Searching for value

George Morgan, the Canadian-born manager of the giant Templeton Growth Fund, seemed reasonably satisfied with the fund’s performance when he was in Toronto last month for the annual meeting.

True, investors had lost 6.5 per cent over the year to June 30. But that was a lot better than the performance of the benchmark MSCI World Index. It was also clearly superior to the 14 per cent average loss recorded by funds in the Global Equity category. So things really weren’t so bad, relatively speaking.

Or were they? One of the problems in assessing mutual fund results is that we too often compare apples with oranges. Yes, Templeton Growth did outperform the benchmark index and the category average. But how did it do in comparison to other funds that use a similar value style of stock selection? The answer is: not very well.

For many months, I have been saying that value funds are the best refuge for equity investors during bear market such as we are experiencing. Growth-oriented funds have been clobbered. So have index funds, which have no defence mechanisms that managers can use to shield investors from falling share prices.

Value funds have donrelatively well for several reasons:

1) The stocks in their portfolios are selected in large part on the basis of price. A true value manager will never overpay for a security. That limits the downside risk.

2) Because of the strict disciplines they apply, most value managers had little or no exposure to the high-tech bubble. The stocks were too expensive for them. So when the bottom fell out, most value funds weren’t affected.

3) Value managers will often build cash cushions during bear markets to preserve capital. This reduces exposure to falling equity prices.

But, as with all mutual funds, there are good, bad, and mediocre value managers. Some value funds have done much better than others since the market collapse began in the spring of 2000.

Finding the right value fund is a two-step process. First, you must identify which funds use a value style. Then you have to weed through those to settle on the ones you want to own.

To help with the process, I did an analysis for the August edition of my Mutual Funds Update newsletter of several selected Canadian equity value funds. Most of the funds I looked at made modest profits in the 4-10 per cent range for the year ending June 30. But two turned in spectacular results: ABC Fundamental-Value Fund, which gained 22 per cent, and Saxon Stock Fund, which added 18.1 per cent.

Other standout performers were the Spectrum Canadian Investment Fund and the CI Harbour Fund, run by Gerald Coleman. At the other end of the scale, the AIC Diversified Canada Fund has been a disappointment. The fund follows the principles of Warren Buffett, who is once again being regarded as a financial miracle man after going into a brief eclipse during the late ‘90s. But the magic didn’t translate to our side of the border and the fund lost 7.9 per cent over the past year. There are other value funds that are doing their job more effectively right now.

The following table shows the relative performance of several Canadian value funds over one-year and three-year terms, along with the three-year risk rating for each as calculated by Globefund. Average risk rating for the Canadian Equity category is 15.76. The lower the number, the less the volatility.

The one-year result is simple return; the three-year figure is average annual compound rate of return.

1 Year3 YearsRisk
ABC Fundamental-Value+22.0%+16.6%13.63
Saxon Stock+18.1%+17.3%10.16
Spectrum Canadian Investment+ 9.9%+12.3%8.64
CI Harbour+ 7.6%+11.2%9.72
Beutel Goodman Canadian Equity+ 6.0%+ 8.9%10.42
Mackenzie Ivy Canadian+ 4.9%+ 7.6%9.01
Mackenzie Cundill Canadian Security “C”+ 4.0%+ 7.7%9.86
Synergy Canadian Value+ 2.2%+ 6.8%12.30
Trimark Canadian “SC”+ 1.0%+ 6.2%10.99
Templeton Canadian Stock0.0% + 6.3%11.60
Investors Canadian Large Cap Value– 1.5%+ 6.3%11.41
AIC Diversified Canada– 7.9%+ 5.8%16.31

The bottom line is clear. It’s not enough simply to add a value fund to your portfolio. You have to go beyond that to find the value funds that are outperforming their peers. Look for the best combinations of low risk and high returns and go from there.

Adapted from the August issue of Mutual Funds Update, a monthly newsletter that provides top fund selections and portfolio management advice.