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'Value' investing a minefield

In tightened market, terms of reference can vary widely, observers caution

MUTUAL FUNDS REPORTER

Value investing is a much used -- and abused -- word in mutual funds these days.

A long list of fund managers, from deep value buyers to index-weighted stock pickers, are searching high and low for bargains. It's a stark contrast to the late nineties when the dot-com tech bubble brought an onslaught of growth-focused fund managers.

The catch is that in today's oversold market, the deals are few and far between. Value managers are in a desperate mood.

"We are struggling right now, as everybody is, to find absolutely cheap companies," said David Taylor, a value and dividend manager for Dynamic Mutual Funds Ltd. in Toronto.

Strategies differ

It's a potential minefield for investors. Many funds claim to follow a value investing philosophy but strategies differ greatly, said marketing consultant Dan Richards.

"Given the pressure on performance, its getting harder and harder to be a purist as an investment manager. You are seeing a lot of blurring of the lines," he said.

In general, a value investor looks for overlooked stocks on the cheap with an eye to unloading then at a 50-per-cent or better gain within a two- to five-year time horizon. Fund managers interviewed use a long list of financial criteria before pulling the trigger on a stock, including historic and future earnings ratios and cash flow.

The problem is many larger cap value funds are hamstrung when it comes to stock picking. Many funds benchmark against the S&P TSX composite index so the manager has a limited universe of about 200 equity choices. When specific financial criteria are taken into account, that list of potential stock picks grows shorter still.

Value in name only

As a result, there are a lot of so-called "value" funds out there that are barely distinguishable from ordinary equity funds, especially among the largest value players. For example, Investors Group's $2-billion Canadian Large Cap Value Fund top stock holdings include Royal Bank of Canada, TD Bank and BCE Inc. The same three blue-chip equities have equally heavy weightings in the Winnipeg investing giant's Canadian Equity, Summa and Dividend funds. The other top holdings come from the ranks of large-cap blue chips found in most Canadian stock funds.

"We are swimming in a smaller fish bowl" and as a result, many value-oriented funds "tend to own a lot of the same names," said Geoff MacDonald, Toronto-based manager of the Trimark Canadian Endeavour Fund. He argues that a big part of investing success in Canada may hinge on stocks that managers have avoided rather than bought, a list that includes Bombardier Inc., Nortel Networks Corp. and Biovail Corp.

Several managers interviewed argue that smaller value funds can be more nimble traders, getting in and out of equity positions with greater ease than their larger cap rivals.

"Canadian equity markets are not particularly liquid" and larger cap funds with a limited number of stocks they can own may find it difficult buying a healthy position in an equity with a limited float, said Fred Pynn, the Calgary-based portfolio manager of Bissett Canadian Equity Fund.

Several value managers interviewed doggedly defend their contrarian approach. Trimark's Mr. MacDonald views oil and gas plays as pricey and, as a result, the sector makes up a slender 2 per cent of his holdings compared with a 17 per cent weighting on S&P TSX index.

Irwin Michael, president of Toronto-based I.A. Michael Investment Counsel Ltd., said the ABC Fundamental Value Fund avoids "index hugging" and relishes buying the "unloved, unwashed common share" that are little followed by mainstream analysts. "I don't have to have all the banks. I have the one everybody hates -- Laurentian. That turns me on," he said.

Some value plays

Value managers shared some stock picks, and their choices may be surprising:

Royal Bank of Canada -- Fund manager Dom Grestoni of Investors Group said the stock "is being brutally punished" for a downturn in its U.S. mortgage business. "They will fix their problems, they will take action, they will get back on course," he said. On the Toronto Stock Exchange yesterday, shares were up 46 cents to $62.86.

Dorel Industries Inc. -- The consumer products company has been unfairly put in the penalty box for its U.S. revenue exposure, said Bissett's Mr. Pynn. He likes its low-cost business model and growing list of big box customers. In trading on the TSX yesterday, Dorel's class A shares fell $1.08 to $40.42.

Total Energy Services Ltd. -- The little-known oil services company is poised to grow in tandem with Alberta's oil patch, reports Dynamic's Mr. Taylor. Shares were up 4 cents to $6.76 on the TSX yesterday.

The hunt for value

Do you know what you are getting when you buy a mutual fund with "value" in the name? The ABC Fundamental Value fund is an example of a purist approach to value stock selection, with picks that are off the beaten track. Meanwhile, Investors Canadian Large Cap Value A is representative of value funds that look a lot like typical equity funds.

ABC Fundamental Value

Total assets: $411.71-million

Management expense ratio: 2%

Top 10 Holdings, as of Sept. 30, 2004

Canfor Corp.

CanWest Global Communications

E-L Financial Corp. Ltd.

Lionore Mining Int'l Ltd.

Morguard Corp.

Northbridge Financial Corp.

Petro-Canada

Talisman Energy Inc.

Teck Cominco Ltd. B

Timberwest Forest Corp.

Investors Cdn Large Cap Value, A

Total assets: $1.98-billion

Management expense ratio: 2.75%

Top 10 Holdings, as of Oct. 31, 2004

Royal Bank

Bank of Montreal

Bank of Nova Scotia

BCE Inc.

Sun Life Financial Services Canada

National Bank

TransCanada Pipelines Ltd.

Toronto-Dominion Bank

EnCana Corp.

Canadian Natural Resources Ltd.

SOURCE: GLOBEFUND.COM

© 2007 The Globe and Mail. All rights reserved.

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