A small-cap fund for the cautious investor

Canadian Mutual Fund Adviser, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846


Many small-cap equity funds are highly volatile. But others are able to minimize volatility by emphasizing “quality” in their investment approach. Here is one such fund that seems to weather the market’s difficulties with greater ease than its peers.

Though small-cap stocks continue to under-perform large-cap equities in the Canadian market, IA CLARINGTON CANADIAN EQUITY SMALL CAP FUND has bucked the trend, even outperforming the large-cap indices. Since the beginning of the year to the end of September, the BMO Canadian Small Cap Index declined by 1.4 per cent, while the S&P/TSX Composite delivered a total return of 5.3 per cent. Clarington Canadian Equity Small Cap, by contrast, rose a stellar 22.6 per cent over the same period.

We attribute the fund’s success to the excellent portfolio management of QV Investors Inc. “QV” stands for Quality and Value, which is the cornerstone of the investment philosophy of the investment advisory firm founded by Leigh Pullen in 1996.

QV Investors evaluates stocks based on top-down, bottom-up, value and growth analysis. The key criterion for selection is based on “quality growth.” The firm typically invests in stocks that grow at higher rates than the market but have lower valuations.

What the firm looks for

QV has been the portfolio adviser to Clarington Small Cap since its start in 1997. The fund seeks to maximize long-term growth by investing mostly in the equities of small-capitalization companies. These, for the purposes of the fund, are generally stocks with a maximum weighted average market capitalization (stock price x shares outstanding) of about $2.5 billion.

The fund’s managers, Joe Jugovic and Ian Cooke, generally look for such companies that provide a unique product or service, strong growth in sales or assets, entrepreneurial management with an equity interest and undervalued assets.

QV Investors has done an excellent job with this fund as portfolio adviser. Since the fund’s inception in 1997, its compound annual growth rate is 10.5 per cent. Over the past 10 years, its annualized return is 11.0 per cent, which ranks in the top quartile of the Canadian mid /small-cap equity category.

Performance has generally been consistently strong over this time period. The fund has performed in the top half of the category in seven of the 10 years.

Overall, the pattern is one of a fund that may lag in strong markets but generally holds up better than its peers in poor markets. In 2009, for instance, when markets began to rebound from the slump of 2008, Clarington Small Cap gained a whopping 29.6 per cent. But this gain was a fourth-quartile performance in the category, and less than half the 68.9 per cent gain of the BMO Small Cap Index.

In 2012, on the other hand, the Index declined by 0.5 per cent. Meanwhile, Clarington Small Cap gained 20.2 per cent to rank in the top quartile of the category.

So far this year, the fund has continued to rank in the top quartile. We attribute its success in difficult markets to QV’s generally defensive investment approach.

Their search for quality leads Messrs. Jugovic and Cooke away from aggressive resource stocks to more stable companies in other sectors of the economy. What’s more, individual sector weights are generally kept under 25 per cent of the portfolio to ensure diversification.

The portfolio’s industry sectors break down as follows: financials, 21.3 per cent; energy, 16.2 per cent, industrials, 14.6 per cent; consumer staples, 14.4 per cent; materials, 11.6 per cent; information technology, 7.4 per cent; health care, 4.2  per  cent;  consumer  discretionary,  2.6  per cent; telecommunications, 2.6 per cent and cash, 5.1 per cent.

Another mark of quality is dividends. The fund focuses on a portfolio of 35 to 40 names with an emphasis on dividend yield.

Beware high dividend-yielding stocks

That said, the managers are not inclined to simply reach for yield. In fact, though they regard dividends as important over the long run, they find that with interest rates as low as they are, high-dividend stocks have become increasingly risky from both operating and valuation standpoints.

Consequently, they have recently sold high dividend-yielding positions when their  price gains have outpaced their operational performance. The advisers insist they will not invest exclusively on the basis of dividend yield without considering a company’s outlook, balance sheet strength and stock valuation.

Thus, you’ll typically find stocks such as the fund’s largest holding, Canadian Western Bank, in the portfolio. This stock has a modest dividend yield of 2.2 per cent.

Quality holdings such as Canadian Western Bank help keep the fund’s volatility well below that of its peers, making the fund appealing to even conservative investors.

IA Clarington Canadian Small Cap is a buy for investors seeking an aggressive fund that emphasizes higher-quality stocks.


Canadian Mutual Fund Adviser, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

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