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A less-is-more investing strategy

High-conviction stock picking can pay off handsomely, but comes with risk


When Andrew Parkinson is ferreting out stocks for a mutual fund, the magic number is 20.

"What's the benefit of holding a stock that is less than 1 per cent of a portfolio?" asks the manager at Van Arbor Asset Management Ltd. "If it doubles, it really doesn't do much for the portfolio."

Betting boldly on 20 stocks has helped his $15-million Van Arbor Canadian Advantage and the $3-million World Advantage funds gain 32 per cent and 39 per cent, respectively, for the year ended July 31.

Mr. Parkinson is among a group of managers who use a high-conviction strategy. While this tactic to beat market indexes can produce winning results, some analysts also caution about the risks inherent in this strategy.

"Whatever gives you the chance for outperformance also gives you greater chance for underperformance," said fund analyst Dan Hallett. "But I'd rather take that risk than spread my money everywhere to pay fees in excess of 2 per cent for what amounts to a very index-like portfolio."

Mr. Parkinson, who began running his first fund in 2004 after a stint as president of Cundill Investment Research Ltd., focuses on 20 stocks - 5 per cent for each name - to keep things simple.

"A lot of research suggests the efficient number is between 17 and 23," he said.

The value-oriented manager uses quantitative analysis to screen for cheap stocks, but then chooses which ones best fit his bullish sector bets.

Energy and base metals are favourite areas now because of the infrastructure spending by governments to pull their economies out of recession. Some of his recent winners have included Teck Resources Inc. and Petro-Canada, which was bought by Suncor Energy Inc.

It's not always smooth sailing for managers if they have a high stock concentration in the wrong sector, said Philip Lee, analyst at Morningstar Canada. "No matter how good your stock picking is, if something happens to the sector, the negative headlines are going to have an impact."

AIC Ltd. mutual funds, which are now being sold to Manulife Financial Corp. have long focused on financials.

"Over the last couple of years, financials have not been the best places to invest in, and so a lot of their funds have taken big hits," Mr. Lee said. "You see the good and the ugly of some of these strategies."

AIC Advantage I and II, which are run by Michael Lee-Chin, hold 15 stocks each. Many are wealth management companies (including CI Financial Corp. and IGM Financial Inc.) that he believes will benefit from baby boomers saving for retirement.

While these funds posted an average annual loss of 23 per cent over the two years ended July 31, the volatility is evident from the fact they have rebounded 70 per cent from their March lows.

Jonathan Wellum, chief executive officer of AIC Ltd., said it's a challenge trying to run high-conviction funds "when you think you are going to be right over three years, but people are evaluating you in the middle of a crisis."

"Wealth management stocks have a high beta in that they can move twice the market index," Mr. Wellum said.

Mr. Lee-Chin has tried to dampen volatility in his funds by diversifying to names like Mundra Port, an India-based port, and two Canadian energy stocks - Husky Oil and Petro-Canada, which are now Suncor stocks.

But Mr. Wellum dismissed the notion that high-conviction funds are risky, saying that there is "less risk" because managers know the holdings more intimately.

Last year's market collapse, however, has persuaded others that it might not pay to have too much conviction.

McElvaine Investment Management Ltd. president Tim McElvaine said he believes his Canadian small-company fund, McElvaine Investment Trust, ran into problems last year because it was "too concentrated."

The $70-million fund lost 49 per cent last year amid a market crash that saw investors bail out of the riskier small-cap sector. The top 10 stocks and cash made up about 90 per cent of the fund.

Mr. McElvaine, a value manager, is increasing his holdings, and holds 15 stocks in the fund now. The largest positions include a 15-per-cent weighting in both Indigo Books & Music Inc. and Glacier Media Inc.

"I might expand to 20 securities," said Mr. McElvaine, who was once chief investment officer at Cundill Investment Research. He also ran what is now Mackenzie Cundill Canadian Security Fund with 20 stocks from 1991 to 1999.

"When I started the Trust in 1996, our position sizes tended to be 5 to 10 per cent, but over the last couple of years, my position sizes got to be more than 10 per cent," he said. "I think our performance was better when we had 20 stocks."


Sample of High-Conviction Funds

(As of July 2009)Latest% returns (as of July 31, 2009)
Fund NameCategory Assets ($-mil)MERYTD1-yr3-yr5-yr10-yr15-yr
Van Arbor Canadian Advantage*Canadian Equity15.086.631.510.916.4
Van Arbor World Advantage-A*Miscellaneous3.040.1
AIC AdvantageCanadian Focused Equity525.22.4232.2-14.3-9.4-
AIC Advantage IICanadian Focused Equity332.12.6831.4-15.2-9.9-1.3-0.3
Resolute PerformanceCdn Small or Mid Cap Equity334.22.9415.9-63.9-14.7
Chou AssociatesGlobal Small/Mid Cap Equity420.91.749.9-18.3-8.1-0.55.410.6
McElvaine Investment Trust-BCdn Focused Sml/Md Cap Eq.68.00.602.5-33.5-18.1-6.84.7
MSCI World ($ Cdn)2.1-17.0-6.6-1.3-2.83.9
S&P/TSX Total Return22.5-17.7-
*Available to accredited investors
Source: Globe Investor, company

© 2007 The Globe and Mail. All rights reserved.

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