canadian wide moat portfolio.

It’s a trade off. I hold a concentrated portfolio of Canadian stocks. What I give up in greater diversification, I gain in the business strength and potential for the companies that I own to not fail. They have wide moats or exist in an oligopoly situation. For the majority of the Canadian component of my RRSP account I own 7 companies in the banking, telco and pipeline space. I like to call it the Canadian wide moat 7 portfolio. I also hold oil and gas stocks at a 12-15% weighting. The Canadian contingent then takes a backseat to our U.S. stock portfolio. I always encourage readers to consider a portfolio that holds more moaty sectors including the grocers and railways.

Like many Canadian investors I discovered over the years that my Canadian stocks that happen to pay very generous dividends were beating the total return performance of the market. You’ll find that market-beating event demonstrated by the Beat The TSX Portfolio. Over longer periods you’ll see that BTSX beat the TSX 60 by over 2% annual. That approach finds value and profitability in addition to business moats. Keep in mind it is the share prices that drive returns, not the dividends. I seek total return as I manage risk.

Eventually, I moved to the stock portfolio approach.

Big moats under pressure

And as always, past performance does not guarantee future returns. High dividend investors have recently experienced a period of underperformance, as many of these Canadian big dividend payers are rate-sensitive. They were under pressure in a period of rising rates. These high yielders compete with the risk-free yields available with cash, GICs and ultra short term bonds. Debt becomes more expensive putting pressure on balance sheets. Telcos have faced the most pressure due to mounting debt servicing charges and increased competition. Regulators are changing the rules for the sector.

From testfolio a look at key sectors from 2022 (when inflation was unleashed). The pipelines have been a strong performer from 2022.

Canadian banks have underperformed due to recession risks. Canadians’ mortgages are being reset at much higher rates. HELOC rates have increased dramatically. This tweet from Hanif Bayat from wowa.ca demonstrates the recent stress. Bank write offs are higher than COVID levels.

💸 Financial Struggles for Canadians:

Big 6 🇨🇦 Banks wrote off $3.49B in loans in Q3 2024 (+48%⬆️YoY)

🔹Higher than COVID Peak: $2.6B in Q3 2020

🔹Double the 2008 Crisis Peak: $1.5B in Q4 2008

🔹Minimal Risk for Banks: Significant ACL reserves set aside

🔹Dark Clouds:… pic.twitter.com/dcZ2AhFBee

— Hanif Bayat (@HanifBayat) August 29, 2024

All said and in response, the Bank of Canada has cut rates twice and estimates call for an aggressive rate cut cycle. This is taking pressure off of rate-sensitive equities. We appear to be back in a lower inflation, disinflationary environment.

Wide Moat 7

For the bulk of my Canadian contingent I hold 7 stocks. Of course, you may (should) choose to hold more names in the financial, telco and pipeline/utility space. For even greater sector diversification and total return potential – please look to the WIDER Moat Portfolio, shown below. It includes the moaty sectors of grocers and railways, plus picks (honourary moat stocks) of Alimentation Couche-Tard, Brookfield and Waste Connections. That has been a superior approach, with much greater returns and less volatility.

Canadian banking.

Royal Bank of Canada, Toronto-Dominion Bank and Scotiabank.

Telco space.

Bell Canada and Telus.

Pipelines.

Canada’s two big pipelines are Enbridge and TC Energy (formerly TransCanada Pipelines).

My followers on Seeking Alpha or Cut The Crap Investing readers will know that I also own Canadian energy producers, gold stocks and gold price ETFs (holding gold) and the all-in-one real asset ETF from Purpose. I also own Canadian bonds. U.S. bonds and bitcoin.

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It’s all part of the all-weather portfolio model.

For the U.S. component there is a basket of U.S. stocks. Here’s an update of our U.S. stock portfolio on Seeking Alpha. You can sign up for a free read. And here’s the key chart.

Our U.S. portfolio has a nice long term beat, but the gap is closing as it has been more than difficult to keep up with the tech-heavy S&P over the last 2 years. Those U.S. market returns are largely driven by the Magnificent 7.

I look for stability (during any recession or major market correction) from the Canadian equity component, while many of the U.S. stocks provide the growth kicker.

Canadian wide moat update to the end of August 2024

Here’s the total return chart from testfolio.

As per the usual we see the outperformance of the Wider Moat portfolio (including grocers/railyways/picks) over the concentrated Wide Moat 7, the TSX Composite and Vanguard’s VDY.

Here’s the Wider Moat Portfolio.

I really like Waste Connections as a moat stock. It would have contributed to the outperformance. That said, the valuation seems very stretched in 2024. I did not add that stock to the total return evaluation.

That is a Canadian stock portfolio model that is hard to beat. It tracks quite closely to BMO’s Low Volatiliy ETF – ZLB. From that post …

The Canadian Wider Moat Portfolio offers a slight beat over ZLB.TO.

Concentration risks

I am currently paying for my concentration (company and sector) risk. From the Wide Moat comparison chart we can see that the Wide Moat 7 was outperforming but has slipped drastically from 2022. That’s due to the sector concentration in the telcos. Also, my 3 banks have underperformed the banking sector. We call that company risk.

While my Canadian oil and gas stock exposure has picked up some of the slack, there’s no denying the recent underperformance of the Wide Moat 7. From the beginning of this blog I’ve begged readers to use the Wider (more) Moat model.

I’ll stick with the holdings, but in 2024 I certainly wish I had eaten my own cooking.

More on telcos

Canadian investors will know that the telcos have been getting hit hard. They do not like the higher rate environment. Plus, the regulatory environment has changed and there’s not enough growth to pick up the slack. It is now a no-growth to low-growth sector.

A few months ago, I sold half of my Bell Stock. The dividend is not covered by free cash flow. From that post you’ll see that I moved the proceeds to iShares U.S. Quality – XDU.TO.

I don’t mind beefing up my U.S. exposure, especially with a value tilt.

I have also trimmed my Telus position. The proceeds also went to XDU.TO.

Creating the VDY Plus Portfolio

In my wife’s accounts I used VDY to not expose her to my concentration risk. That ETF has beat the market by over 1% annual. Mission accomplished.

But given the fees and the size of my wife’s VDY holding, I sold the ETF to create what we can call the VDY Plus Portfolio. It has the core elements of VDY plus a wider moat slant due to the consumer staples (XST.TO) and Couche-Tard. It’s off to a nice start beating VDY.TO and the TSX Composite XIC.TO.

Observations and takeaways

Dividend paying stocks have benefited from the low inflation and disinflationary period that began in 1981. With bond yields falling for the most part, investors enjoyed very good returns from bonds and big dividend payers. Given that stocks and bonds perform well in a disinflationary environment, balanced portfolios have delivered very good returns for many decades.

It’s possible that the inflationary shock is behind us. Rates are coming down and perhaps we return to the environment we’ve mostly known from 1981. That would be my guess. But of course there is always the risk of an inflationary shock.

Wide moat stocks as bond proxies

Many Canadian retirees will use the banks, telco’s, pipelines, grocers and utilities as bond proxies to work in concert with a cash and bond allocation. As a semi-retiree I am in that camp.

Our U.S. consumer staples and healthcare stocks also help to build that defensive wall.

Defensive sectors for retirement.

As that post demonstrates, there’s nothing better than defensive sectors and wide moats.

Portfolio success in retirement will come down to total return and risk level. That’s it.

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