Canadian stock fund identity crisis

Value-oriented Canadian equity managers tell me that good values are tough to find – even after the market’s recent breather. Given that value funds have excelled over the past few years, strong net sales have continued gushing into these big strong performers. High valuations, big foreign content allocations, strong net new inflows, and Canada’s small market have caused many Canadian equity managers to hold relatively small amounts of Canadian stocks.

More than fifty investment funds tracked by Morningstar Canada categorized as Canadian equity mid- large- and small- cap funds (excluding ‘pure’ funds) report a Canadian equity weighting of less than sixty percent. Here are some of the larger and most notable examples.

Mackenzie Cundill Canadian Security

In just a few years, this value fund has ballooned in size to nearly $1.2 billion. In the summer 2001, Alan Pasnik (then lead manager) pointed to the fund’s modest $250 million asset base as an advantage since it did not restrict him by market capitalization. At the time, it had a large cap bias and held only 55 percent in Canadian stocks. However, excellent bear market performance and solid longer-term numbers have attracted a flood of new cash. This influx has effectively precluded it from shopping among Canada’s smaller cap stocks. Now, its Canadian equity weighting stands at just over one-third of assets. In fact, it holds roughly the same amount of cash as it does in Canadian stocks.

Co-manager Wade Burton (who stepped in last summer after Pasnik’s departure) says he’s working hard to find new investment ideas. While he admits that it’s tougher today, he maintains that he’s still finding new stocks to buy – but apparently not as quickly as cash is piling up.

Mackenzie Ivy Canadian

At 57 percent, this $5.3 billion fund is a poor proxy for Canadian stocks. The Ivy team prides itself on assembling a concentrated list of growth stocks that are reasonably priced relative to future potential. However, more than four years ago, when this fund was just slightly smaller, Javasky admitted to having to stick strictly to big cap stocks based both on assets and portfolio concentration.

Javasky’s typically high cash balance (which actually sits at 15 percent, historically low for this fund) results from Canada’s relatively small large cap universe. Credit this team for sticking to their knitting in the face of significant constraints. However, investors desiring pure Canadian stock exposure should look elsewhere.

CI Harbour Fund

Like his former Ivy teammate, lead manager Gerry Coleman held 55 percent in Canadian stocks and 20 percent in cash as of the end of April. A recent commentary by the Harbour team highlights the significant contribution that small-to-mid cap stocks have had on longer-term returns. However, with more than $3 billion in this fund and its various incarnations, Coleman and his team will be more restricted from significant participation in smaller firms. Hence, Coleman’s selectivity, big asset base, policy of maximizing foreign content, and high current valuations add up to a portfolio that doesn’t come close to offering full exposure to domestic equities.

Other examples

Despite its $1.4 billion asset base, Universal Canadian Growth is a lower profile Mackenzie domestic stock fund. While it’s not as flush with cash as some others – at 12 percent – it is on the high side. However, its foreign content, at 32 percent of market value, leaves just over half for domestic stock exposure.

Chou RRSP, while a solid long-term performer, is one of the worst offenders. As of the end of March (according to Morningstar Canada’s PALTrak software), it held less than a one-third of its assets in domestic stocks due in large part to a recent cash infusion from Fairfax Financial (the manager’s employer). However, high stock valuations make the recent influx of new cash potentially ill timed since there are relatively fewer good opportunities in which to deploy the cash – compared to a year ago. The firm has also ceased providing top holdings and asset mix information to mutual fund data trackers, hence the March data.

The managers of the Cundill, Universal, and Harbour funds noted above are on my recommended list. However, a fast-growing asset base and very low Canadian equity content make all of these funds questionable holdings if pure exposure to the asset class (or something close to it) is the goal. Even when cash is deployed, many value managers tend to hold 10% in cash. Adding the usually maximized foreign content of most funds and this leaves a maximum of 60% for domestic stocks. Hence, very few pure funds exist in this category.

As for cash, some will prefer the chosen manager to deploy it where they see fit – or sit on it in the absence of suitable opportunities. Others rather prefer a fund that offers a higher and more consistent asset class exposure. Whatever your preference, it is most important to know what you are buying since such drastic changes in asset mix can play havoc with unitholders’ individual investment strategies.

Those desiring ‘pure’ domestic stock funds can look to firms like Calgary-based Mawer, which mandates pure exposure in all of its funds (which includes the excellent Canadian Equity and New Canada funds). Leith Wheeler ($50k minimum) and Legg Mason Canada are other options. Index funds and exchange-traded funds are even lower cost, passive alternatives that can be considered.

However, none of the ‘pure’ alternatives mentioned pay much (if anything) to financial advisors. Advisors will have to settle for funds that hold at least 70% in Canadian stocks, of which there aren’t many. CI Canadian Investment (large cap) and Dynamic Value Fund of Canada (all cap) are two strong, value-oriented, core Canadian stock funds that should be considered in the ‘load’ universe.

Dan Hallett, CFA, CFP, President, Dan Hallett & Associates Inc., 430 Pelissier Street, Suite 501, Windsor ON, N9A 4K9, T. 519.254.4141, E. dha@danhallett.com DH&A provides investment advice to Ontario residents for a fee, and sells investment research to financial advisors.