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Beutel Goodman Canadian Intrinsic

The Beutel Goodman Canadian Intrinsic fund racked up an uneven record since its start in 1999. Over five years it returned an average of 11.2% annually compared with the 1.9% average gain of the S&P/TSX Composite Total Return index. However, this figure masks the true story. The fund made strong gains in its first two years but over the past three years the fund has struggled, gaining in 2003 what it lost during the previous year. In 2004 the fund remained flat to record an average three-year loss of 0.19% compared to the index's 8.9% average gain.

The fund is managed by Mark Thomson and follows a bottom-up value style that emphasizes absolute after-tax returns. Mr. Thomson selects stocks of strong, well-established, but undervalued companies for the fund. A stock's value is based on the intrinsic value of the underlying business, which is estimated with emphasis placed on analyzing its future free cash flow. Taking a long-term view, and to reduce the impact of taxes, Mr. Thomson also aims to hang on to his stocks for two to three years. In this way the fund's turnover is kept as low as possible which helps it avoid large capital gains.

What makes this fund different is its intense concentration. The fund isn't expected to hold more than eighteen stocks at any given time. The stated reason for such a high level of concentration is to effectively set the bar so high that only the the very best stocks make the cut. Conventional investment wisdom suggests that such a focused portfolio is insufficiently diversified and carries a higher risk. However, it turns out that the fund's three-year volatility (a measure of market risk), is just a touch higher than the index's.

Once a stock is purchased it generally remains in the portfolio until it reaches its target price, at which point one-third of the position is sold and the stock is re-evaluated. Mr. Thomson points out that he is satisfied with the current portfolio and isn't very active in seeking out new stocks. This is consistent with the fund's lowturnover strategy. Indeed, the fund's turnover comes in at a five-year average of 23%, and for the past two years has averaged an even lower 12%.

Based on the fund's holdings on April 21st, it isn't too expensive. It had a 5% earnings yield, which is equivalent to a price-to-earnings (P/E) ratio of 20, and an attractive 2.6% dividend yield. These can be compared with the median values for the S&P/TSX Composite at the end of the first quarter. The index had a median P/E ratio of 20.8 and a more modest 0.52% median dividend yield. The fund is comparable to the index on a price-tobook- value basis. Not deep value to be sure, but reflective of the fund's emphasis on quality.

At the end of the first quarter the fund held fifteen stocks and a 3.4% cash position. The top three sectors in its portfolio were Consumer Products, Financial Services, and Oil & Gas, which together accounted for about 75% of the portfolio. The top three stocks were Johnson & Johnson, Manulife Financial, and TD Bank. As mentioned previously the fund wasn't very active during 2004, selling Magna International and SBC Communications, and adding Johnson & Johnson during the first half of the year.

So far this year the only significant activity has centered around Molson, which merged with U.S.-based Adolph Coors in February. At the end of 2004 Molson was the fund's largest holding at almost 12% of assets. Concerned that the premerger 'will they or won't they?' uncertainty was exposing the fund's investors to undue risk Mr. Thomson sold half of the position early in the year. Molson now represents 6.8% of assets.

Asked to identify his best and worst picks, Mr. Thomson points to Quebecor as one of his favorites of the past few years. Noting the company's better than expected management Mr. Thomson points to Quebecor's acquisition of Groupe Videotron in 2000 as an example of its business savvy. On the other hand the stock that has most disappointed is American grocer Safeway. Mr. Thomson attributes its poor performance, and deteriorating fundamentals, to strong competition from Wal-Mart as well as to overspending and unwise acquisitions.

Why then has the fund yielded such lacklustre performance lately? The main reason, explains Mr. Thomson, is the generally poor performance of consumer stocks, and in particular of the fund's American holdings which make up nearly 30% of the portfolio. Anomalously high redemptions in 2004, which chopped the fund's assets in half, haven't helped. The fund was forced to sell stocks in order to raise cash and in so doing incurred uncharacteristically high capital gains in 2004.

The Canadian Intrinsic fund is typical of pension manager Beutel Goodman's retail funds in that it charges a modest management expense ratio (MER) of only 1.39%. For a $10,000 minimum, the fund is available everywhere in Canada. But because it carries a front-end load the fund should be purchased through a broker who will waive the load.

Despite a portfolio of good businesses the fund's performance has stalled for over a year as it awaits the return to favour of many of its stocks. As a result the Beutel Goodman Canadian Intrinsic fund should only be considered for inclusion in a well-balanced portfolio by valueoriented frugal investors with long time horizons.

FF: Q1 2005

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