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Funds engage juggling skills

As profits in energy lose some steam, managers look to value in others sectors

With crude oil prices floundering at the $60 (U.S.) level and the future of energy trusts looking grim, there's a good chance that old Canadian equity fund is -- or is about to be -- undergoing major changes. At each end of the spectrum, portfolio managers are caught between squeezing every last cent from the oil and gas boom, and cashing out and looking for the next boom in the next sector.

And the gap between those managers is wide. In October, energy weightings in Canadian equity funds ranged from over half to nothing. The Acuity Pooled Income Trust holds 54.7 per cent of its assets in energy. The AIC Advantage Fund has taken a pass on energy completely, instead taking an 84.4-per-cent stake in the financial services sector.

Somewhere in the middle is the S&P/TSX energy index, which currently makes up about 25 per cent of the broader S&P/TSX composite. Many Canadian equity fund managers use the TSX composite as a benchmark for their own portfolios. When they're bullish on a sector they overweight their portfolios there. When they feel the sector is headed for devaluation, they take an underweight position.

The energy index is based on market capitalization, so falling crude oil prices and the resulting dip in energy stocks have pulled the index weighting off its highs lately.

One portfolio manager who feels the 25-per-cent energy weighting is still too high is Peter Moeschter of Franklin Templeton Investments. Over time he switched his position in the Templeton Canadian Stock Fund from overweight to underweight. Less than 12 per cent of the $246-million portfolio is committed to energy. "Oil prices have become unsustainably high," he says.

As a value investor, Mr. Moeschter prefers sectors that have fallen out of favour -- cheap ones to be exact. Two of those sectors are consumer discretionary and information technology. Two specific stocks he likes in those sectors are Open Text Corp. and Jean Coutu Group (PJC) Inc. "They've had their problems, but management has fixed them," he says.

As of Sept. 29, the Templeton Canadian Stock Fund was overweight in both sectors: 12.3 per cent of the portfolio was invested in consumer discretionary stocks against a 6-per-cent weighting in the TSX, and 5.5 per cent was invested in IT compared with 4 per cent for the index.

Chasing out-of-favour companies has its price. The Templeton Canadian Stock Fund returned under 2 per cent over the past year while the index gained 9.2 per cent and the average Canadian equity fund advanced by 7 per cent. Mr. Moeschter considers it short-term pain for reducing the risk of a selloff in the energy sector. "People should know how much of their portfolios are exposed to volatile commodities," he says.

At the other end of the spectrum, the energy-rich Highstreet Canadian Equity Fund returned nearly 10 per cent over the past year -- beating both the index and the group average. During that time, portfolio manager Shaun Arnold has gone from an overweight position in energy to right about even with the TSX. The equal weighting is not intentional but rather part of a shift toward sectors with strong earnings. "We have been experiencing a transition in the market from an earnings perspective," he says.

Mr. Arnold says profits in the energy sector have "moderated" and he is starting to see other sectors contributing to earnings growth. For that reason, he has been investing in telecom stocks including Rogers Communications Inc., BCE Inc. and Manitoba Telecom Services Inc. In the past month the telecom services weighting in the Highstreet Canadian Equity Fund has jumped to 8.8 per cent from 6.8 per cent. "We have been reducing our exposure to energy as we've been witnessing this transition," he says.

That's not to suggest Canadian equity funds with large energy weightings have been performing better than funds with small weightings in that sector. One of the top performing funds so far this year is the Caldwell Canada Fund. It has managed to return over 20 per cent while investing only 11.6 per cent of the portfolio in energy stocks. Inversely, one of the worst performing funds so far this year -- Accumulus Talisman A -- is down nearly 10 per cent and has an energy weighting of 22 per cent.

Dale Jackson is a producer at Report on Business Television

© 2007 The Globe and Mail. All rights reserved.

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