The first impression I get of John Kellett is
that he really enjoys his work. And you
can’t begrudge his happiness unless of
course your one of the other dividend fund managers
that must compete against Kellett’s stellar
track record behind the RBC Dividend fund.
Kellett has cranked out one of the best performing
dividend funds over just about any time
frame. Consider the following compound annual
returns: One year, 26.4%; Three year, 10%; Five
year, 11.9%; Ten year, 11.9%; Inception, 14.2%.
Returns are one thing, and risk-adjusted returns
Kellett has achieved one of the best risk-adjusted
returns for all Canadian equity funds when taking
into account that his fund is less volatile
than the market. The RBC Dividend fund has a 3
year beta of less than .5 which means his fund
has less than half the volatility of the S&P TSX
60. The result is one of the best all around
mutual funds in Canada.
This result was not lost on the investment community.
Recently, Kellett was awarded the distinction
of fund manager of the year by
Investment Executive, one of the preeminent
industry trade publications.
What is truly impressive about this accomplishment
is that the universe of Canadian dividend
paying companies is small, so there is little room
for a manager to differentiate himself from the
Kellett does make a difference by focusing first
and foremost on running a tax efficient fund.
“When we launched it eleven years ago, I had 5
million in seed money, and I was told it wouldn’t
grow. It was strictly for outside the RRSP and
I had to manage it accordingly,” Kellett’s
explains as to why taxation was a focus from the
Kellett boasts that in all the years at the helm he
has had only one capital gain distribution arising
from a well-timed sale in the midst of the
tech bubble. “We had one when BCE spun out
Nortel. We sold the vast majority of the position
at $75-80 dollars, and we couldn’t shelter all that,” says Kellet. “The only people who would
have lost are those that sold badly. We will never
be 100% tax efficient because we pay dividend.”
The capital gains in the RBC Dividend fund are
sheltered through a variety of innovative strategies.
He continually roles out of equity positions
with substantial capital gains whenever there are unapplied losses in the fund. In doing so,
Kellett is able to allow investors to avoid paying
capital gains tax on profitable investments.
When there is a stock in the portfolio that Kellett
can sell for a capital gain, he will often do so and
buy a stock in the same sector with similar fundamentals
so as to not sacrifice his investment
position. However, by triggering the capital
gains when the fund has unused shelter ensures
that investors will not receive capital gains distributions.
Kellett is obviously an astute stock picker, but
his success is owed to several strategies he pursues
to minimize taxation. Kellett manufactures
losses in his portfolio by purchasing short-term,
high coupon bonds. “When I do that it has three
positive impacts,” says Kellett who has found a
market for short-term bonds that pay an unusually
high coupon of 8 percent or more. In order
to pay high interest, the bonds sell well above
par as high as ten or twelve dollars beyond, so
there is an implicit capital loss in the bond.
Kellett uses this capital loss to offset capital
gains in the fund, as described above. He uses
the coupon payment to create an income stream
to pay his management expense ratio (MER).
And he claims he is getting value because the
bonds are not efficiently priced.
If his loss creating strategy sounds complicated,
consider his use of Dutch Auctions. Kellett gets
all excited when he describes the many successes
he has had for his unitholders by participating
in the occasional Dutch auction. He has
astutely placed several successful bids in these
auctions which corporations often use to retire
In one example, Moore Corporation, Kellett explains that he walked away from the
auction with a sizeable deemed dividend and
useable capital loss and a substantial profit on
the stock that would otherwise have counted as a capital gain. All this, and Kellett hasn’t even
started talking about his stock picking strategy.
When it comes to his investment philosophy,
Kellett focuses on dividend growth over yield.
“In 1979-80 I went to a conference with a lot of
pension managers and academics. The academics
had studies as to how you value stocks and
it was so clear that it was a stream of income
that is generated, the dividend discount
model.” Kellett has never looked back.
The value of a company to an investor, according
to Kellett is its ability to continually
increase the dividend payment. Even if the current
dividend yield stays constant (because the
stock price is rising), the yield on the initial
investment is rising because the dollar value of
the dividend is rising. So Kellett does not look
for high current dividend yield. He looks for
high historical dividend growth.
Kellett has about 45 companies in his portfolio
out of a choice of 60 or 70 stocks that pay dividends,
so he has had to be very creative to
achieve his winning results. He likes the banks,
“the preeminent grower of dividends, an eighteen
percent increase in dividends on the sub
index over the last 12 months and a 12 percent
per annum increase over the last 5 years,” says
Kellett. He also like the fund companies referring
to Bill Holland, President of CI funds as a
“genius at creating value.” He rounds out his
portfolio with traditional high yielding companies
such as utilities and pipelines. He has
never purchased an income trust for his portfolio
as Royal offers other funds that do.
Kellett has carved out a niche for himself managing
the RBC Dividend fund over the past
eleven years. Investors are attracted to his
steady hand and strong returns and have
pushed the fund to the biggest in terms of assets
at RBC Funds. Still, the size of the fund does not
appear to have created difficulty for Kellett in
maneuvering the $3.4 billion in assets in and out
of the market. And given the genuine joy Kellett
exudes at the helm of this fund, odds are that
the best days still lie ahead for Kellett and investors in the RBC Dividend fund.