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Large fund or small: Get the best of both

In Canada, smaller players are king; abroad, big is better, KEITH DAMSELL writes

Small is beautiful when it comes to Canada -- but when looking overseas, the bigger the better.

Boutique fund companies and their managers posted the best returns in Canadian equity funds in recent years, research shows. In contrast, funds overseen by large companies with more than $5-billion in assets under management excelled when it came to global funds.

The results are indicative of the conundrum that is the Canadian market. Nimble small funds have been best able to take advantage of three sectors -- energy, financial services and materials -- that are driving returns. Meanwhile, the sheer size of multibillion-dollar funds has hampered their opportunism and, as a result, sister international funds are emerging as a core strength.

In Canada, "smaller funds are probably a little more prone to making a bigger bet and some of them got it right," said David Feather, president of Mackenzie Financial Services Inc. "On the global side, the big funds tend to be core, well-researched products, mainstream funds. And energy hasn't been as big a part of the global scene as it has been in Canada. The more traditional approaches have tended to fair a little better."

There's some compelling attributes shared by the top six performing Canadian funds for the past one-and three-year periods. Average assets under management are less than $120-million; the largest fund is the $223-million Resolute Growth Fund. The members of the group are all in the Canadian small-capitalization fund category, an asset class that trumps the returns of funds in seven competing Canadian asset classes, including in-demand balanced, income and income trust funds.

And most importantly, the group of six share a heavy weighting in the commodities-driven energy and resources sector. At least four funds had more than 30 per cent of assets under management invested in small-cap oil and gas equities, to a lesser extent, resource companies. For example, a whopping 92 per cent of assets held in the $166.6-million Front Street Small Cap Canadian Fund are in materials and energy companies.

Agility is the small-fund manager's secret weapon, said Paul Harris, principal and portfolio manager of Avenue Investment Management Inc. The Toronto firm manages about $30-million in equities and fixed-income securities.

"If you are a smaller fund, history has shown that you tend to outperform because you have more flexibility, you can be in more illiquid names, you can be in smaller-cap names that a large-cap fund can't be," Mr. Harris said. "A billion-dollar fund, a $2-billion fund, by nature, has to become an index hugger because they don't have the liquidity, the small positions . . . as they get bigger, they start to underperform."

Case in point is the $12-billion Investors Dividend Fund, the largest equity fund in Canada. The fund holds only preferred and common shares in some of the largest publicly traded companies and, as a result, has a hefty 49-per-cent weighting in financial services. The fund returned 17.3 per cent for the 12 months ended Jan. 31, a respectable gain that nevertheless falls far short of the S&P/TSX 60 index's 32.8-per-cent return for the same period.

The once-powerful AIC Advantage II Fund is a good example of how a large fund can lose momentum by holding major positions in large-cap stocks. In 1998, the fund had $4.4-billion in assets under management; mediocre performance has whittled the fund down to $966-million.

Yet the fund has continued to maintain an enormous weighting in financial services and currently holds 73 per cent of its assets in banks, brokerages and fund companies. Five stocks, including CI Financial Inc. and AGF Fund Management Inc., make up more than 60 per cent of the fund's assets under management.

The problem is that the AIC fund has become a major market maker in the shares it owns and is at the mercy of the market when it wishes to liquidate large positions, industry observers said.

Canada represents a slender 3 per cent of the world's equity market and that factor, more than any other, is driving the success of small-cap funds and the woes of some billion-dollar players, said Chris Reynolds, president of Investment Planning Counsel Inc. of Mississauga.

"Once you get a large asset base, it is hard to make a significant impact in the Canadian market. If you have billions of dollars to allocate into a very small capital market, you have got to make a lot of good plays," Mr. Reynolds said. "But if you look to a foreign market like the United States, which represents 40 per cent of the world's market, you can find some very significant opportunities that will have real impact. The bigger players tend to do better in international markets."

Indeed, large-cap funds managed by some of the country's largest fund companies dominate foreign fund performance. The top 11 in the group are emerging market funds managed by top-tier players that include Mackenzie, Fidelity Investments Canada Ltd. and TD Asset Management Inc. There are only two small-fund companies with assets under management below $5-billion that breach the top 25: the Quadrus Mac Universal Emerging Markets Cap Fund, a $3.9-million fund that is, in fact, managed by Mackenzie, and GBC International Growth Fund, a $95-million fund that has benefited from a 22-per-cent weighting in the hot Japanese equity market.

Major fund companies excel in international markets thanks largely to depth of research and analysis, said Don Reed, president and chief executive officer of Franklin Templeton Investments Corp. The manager of the $2.3-billion Templeton International Stock Fund receives global equity research from a Templeton team of 34 analysts.

Size matters, said Joe Canavan, chairman and chief executive officer of financial advice firm Assante Corp. in Toronto. Large foreign funds and their management teams have more clout and more power when it comes to the global stage, and that, ultimately, lends itself to better performance, he said.

"If a CEO of a global company is going to New York, he is going to see the guy with the biggest asset pool to make sure he remains an investor and if not, get them in," Mr. Canavan said. "If it's a $20-billion equity fund versus a $20-million fund, you are far more interested in the guy with the greater purchasing potential."

So what's an investor to do? Seek out small-fund companies at home and buy the large-cap funds for international gains?

The winning formula is somewhere in between, Mr. Canavan suggests. He urges investors to review a fund's asset size and its fund flows when considering purchasing decisions.

"You want to look at a portfolio manager's ability to liquidate position in the future," he said. "You are looking for funds that have positive flows, that have manageable account size . . . that they are not so big that they are the market and they have the flexibility to buy and sell as their research or models would dictate."

IPC, meanwhile, tells clients to ignore short-term results and trends and review fund manager performance with one key question in mind: who is best positioned to protect your downside?

"Every dog has their day," Mr. Reynolds said. "Very often one day's hero is tomorrow's dog. What we look for more than anything is consistency within a fund manager's stated objectives."

Drawn to scale

Investors looking for the best way to play the Canadian market should turn to smaller more agile funds according to data from but if looking abroad, place your money with the giants for greater reach and more depth.

Top 25 Canadian funds

Based on one-year return (as of Jan. 31, 2006)

Asset class included in the search: Canadian Balanced, Canadian Equity, Canadian Income Trusts, Canadian Tactical Asset Allocation, Canadian Dividend, Canadian Income Balanced, Canadian Equity (Pure), Canadian Small Capitalization.

Fund name 1 year return 3 year return5 year return Net assets ('000)
Resolute Growth 130.52%63.16%47.87%223,278
Mavrix Strategic Small Cap67.43%51.50%6.68%8580
Front Street Small Cap Canadian 62.21%47.08%34.15%166,596
Mavrix Small Companies 57.64% 15,332
Norrep Fund 45.84%38.15%30.12%120,629
Norrep Opport Corp-Norrep II Class44.52%37.06%165,610
Dynamic Power Canadian Growth44.40%32.47%13.59%1,435,722
IUnits Composite Cdn Eq Capped Idx43.27%26.62%46,1150
Dynamic Power Canadian Growth Class 42.29%31.54%14.48%37,495
Altafund Investment Corp. 41.52%30.42%10.41%80,792
Desjardins Environment 41.47%24.02%8.83%106,313
Norrep Opportunities Corp- Q Class40.80%48,370
AGF Cdn Small Cap40.65%25.74%4.65%381,607
Standard Life Cdn Small Cap - L40.50%29.39%17,011
Standard Life Cdn Small Cap - E39.62%5,553
Van Arbor Canadian Advantage 39.59%4,567
Standard Life Cdn Small - A 38.63%27.66%16.14%176,541
Fidelity Canadian Large Cap - B38.06%24.37%9.18%163,751
TD Canadian Equity 37.98%27.12%10.05%2,690,776
Dynamic FocusPlus Energy Inc. Trust37.90% 491.113
Fidelity Canadian Large Cap - A37.73%24.27% 9.13% 78,384
Renaissance Canadian Small - Cap37.47%28.13%20.61%110,339
TD Canadian Equity - A36.85%26.67%9.85%
United Canadian Equity Value Pool 36.82%25.98%20.41%1,764,939
Accumulus Talisman - 136.78%1,212

Top 25 foreign funds

Based on one-year return (as of Jan. 31, 2006)

Asset class included in the search: Asia ex Japan, Emerging Markets Equity, European Equity, Asian and Pacific Rim, Global Equity, Global Balanced and Asset Allocation, International Equity, Japanese Equity, North American Equity.

Fund name 1 year return 3 year return5 year return Net assets ('000)
Fidelity Latin America-B67.82%46.28%14.01%41,085
Fidelity Latin America-A67.51%46.19%13.97%12,572
TD Latin America Growth 65.81%45.67%15.38%99,890
Scotia Latin American Growth 63.92%42.70%14.75%53.234
Fidelity Emerging Markets - B46.80%29.80%11.21%19,159
Fidelity Emerging Markets - A46.46%29.70%11.16%13,204
AGF Emerging Markets 46.46%33.27%11.24%147,369
CIBC Latin American45.84%39.48%1L09%16,584
Mackenzie Univ Emerging Mkts Cap-M44.82%27.85%6,045
Mackenzie Univ Emerging Mkts Cap-CI44.45%27.47%44,279
IG Mackenzie Univ Emerg Mkt Class-A44.10%28.26%83,544
Quadrus Mac Unv Emerging Mkts Cap27.04% 3,918
IG Mackenzie Univ Emerg Mkt Class-B
GGOF Emerging Markets Mutual 39.82%30.70%12.05%8,187
CIBC Emerging Markets Index38.90%29.73%11.04%50,503
Frk Japan CC38.52%21.48%61,744
CI Emerging Markets38.03%22.99%7.39%162,976
CI Emerging Mkts Corporate Class37.72%23.56%7.60%27,103
TD Emerging Markets37.24%30.03%11.21%115,315
TD Emerging Markets-A37.23%30.25%1L24%
National Bank Emerging Markets35.68%27.14%9.36%48,806
Altamira Global Discovery35.42%31.09%12.50%22,091
AGF Aggressive Global Stock 35.38%23.09%-1.72%121,559
Renaissance Developing Cap Markets34.78%28.10%1L02%22,341
CBC International Growth33.84%28.14%4.33%95,411

© 2007 The Globe and Mail. All rights reserved.

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