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Beutel Goodman Balanced Fund

Over the last three years the Beutel Goodman Balanced fund gained an average of 2.4% annually, beating the average Canadian balanced fund by 4.7 percentage points. During the same period, a blended index made up of 40% Scotia Capital Markets Universe (SCMU) bond index, 35% S&P/TSX Total Return, 12.5% S&P 500, and 12.5% MSCI EAFE (Europe, Australasia, and the Far East), which is suitable for this fund, dropped an average of 2.8% annually.

Mark Thomson and Brian Brownlee oversee, respectively, the Canadian and foreign equity components of the fund, while Bruce Corneil is responsible for fixed income investments. These managers regularly re-balance the fund's portfolio to maintain a target asset mix of 40% fixed income and 60% stocks. The fund generally tries to maximise its allowed foreign content which is split roughly evenly between U.S. and international stocks. The balance is invested in Canadian equities.

Mr. Thomson, who has managed the fund since 1999, is a contrarian value manager. He uses bottom-up analysis to find undervalued companies that are on a sound financial footing. His preferred indicators of intrinsic value are strong working capital and healthy free cash flow. To ensure that the fund buys at a deep discount, he requires an expected return of 50% over a period of two to three years (100% for cyclical stocks). When a stock reaches its target, the fund sells one third of its position with "no questions asked", and the stock is re-assessed.

Until recently, the U.S. equity component of the fund was controlled by another manager with more of a growth-at-a-reasonable-price (GARP) perspective. About six months ago, Mr. Brownlee began the process of re-positioning the U.S. portfolio to better reflect the fund's strong value approach. Because of this shift in management, the aggregate properties of the fund's Canadian and foreign equities are best studied separately.

The Canadian stock portfolio has a dividend yield of 2.7% and an earnings yield of 4.8%. It's price-to-book ratio is about 1.55.** On balance, this represents modest value relative to the S&P/TSX Composite, which has a yield of 1.9%, an earnings yield of about 3.5%, and a median price-to-book of 1.8. The fund's U.S. holdings, on the other hand, still exhibit the features of a GARP style and are somewhat more expensive.

At the end of the first quarter, the fund was almost fully invested and held 114 stocks. The top three sectors were Financial Services, Energy, and Utilities. The fund's largest single equity holding was the Beutel Goodman Small-Cap fund, and the top three individual stocks were TD Bank, Manulife, and BCE. During the first quarter, the fund cut its Canadian holdings from eighty-one stocks down to thirty-nine, locking in profits or taking losses on several small positions. Purchases included Nexen, Barclays, and Volkswagen, while Open Text, Viacom, and Fast Retailing were sold. In the current bear market, Mr. Thomson has recently been a net buyer.

Turning to the fixed-income side of the portfolio, the fund's approach to buying bonds meshes well with its value-based stock selection strategy. In addition to a core of Canadian government bonds, Mr. Corneil looks for corporate bonds that satisfy three main criteria: they must be very liquid, the issuers' reporting must be transparent, and the related business should be non-cyclical and have high barriers to entry. His approach obviously favours utilities and pipelines.

Currently, corporate bonds represent almost 35% of the fund's fixed-income portfolio, which reflects Mr. Corneil's favourable view of current corporate yields relative to government issues. In contrast, provincial bonds are underweighted at 20%. Looking ahead, Mr. Corneil does not foresee further domestic interest rate hikes in the near future. He expects that the dual shocks of a weak U.S. economy and the SARS crisis will cause the Bank of Canada to moderate its recent money tightening policy. For this reason, the bond portfolio currently favours mid-term maturities and is positioned to be a bit more sensitive to interest rate changes than the SCMU index.

It is pleasing to note that the MERs of all of Beutel Goodman's equity funds have dropped steadily since 1998. The Balanced Fund's fee has dropped by 1% to 1.12% in that time. Readers should note that the fund is only available through dealers and brokers. Because it charges a front end load, it should only be purchased through a discount broker.

The Beutel Goodman Balanced fund provides the convenience of one-stop shopping and is fairly priced compared to the other funds in its family. With a low 1.12% MER and a modest $10,000 minimum investment, it is a good choice for more conservative value-oriented investors.

FF: Q1 2003

** This analysis refers to stocks only and excludes units of the Beutel Goodman Small Cap fund.

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