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Small-cap scene spurs manager to play it safe

Current situation similar to what preceded meltdown in August, 1998


The valuations being accredited some Canadian small-cap stocks are making fund manager Christopher Fernyc a little nervous. He remembers only too well what happened in August, 1998, when the Canadian small-cap market lost 20 per cent in a single month.

The current situation reminds him of that in 1996-97. The economy was growing, profits were increasing, and then, price/earnings multiples exploded.

"I sure hope we don't run into a '98 problem again because it wasn't a fun month of August that year," said Mr. Fernyc, who has managed the Bissett Small Cap Fund since June of 2000 for Bissett Investment Management of Calgary. The problem with valuations is "that they inflate and they deflate, the timing of which is unknown."

"You are starting to see stock prices to a certain degree disconnect from ongoing fundamentals," he said. Investors are building into a lot of stock prices an expectation of an income trust conversion, a takeover or a privatization.

Mr. Fernyc prefers to play it cautious. "We would rather focus on the highest-quality names possible," he said. He looks for stocks with high-quality earnings, a high-quality balance sheet and a management team with a good track record. He also likes the companies to be able to finance their operations internally. "We tend not to be chasers of the flavour of the day, which right now is metals and materials and golds," he added. Instead, he has overweighted energy, financials and consumer-related issues.

The $965-million Bissett Small Cap Fund has gained 4.25 per cent so far in 2006, which lags the pace set last year when the fund had a 23.86-per-cent return in the 12 months ended Feb. 28. Over the past five years, the return was 21.52 per cent annualized, and over 10 years, 14.49 per cent.

The fund's biggest holding is Flint Energy Services Ltd. (FES-TSX), which provides production services to the energy industry. "We continue to believe that Flint should be a core holding [in the portfolio] given its strategic relationships" with clients such as Suncor Energy Inc., he said. Those relationships position it well to participate in the building of the oil sands infrastructure, he added. He expects that Flint's profit will rise more than 30 per cent this year, which means the shares are trading at a reasonable 13.8 times this year's share profit estimate in the $3.60 range. Flint shares climbed to a record high on Feb. 28 of $54.71, up from $24.11 in May, 2005, but have since eased, closing yesterday at $49.50 on the Toronto Stock Exchange.

Mr. Fernyc has held Alliance Atlantis Communications Inc. (AAC.NV.B-TSX) since the late 1990s when the predecessor companies merged. He believes the Toronto-based entertainment firm's core assets are undervalued.

"Alliance has a broad portfolio of highly successful specialty broadcasting channels in Canada that continue to post industry-leading growth in revenues and profitability," he said. Also, Alliance owns a 50-per-cent interest in the CSI series on television. All three CSI shows rank in the top 20 in the U.S.

"Given that both core assets throw off cash to Alliance, it really is a question of what does the company do with the money," he said. He expects it will be very aggressive with share buybacks. Longer term, "we believe that ultimately Alliance's assets may be highly coveted in the event of potential media consolidation," he added. Alliance Atlantis's shares are currently trading at $35.

Mr. Fernyc's third stock pick, Atlas Energy Inc., (AED-TSX) is a small Calgary-based exploration and development firm that currently produces about 6,000 to 6,500 barrels of oil equivalent a day. He said Atlas now seems to be on the verge of a material increase in output with the development of a heavy oil project in northwestern Alberta and a shallow natural gas field in western Saskatchewan.

"We expect over the next quarter or two these two projects could see corporate production grow by nearly 50 per cent in a very short period of time," he said. If those projects come on stream on schedule, the stock will be trading at a significant discount to its peer group, he added. Ultimately, if the stock's valuation continues to lag, the firm could be taken over, or merged or converted into a trust, which would benefit existing shareholders, he suggested. Atlas shares retreated from a 52-week high of $5.73 last August and now stand at $4.71.

Easy does it

Small-cap fund manager Christopher Fernyc prefers to play it cautious. "We would rather focus on the highest quality names possible," he said. "We tend not be chasers of the flavour of the day."

Top 10 holdings*

1Flint Energy Services Ltd.8.5%
2Producers Oilfield Services5.2
3Alliance Atlantis Comm CI B non-vtg5.1
4Aastra Technologies Ltd. Com4.9
5Reitmans Canada Ltd. cl A4.6
6Navista Energy Ltd.3.9
7Gildan Activewear Inc. Sv cl A3.6
8Equitable Group Inc.3.5
9Atlas Energy Ltd.3.2
10Richelieu Hardware Ltd.3.1

Bissett Small Cap

Inception dateDecember, 1991
Total assets$965-million
Fund typeOpen-ended
RRSP eligibilityYes
5-star rating system****
Management expense ratio1.83%




*AS OF FEB. 28, 2006

© 2007 The Globe and Mail. All rights reserved.

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