AGP mentioned in FP column....
canoe.ca
May 8
Fund Faceoff
Making cash mountains from microcap
molehills
By JOHN GREENWOOD
The Financial Post
Small-cap equity mutual funds have reached prominence in recent years as Canadians sought a diversified means of investing in small but fast-growing companies.
Now investors with their sights set on even smaller companies -- and, in theory, even more growth potential -- have a more practical means of investing: microcap funds.
So far there are just two microcap funds sold in Canada, launched late last year by Bissett & Associates Investment Management Ltd. of Calgary and Toronto-based Clarington
Capital Management Inc.
Since this is new territory for many investors, it is not surprising "micro" might also describe
the size of each fund's assets. As of March 31, Bissett Microcap had $13.4 million in assets and Clarington Canadian Microcap had just $2.8 million in assets.
Though barely out of the starting gates, both have racked up promising numbers. In the six months ended March 31, Bissett Microcap had a return of 11.4%, compared with the average Canadian small-cap equity fund return of -2.8%. For the month of March, Bisset gained 9.3%, compared with the group's average one-month return of 3.8%. The
Clarington fund had a 5.2% return in March.
Canadian microcap companies, which are generally defined as those with a market capitalization of less than $100 million, offer major investment opportunities.
But they are not for the faint of heart. Microcap funds are among the most volatile in the Canadian equity sector, says Stephen Kangas, vice-president of mutual funds and marketing at Canada Trust. He stresses fund performance depends largely on the manager's research
abilities because the sector receives little attention from institutional analysts.
Gene Vollendorf, portfolio manager of Bisset Microcap, says he first became interested in the idea of a microcap fund when he was helping to pick stocks for the Bisset small-cap fund. "We kept seeing all these small companies that were doing extremely well but that we couldn't invest in because they did not fulfill the fund's mandate," he says.
Companies that fit the bill for Bissett Microcap typically have a market cap of less than $75 million, are Canadian and are on a growth trajectory.
Though fundamentally a bottom-up stock picker, Vollendorf pays close attention to a few key themes. With consumer spending suddenly coming back to life, he favors companies
that are poised to benefit from the spending spree.
One company that has done well for the fund is Afton Food Group Ltd. (AFTN/CDN), owner of the fast-growing 2-4-1 Pizza chain.
Another is Arctic Group Inc. (AGP/ASE), his biggest holding at 7% of the portfolio's assets.
Vollendorf describes Arctic as "a simple, boring retailer of packaged ice." Formerly a fragmented industry made up of mom-and-pop companies, the packaged ice business is now dominated in most of Canada by Arctic, which over the past few years has
gone about acquiring most of the smaller players.
"One of my big themes is consolidation," says Vollendorf. His theory is that there are many industries where the main players are predominantly small companies run by one
entrepreneur. If those firms are successful and have a solid track record, then the principals are likely approaching retirement age, he argues, and may be looking for a buyer.
Diagnosticare Inc. (DCE/TSE), his second biggest holding at 4.3%, is a good example. "These guys are going out and acquiring MRI [magnetic resonance imaging] clinics, which are often owned by physicians. They offer the owners cash and stock for their business. So, the physicians can focus on the medical aspect of the clinic while others handle the business
side."
Another theme is the revolution in western agriculture. With the elimination of the grain transportation subsidy, the economics of prairie farming have shifted in favor of those who
know what to do with the mountain of grain that has become too expensive to export.
Vollendorf believes there are opportunities to be found. One is Ridley Canada Ltd.
(RCL/TSE), which is starting to consolidate the feed milling and distribution business.
The money manager has a "buy-and-hold" philosophy and hopes to keep the portfolio's
turnover at about 20% a year. Ideally, he would hold a company only long enough for it to
graduate to the small-cap universe.
Clarington has contracted management for its microcap fund to QVGD Investors Inc. in
Calgary, where it is handled by Patrick Slater.
Like Vollendorf, Slater calls himself a "buy-and-hold" investor. He is looking to build a
portfolio of about 40 companies with a market cap mostly in the $20- million to $60-million
range. In general, he keeps to firms that trade on a major exchanges.
Slater also is a bottom up stock picker. "We're looking for companies with a solid track
record and good management," he says. "The most important is the quality of management.
If the company is not already earnings positive then there must be visible evidence of
earnings potential."
Slater's other major theme is diversification. "That's the key," he says. "We realize that to
get investors into [the micro-cap] area you have to reduce risk. This sector will never be
low-risk, but you can mitigate it with diversification."
One company that has done well for the Clarington fund is Home Capital Group
(HGC/TSE), which specializes in mortgages for the self-employed. Big banks are uneasy
about lending money to people who work for themselves, Slater says.
Home Capital has found a niche in risk assessment in this area and Slater says the company
is now getting business referrals from banks, which hope to benefit down the road when the
successful entrepreneurs decide they need a place to put their money.
"We bought Home Capital at $3.15 [a share] and within a few months it had gone to $4,"
Slater says.
Another holding is Burnt Sand Solutions Inc. (BRT/ASE), an information technology
company specializing in data management.
In many companies, each department has its own computer network and separate data
storage that is not accessible to other departments, says Slater. Burnt Sand brings all those
data streams together and allows it to be shared across departmental lines. Slater bought the
company at 60› a share and it now trades at about $1.10.
Further diversification is provided by Claude Resources Inc. (CRJ/TSE), a
Saskatchewan-based gold mining company that has succeeded in cutting its production
costs to the $200-an-ounce range, making it one of the most efficient gold producers in the
country. So even with the price of gold at historic recent lows, the company can still turn a
profit.
While Slater likes diversify his portfolio, he still keeps a close eye on trends.
Like his counterpart at Bisset, he is interested in the explosion in consumer spending and
likes companies that are poised to benefit. One holding in that category is Delicious
Alternative Deserts Ltd. (DD/CDN), a dairy products company that recently became the
sole manufacturer of Ben and Jerry's ice cream in Canada.
Slater bought the company at 30› a share and they already have climbed to about 50›.
The idea, he says, is to find good companies that have been overlooked by the market.
Once that value is discovered, and the price moves up accordingly, he locks in his gains and
moves on in search of other undiscovered riches. |
