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The homespun value investor

Michael Decter's funds are on a roll. 'I don't like to pay retail,' the Winnipeg native says

Michael Decter, formerly a mandarin in a couple of NDP governments, has undergone a metamorphosis and emerged as a manager of mutual funds that do opportunistic hedging.

In his latest transformation, he is president and chief executive officer of Lawrence Decter Investment Counsel Inc. in Toronto. His Redwood Diversified Income Fund posted a 21.3-per-cent return for the 12 months ended Oct. 31, about double the 11.2-per-cent average of Canadian income balanced funds. His Redwood Diversified Equity Fund did a bit better with a 23.6-per-cent return, more than double the 10.1-per-cent average return of Canadian balanced funds.

Mr. Decter tends to hold 80 per cent in equities and 20 per cent in fixed income in his balanced funds. He not only holds long positions in anticipation of share price increases, but also does a modest amount of short selling when he thinks selected stocks are due for a fall. The combination of short sales and a higher stock-to-bond ratio than the 60/40 mix usually held by balanced funds explains part of the superior performance of the funds.

Overweighting stocks could lead to the conclusion that Mr. Decter is just gaming his benchmark by carrying a heavier load of stocks. But that's too easy, for his funds charge fees of 20 per cent of the amount by which they beat benchmarks. With those performance fees put back into returns, it becomes clear that Mr. Decter is even further ahead of peer balanced funds.

There is irony in Mr. Decter's performance as a practising capitalist for he was clerk of the executive council in Howard Pawley's Manitoba NDP government in the early 1980s and, later, deputy health minister in Bob Rae's Ontario NDP government in the early 1990s.

Mr. Decter moved into the private sector as a land developer, private investor and then a partner in his investment firm.

He is underweight in financial services, which tend not to have the growth potential of less well-known stocks, he said. He is light on technology stocks, which are too volatile for his taste, and has minimal holdings in health care. While health care is usually thought of as a defensive sector, he said the shares are too vulnerable to being sideswiped by class-action litigation from plaintiffs who claim to have been harmed by drugs and medical devices.

"Health care is the next tobacco industry," said John Clapham, president and CEO of Redwood Asset Management Inc., which markets Mr. Decter's funds. "Michael does not see health care as a growth sector," he explained, suggesting that the common wisdom that an aging population will be a demographic driver for drug companies and businesses that run hospitals and pharmacies is flawed.

A contrarian value investor, Mr. Decter suggested that the only way to make the big scores in the market is to buy what analysts at major brokerages are not covering.

He also holds no grocery stores and no gold. His view of investing, generally, is to avoid anything that "has a 2 or higher in front of its ratio of price to earnings," he said.

This is investing in the style of Ben Graham, the inventor of security analysis and of value investing, but with a twist -- Mr. Decter's homespun rules for asset selection are more like the Old Farmer's Almanac than what chartered financial analysts practice in quantitative finance. Indeed, Mr. Decter, who is not a CFA, explained his style as rooted in his early life in Manitoba, where value shopping is the norm.

"I am from Winnipeg," he said. "So I don't like to pay retail."

What he does like are companies for which he can develop a congenial feeling that goes beyond numbers. His leading position in both of his funds, HudBay Minerals Inc. (HBM-TSX) is a zinc and copper miner for which he did consulting work. He bought shares in late 2004 at an average cost of $5.14; they closed Friday at $17.37. HudBay works familiar ground, for its main mine is in Flin Flon, Man., and its head office is in Winnipeg.

"This is a growth story," he said, but it is also a value story, trading at a 5.9 times $3.41 earnings for the 12 months ended June 30, 2006. HudBay earnings should rise to $7 a share for the year ended Dec. 31, propelling the stock to $30 within 12 months, he added.

Algoma Steel Inc. (AGA-TSX), based in Sault Ste. Marie, Ont., has survived insolvency to become a hit of the global materials business. Shares that Mr. Decter bought in 2004 at an average cost of $26.45 closed at $32.32 Friday on the Toronto Stock Exchange. Priced at 5.4 times trailing earnings of $5.93 for the 12 months ended Sept. 30, 2006, the low valuation reflects investor apprehension that a decline in U.S. growth will hurt sales of steel to the auto industry, Mr. Decter said.

That fear is misplaced, he explained, noting that Japanese car makers are building plants in Ontario that will be able to use Algoma's sheet steel and other products. He estimates that earnings can rise to $7.50 a share for the year ended Dec. 31, from $6 a year earlier. That would push the share price up to $39 within 12 months, he said.

Tim Hortons Inc. (THI-TSX), based in Oakville, Ont., has 2,625 stores. Coming out of a marriage to Wendy's International Inc., Hortons continues to flourish. Its sales were a third of Wendy's total, but accounted for two-thirds of its profits, Mr. Decter said. He bought the shares at a cost of $28.50. They closed Friday at $33.75. Earnings per share for the year ended Jan. 1, 2007, should rise to $1.50 from $1.19 a year earlier, pushing up the shares to $36, he said.

© 2007 The Globe and Mail. All rights reserved.

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