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Spectrum shows signs of strength during downturn

Fund thrives in poor markets, analysts say

MUTUAL FUNDS REPORTER; Sources: and company

Spectrum Canadian Investment Fund emerged as one of the jewels among Canadian stock funds last year as the domestic market turned in its worst performance in a decade.

The $540.3-million Canadian large-capitalization fund, co-managed by Kim Shannon and Gaelen Morphet for Toronto-based Spectrum Investment Management Ltd.,posted an 8.9-per-cent gain for the year ended Dec. 3, 2001, and was the top mutual fund within its category.

The fund handily beat the 13-per-cent loss posted by the Toronto Stock Exchange 300 composite index, including reinvested dividends, and the 7-per-cent loss for its Canadian large-cap peers. Over three years, the fund had an average annual return of 11.1 per cent versus an average of 7.9 per cent for its peers.

Analysts are upbeat on Spectrum Canadian Investment, saying it's a low-risk stock fund that tends to outperform in poor markets because it focuses on reasonable valuations and quality companies.

"It's one of our top picks," said fund analyst Peter Loach of BMO Nesbitt Burns Inc. "It has a superior balance of downside protection with performance."

Raynor Burke, an analyst at National Bank Financial Inc., also likes the fund as a core holding for investors. The fund is well diversified with a "pretty good smattering of sectors," and is at an asset size where it "is still nicely manageable" compared with some giant funds, he argued.

Ms. Shannon, 43, and Ms. Morphet, 40, have co-managed the fund since June, 1999, as employees of Mercury Asset Management Canada, a unit of U.S.-based Merrill Lynch & Co. Inc. But Ms. Shannon's tenure on this fund actually goes back to October, 1996, when she was with Toronto-based AMI Partners Inc.

A big part of the fund's outperformance stems from a return to normalcy in the stock market after the "biggest financial mania of all recorded history," says Ms. Shannon, referring to the technology bubble that burst in March, 2000.

The value manager -- who buys companies trading below what she believes is their long-term true net worth -- says her stocks "got beaten up brutally during the financial mania.

"People sold the so-called Old Economy stocks to jump into the game of the new-era stocks and pushed the Old Economy stocks to bear market lows," said Ms. Shannon, whose fund underperformed in 1999.

"So this fund has enjoyed the rebound of those stocks from bear market lows to more normal valuation levels, while the market over all has been dragged down by the unwinding of the new-era stocks," she said.

Ms. Shannon said the fund got a lift by exiting battered technology and telecommunications stocks such as Nortel Networks Corp. early last year, even though she tends to have exposure to all industry sectors.

"I recognized early in the year that Nortel was going further south, and I did not want to lose more money for my clients," she said.

The manager said she owned some Nortel shares, but received a whack of them after the company was spun off from BCE Inc. in 2000. She continued to sell Nortel down from May, 2000, to February, 2001.

Ms. Shannon said that by April of last year -- when she finished selling off BCE -- the fund was totally out of the telecommunications sector because she felt it was "dead money" at best.

Winning stocks that helped the fund's performance in 2001 included auto parts maker Magna International Inc., tobacco manufacturer Rothmans Inc. and electrical utilities such as Atco Ltd. and Emera Inc.

Spectrum Canadian Investment Fund usually holds 50 to 70 Canadian stocks and currently holds about 3 per cent in cash. The foreign content part -- whose stocks are chosen by a value team with Mercury Asset Management in London -- represents just under 10 per cent of the fund.

Ms. Shannon said she typically focuses on stocks with dividend yields, adding that they will become even more important in a lacklustre market environment.

"If you are looking at a single-digit return [as some do for the TSE 300 this year], then the relative weighting of a yield becomes more important to total return," she noted.

Ms. Shannon said her "biggest and boldest move" is continuing to avoid investments in the technology and telecommunications sectors. "It's not that we don't want to, but they have to be at the right price.

"We are searching the universe looking for dollars that just so happen to be trading at 70 cents and patiently waiting for them to go back to $1," she said.

"In the technology and telecom area, everything is trading well above $1 and so there is nothing to buy."
Spectrum Canadian Investment Fund
: Canadian large-cap equity
Manager: Kim Shannon and Gaelen Morphet for Spectrum Investment Management since June, 1999.
Load status: Load
Total assets: $540.3-million
Management expense ratio: 2.53%
Globefund 5-star rating system:*****
Returns to Dec. 31, 2001
1-year simple rate of return: 8.9%
3-year compound annual: 11.1%
5-year compound annual: 11.6%
10-year compound annual: 10.9%
Top 10 holdings to Dec.31

1. Royal Bank of Canada            5.6%

2. Magna International A           5.4

3. Bank of Montreal                3.5

4. Cdn. National Railway           3.4

5. PanCanadian Energy              2.9

6. Bank of Nova Scotia             2.6

7. Imperial Oil                    2.6

8. Alcan                           2.5

9. Toronto-Dominion Bank           2.5

10. Brascan                        2.2

© 2007 The Globe and Mail. All rights reserved.

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