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Q1/2 Mawer U.S. Equity







Mawer U.S. Equity

The Mawer U.S. Equity fund was first profiled in the Q1 2002 issue of Frugal Funds. Two years later, it seems appropriate to revisit the fund and to examine how it has performed. The last eight quarters held mixed fortunes for U.S. equities, with the American markets first dropping and hitting bottom in the winter of 2003 and then bouncing back for a total return of roughly 20% as measured by the S&P 500 index. However, Canadians investing south of the border during this time suffered a significant drag due to the appreciation of the Canadian dollar and did not fare as well. For the two years to the end of June the S&P 500 Total Return index, expressed in Canadian dollars, gained only about 10.6%, or 5.2% per year.

During the same period the Mawer U.S. Equity fund generally tracked the index but underperformed with average annual gains of 2.1%. The fund's gains were limited by a third quartile performance in 2003 that saw the fund add only 2.2%. Since the start of this year the fund is up 8.6% and is firmly back among first quartile performers. Looking at the long term, the fund's 9.1% annual gain over the last ten years places it behind the index at 11.5%, but ahead of the average U.S. equity fund which managed 7.7% and in tenth place among 325 actively managed U.S. equity funds.

The fund remains under the management of Darrell Anderson who follows a bottom-up growth-at-a-reasonable-price (GARP) stockpicking style. Mr. Anderson begins by filtering a universe of stocks for performance, financial strength, and growth prospects. Detailed in-house research is then applied to understand each business, and the stocks remaining at this stage are subjected to an extensive valuation analysis based on a discounted cash flow model. With this last step, Mr. Anderson identifies those stocks with the best combination of growth prospects and price, or as he puts it, "going and growing" businesses.

To maintain focus, the fund generally holds no more than fifty stocks. In a reflection of the fund's bottom-up approach, Mr. Anderson does not feel bound by index sector weights and will readily ignore one or more sectors in favour of other more attractive ones. However, to ensure diversification the fund does maintain exposure to at least six different industry sectors. Prudence also dictates that no sector may make up more than 20% of the fund and no single stock may represent more than 5% of assets.

Once a stock is purchased, it is held for the long term provided that there is no undue deterioration of its fundamentals. The emergence of a more attractive name could also trigger a sale. Of the thirty-three stocks in the portfolio two years ago, twenty-five were still there at the end of June. It is noteworthy that, when the opportunity arises, the fund will sell to lock in a capital loss. The result being that the fund has made no distributions to unitholders since 1998 and has, therefore, been 100% tax efficient during that time.

On a quantitative basis the fund's portfolio was consistent with its stated GARP approach at the end of the quarter. It's earnings yield of 3.8% matched the S&P500/Barra Growth index, but a low 0.9% dividend yield fell short of the index's 1.5% yield. The fund was moderately cheaper than the index on a price-to-book-value ratio basis (4.5 vs. 5.3) and on a price-to-sales ratio basis (1.9 vs. 2.3). However, the fund's price-tocash flow ratio was higher than the index's. The fund has become more expensive in the past two years based on dividend yield and price-to-book-value, but its earnings yield remained about the same.

At the end of June the fund held thirty stocks and had a 3% cash position. It's top three sectors were Health Care, Financials, and Consumer Discretionary, which together made up over half the portfolio. The fund's top three stocks were Ecolab, Costco Wholesale, and AIG. During the first half of this year the fund sold three positions including Symantec and Barra. A new position was established in Health Management Associates, and the fund has also been adding to some existing positions, doubling its holdings of Donaldson Company and Johnson Controls among others.

Asked to comment on recent successes and disappointments, Mr. Anderson pointed to long-time holdings Copart and MBNA, and to Donaldson Inc as stocks that have done very well for the fund. Copart, at an average purchase price of $13.79 per share, traded at $26.70 by the end of June, for a 93% gain. On the other hand, the merger of Newell and Rubbermaid did not turn out to be as beneficial to the fund's pre-merger position in Newell as had been hoped. The stock was dropped from the portfolio in the fourth quarter of 2003. As for the fund's lacklustre relative performance last year, Mr. Anderson points to the more favourable environment for growth and small-cap stocks seen last year. The fund's long-standing underexposure to technology stocks, in particular, was another contributing factor.

Looking ahead, Mr. Anderson is cautiously optimistic about the next year but he expects that rising interest rates, and a slowing economy, will limit gains beyond that horizon. As a result, the fund has been adopting a more defensive posture and further lowering its exposure to technology and cyclical stocks. Mr. Anderson adds that there are still many good opportunities to be found in the current market.

With a low 1.3% MER, a moderate 48% turnover, and a solid record of disciplined management the Mawer U.S. Equity fund continues to be a fine choice for more aggressive investors seeking growth opportunities in U.S. equities. Its $5,000 minimum investment makes it particularly attractive for smaller accounts

FF: Q2 2004

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