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Beutel Goodman Small Cap

The Beutel Goodman Small cap fund boasted an impressive 36% return in 2003, but in relative terms it trailed the Barra Canadian Small Cap index which returned 40%. Continuing its profitable ways, the fund gained 10.5% in the first two quarters compared to the index's 7.8%. Over the longer term, the fund yielded an average annual return of 17.3% over the past five years, surpassing the index's 14.3% average annual gain and ranking it among the top five Canadian equity funds for the time period.

The fund is managed by the team of Denis Marsh and Steve Arpin. Messrs. Marsh and Arpin use a value-oriented approach to pick stocks with a market float of between $100 million and $1 billion. This means that they look for smaller stocks that are trading below intrinsic business value. The bottom-up methodology used by the managers focusses on a company's ability to generate free cash flow, either now or in the future, and on the value of its underlying assets. The fund's managers also like to seek out what they call "companies of the future", but only if the price is right.

Usually the fund's portfolio consists of between thirty and fifty stocks selected strictly on their own merits without sector considerations. Once purchased, and provided its fundamentals hold up, a stock is held until it reaches its target price. At that time the company is automatically reviewed and the position is either sold or trimmed. As manifested by the fund's average 35% turnover, a typical stock stays in the portfolio for about three years, although "core" holdings that exhibit strong long-term performance have been held for much longer.

At the end of June, the portfolio had a median earnings yield of 2.6% which was rather low compared to the S&P/TSX Smalland Mid-Cap indices' median values of 6.7% and 5.8%. However, with a price-to-bookvalue ratio of 1.9 the fund was slightly cheaper than both indices, and the same can be said about its 1.6% dividend yield. From a deep-value perspective the portfolio is somewhat expensive.

The fund held 47 stocks at the end of the quarter, all of which were Canadian. The fund's top three sectors were Consumer Products, Industrials, and Materials, while the top three stocks in the portfolio were Open Text, Cinram International, and QLT Incorporated. During the first six months of the year the fund was moderately active, selling eight stocks and buying eight. Names sold included Aur Resources and Goldcorp, while SFK Pulp Fund, FirstService, and Alliance Atlantis were added. The fund's 6.3% cash position is, according to Messrs. Marsh and Arpin, normal and gives them the flexibility to buy up to two new positions without having to sell other, potentially illiquid, holdings.

The fund performed uncharacteristically poorly in relative terms during the second half of 2003. The managers attribute this to speculative activity in commodities such as gold and base metals in which the fund did not participate. They continue to feel that much of this sector is too risky given currently high commodity prices, particularly for base metals and gold. They also point out that many otherwise attractive resource companies are too large for the fund.

Asked to name their best picks, the managers point to Cinram, a maker of prerecorded multimedia products, which was purchased at about $2 and now trades at around $24. Open Text, which gets a nod for both good cash flow and disciplined management, is cited as an example of a "company of the future".

Going forward, the managers still see many good opportunities in the small cap sector, but they note that the situation is not as good as it was a year ago. The managers also admit to having become somewhat more cautious keeping in mind the likelihood of a move back to more normal market returns and the possibility of a mild economic slowdown. They hasten to add that they do not expect a major downturn at this time.

It is worth noting that Beutel Goodman has deliberately lowered the fund's MER by almost one-hundred basis points over the past five years. However, the fund does charge a front-end load which investors should avoid by purchasing through a discount, or other, broker who will waive the fee. The fund can be purchased through dealers and brokers in all provinces and territories but requires a minimum investment of $10,000.

With a low 1.36% MER, a focus on value, and a fine long-term record, the Beutel Goodman Small Cap fund is worthy of consideration by conservative investors who want to complement their core equity holdings with exposure to small-cap stocks.

FF: Q2 2004

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