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 cause 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.
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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.
ome 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. |
