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In search of value
Top core value funds

The past two and a half years have provided a striking illustration of the differences in stock picking styles - namely value and growth. While the two aren't really opposite approaches, they each have different focal points. While growth dominated most of the 1990s, the year 2000 saw the return to value investing. In the world of mutual funds, true value managers are a rarity, so it's tough to include them in your portfolio. This week, we'll explain the style differences and profile a few core holdings each practising a value approach to stock picking.

Style Definitions

Growth and value are the two main types of approaches to picking stocks. The similarity between the two styles is that both are looking to buy stocks at reasonable prices today, based on future expectations. That's where the similarity ends. Growth managers accomplish this task by focussing on companies that they expect will grow their profits at a rate that is above average. Hence, the growth manager will seek to pay a price that is low, compared to the stock's growth expectations. If growth expectations are high, the acceptable level of stock prices can also be quite high. A popular subset of growth investing is the earnings and price momentum approach, which proved so successful during the tech boom but suffered during the bust.

On the other hand, a money manager using a value approach will calculate a company's true or intrinsic value using its current financial statistics. The value manager isn't always looking for good companies (growth manager does). Value managers may look at special situations which include companies in financial distress whose prices have been knocked down so far, they trade below liquidation value. So, the future expectation of a value manager is focussed on events, rather than pure growth. Events can include acquisitions, change in market sentiment, spin-offs of subsidiaries, or even corporate liquidations.

Though the two styles produce very similar returns over long periods of time, value has resulted in slightly higher returns over time, with less risk. This is known as the value phenomenon. It's important to note that not every manager will fit neatly into these style descriptions but most do lean one way or another and often put a unique twist on the general style description.

CI Harbour

Gerry Coleman is the lead manager of this large cap Canadian stock fund, which holds about thirty-five stocks currently. A self-described growth manager with a strong value bent, Gerry won't let a stock rise too far above its estimated value. That ensures that he takes profits occasionally and isn't left holding a group of high-priced stocks. Gerry candidly admits that the toughest part of his twenty-five years as a money manager is the sell decision. I think that's very common, but few money manager have the confidence in their approach to admit to any weakness. Gerry's excellent intuitive skills, infrequent trading, good performance and ability to stick to his guns in spite of market conditions (i.e. he never touched Nortel) are why this fund should be considered for a portfolio's core. In my opinion, this is the best Canadian equity fund in CI's entire family of funds.

ABC American Value

If you think it's hard finding a needle in a haystack, just try finding a true value fund investing in US stocks. Trust me, it's not easy. In fact, this fund for sophisticated investors is the only true US value fund I could find. Sure, there are others that are GARP managers but most sit on the growth side of the spectrum. Irwin Michael owns ABC Funds and is the lead manager on all three of its funds, of which this is one. He often talks about his stocks in relation to their net asset values - the sign of a strict value manager. Despite great success with his Canadian funds, performance of the American fund has been mixed in its five-year history - a period which has been dominated by large growth companies. Irwin invests all of his personal investable assets only in his funds and he owns a substantial portion of this fund. Over time, I expect this fund to shine. The minimum investment is subject to the sophisticated investor rule ($150,000 in Ontario).

Mackenzie Cundill Value

This fund embodies all of the qualities of a strict value discipline and applies it on a global scale - a rarity in this category. Co-managers Peter Cundill, Tim McElvaine, and David Briggs have been adding banks located in the Japan region. They say all of the fraud and uncertainty plaguing Japan's banking sector has unfairly dragged down the quality institutions they've added in recent months. In total, nearly forty per cent of this fund is invested in Japan, with less than twenty per cent in the US. Many Japanese stocks are so cheaply priced these days that the market has assigned no value to some firms' core businesses. That's exactly the type of situation this team loves. While I'd expect it to pay off for investors over time, a great deal of patience may be required since Japan's economic picture remains fuzzy in the present and the near-term. Class C shares of this fund are the only ones available. Class A and B shares have been closed to new investors.

Eighteen months ago, it was easier to sell air conditioners to Alaskans than it was value funds to investors. However, the unravelling of tech stocks (and pure growth and momentum funds) has brought investors a little closer to earth and opened their eyes to value investing once again. Yes, that's right, generating profits and cash flows actually has a bearing on the value of a stock. If you're buying these or other value-oriented funds, I hope you prove what investor behaviour studies have consistently concluded that investors chase performance. Rather, I hope you buy these funds with the idea of using them as the foundation of your portfolio and hold them for many years.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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