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Head for cover in an oil-free investing zone

Funds light on energy have been comatose in recent years, but they're alive and waiting for their turn to shine, ROB CARRICK writes

The Canadian equity funds that are motoring along these days are the ones than don't run on oil.

With the price of oil down close to 20 per cent in the past two months, funds heavy in energy have been struggling after years of stellar gains. Replacing them as the past month's top performers are funds that have largely avoided energy.

Many of these funds have appeared comatose in the past few years, but they're alive and waiting for the stock market to get over its obsession with oil, gas and other commodities. Will they prosper if and when the oil boom fizzles? The month of September has been typically cruel to Canadian equity funds, with many down 1 to 2 per cent as of Sept. 28. A key reason: Energy stocks fell about 11 per cent, and many of these funds have around 25 per cent of their assets in the sector.

Meanwhile, funds that minimized their energy exposure -- limited it to no more than 5 per cent of the portfolio, let's say -- looked good in September. AIC Advantage, with no energy exposure at all, made 2.3 per cent through Sept. 28. Brandes Canadian Equity, also with no energy, made 3.3 per cent. Mackenzie Cundill Canadian Security, with a measly 2.1 per cent of its assets in energy, made 1.3 per cent.

Let's look in detail at the top performers in September that have minimal energy holdings. AIC Advantage should be familiar to a lot of fund investors because it used to be one of the best performers in Canada. Returns have been disappointing in recent years, but they've certainly perked up lately. Preceding its strong September gain was a 6.1-per-cent surge in August.

The story behind AIC Advantage's revival is its huge 74-per-cent weighting in financial stocks, including several mutual fund companies. Financial stocks tend to do well in the periods when central banks have paused after a series of interest rate increases, as is the case right now. Also, they can be a safe haven for investors in times of uncertainty. Note that the S&P/TSX index was down 2.2 per cent this month, while the S&P/TSX capped financials index rose 1.2 per cent.

AIC's strong recent numbers are all the more impressive when you consider that the fund has about 8 per cent of its assets in Loblaw Cos., which has fallen sharply lately because of a variety of troubles.

One negative with AIC Advantage is its vast holdings in mutual fund companies. You have to wonder how well the fund would hold up if there was a prolonged slump in the stock markets that hurt mutual fund industry sales.

Another name that stands out among the strongest Canadian equity funds this month is Brandes Canadian Equity, a newer fund run by Brandes Investment Partners, a respected U.S. money manager.

Take a look at the top holdings of this fund and you'll find a who's who of challenged Canadian companies, including Bombardier Inc., Royal Group Technologies Ltd., Quebecor World Inc. and Domtar Inc. and Celestica Inc. Brandes is a value investing outfit, which means it seeks out beaten-down, undervalued companies that are solid at the core. While this strategy hasn't worked well the past couple of years, it could play out well if stocks slump and investors are more open to turnaround stories.

This is exactly what happened in the bear market that began this decade. Value funds minimized losses and made money in a few cases, even while the overall markets posted double-digit losses.

Trimark Canadian Endeavour is another solid performer of late that deserves mention. The manager of this fund, Geoff MacDonald, sold all his oil stocks more than a year ago and has scuffled along since then. For the year to Aug. 31, the return of 5.4 per cent is virtually half the average for the Canadian equity category and about one-third the return of the S&P/TSX composite.

Today, Trimark Canadian Endeavour holds a mix of blue-chip stalwarts such as Toronto-Dominion Bank, Power Corp., troubled names such as Loblaw and Quebecor World Inc. and U.S. stocks such as Zimmer Holdings Inc., a maker of equipment for treating damaged or broken bones and joints.

One sign of how this fund might do in a market where oil stocks are hurting is the small gain of 1.1 per cent this fund has posted in September. Another is Mr. MacDonald's track record for managing risk. Because he avoided tech stocks, unitholders of his fund made money during the bear market.

Trimark Canadian, a sibling of Trimark Canadian Endeavour, has just under 4 per cent of its assets in energy stocks. This fund posted a 1.3-per-cent gain in September, but it has been a somewhat disappointing performer for a period that predates the oil boom.

A fund you'd expect to see on the list of top performers in September is Mackenzie Cundill Canadian Security, which offers a classic case of sacrificing returns in a hot market in order to gain some protection when share prices fall. With just 2.1 per cent of its assets in energy, this fund had a reasonably good September. The bad news is that the fund was up a mere 5 per cent in the past 12 months, and its three-year returns are well below average, too.

Mackenzie Cundill Canadian Security takes a global approach in protecting unitholder money and has one-quarter of its portfolio invested in Japan, the U.S., South Korea, Italy and other countries. Another quarter is in cash, which has helped to keep volatility at levels that are half that of the S&P/TSX composite. The safety record of this fund is sterling -- in the last bear market, it was one of only a few not to post a single money-losing year.

The Mackenzie family's Ivy Canadian has also avoided oil stocks, but it's locked in a prolonged and vicious slump that continued in September when it lost 0.7 per cent. Ivy Enterprise, which holds small and medium-sized companies, made 3.1 per cent in September, but you'll need faith to own this fund because it hasn't had a good year since 2001.

Two other examples are AGF Canadian Real Value and Beutel Goodman Canadian Intrinsic. The AGF offering is a low-volatility fund that has been above average in the past year despite holding only about 3 per cent of its portfolio in energy stocks.

The managers of Beutel Goodman Canadian Intrinsic don't aim to copy whatever's working on the TSX and turn it into hot returns. Instead, they take a much more conservative approach in which they look at quality blue chips from both Canada and the U.S. that are both highly profitable and undervalued. Lately, the fund has been getting defensive with sectors such as staples, consumer discretionary and health care, and it also has a 30-per-cent holding in financials.

The fund's 2.6-per-cent return this month suggests the approach is working, and the 4.7-per-cent weighting in energy should insulate it against declines in oil. One reason for caution is that this fund has been around since March, 1999, and never put together a streak of above-average returns.

Mainstream equity funds have made a killing lately in oil, while energy contrarians have suffered. This past month, we saw what happens when the tables are turned.

No oil for me, thanks

Here's a list of Canadian equity funds that have minimal holdings in the energy sector and were leading performers in September, a month where oil prices fell:

EnergySeptemberOne yearThree year
Fundexposure*return **return ***return***MER
AGF Canadian Real Value3%1.6212.6611.942.48
AIC Advantage02.2521.613.132.45
Beutel Goodman Cdn Intrinsic4.72.5511.639.211.3
Brandes Canadian Equity03.33-0.254.932.7
Mackenzie Cundill Cdn Security C2.11.275.0110.522.42
Mackenzie Ivy Enterprise03.11-4.964.872.43
Trimark Cdn SC3.81.288.3810.921.66
Trimark Cdn Endeavour01.135.3712.382.15
S&P/TSX Total Return Index27.4-3.18.819.4n/a

*as of most recent portfolio disclosure documents **through Sept. 28 ***to Aug. 31


© 2007 The Globe and Mail. All rights reserved.

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