Over the past two years, Tyler Hewlett, the lead manager of the $310-million BMO Canadian Small Cap Equity, has benefited from looking beyond the resources space.
"When people think about small cap in Canada, they automatically default to the 50% of the small-cap universe that is focused on resource stocks," says Hewlett, vice-president and portfolio manager, Canadian equities, at BMO Asset Management Inc. in Toronto. "A fund like ours focuses on the best growth-like opportunities, and right now we're finding them in other areas of the market."
Hewlett says small-cap growth companies in non-resources sectors were "largely ignored" over the last decade. But attitudes have changed. "The tide is really turning, so these companies are getting better access to capital and are having a much easier time in growing their businesses."
As of July 31, BMO Canadian Small Cap Equity held approximately 20% in technology names, 18% in financial services and 17% in consumer stocks. In all, the fund currently holds about 60 stocks with risk parameters to ensure that it is not concentrated in any one sector or investing theme. Individual weightings in the top four or five stocks are generally in the 4% to 5% range.
The investment team for the mandate is made up of Hewlett, analyst David Taylor and a "stable of sector specialists." In terms of the definition of small cap, the "sweet spot" for new additions to the fund is between $100 million to about $1.5 billion in market capitalization. Currently, the average weighted market cap of the fund's portfolio is around $1 billion.
The screening process for stocks within the benchmark BMO Capital Markets Small Cap Index focuses almost entirely on fundamental analysis. Subject to liquidity requirements, the BMO team looks for companies that can grow much bigger over time.
When seeking companies that meet the criteria, the team looks at management's track record as a main area of focus. The team likes to see a high level of insider ownership, depending on the size of the company, and a strong alignment with shareholders. During the course of the research, there may be several meetings with the management of a company before a stock is added to the portfolio.
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Strategic analysis is another key area of the investment process. The managers examine a company's competitive position and whether it can achieve sustainable growth.
In addition to the initial quantitative screening, Hewlett and his colleagues use an internal model to assess a company's growth potential. This research includes valuation analysis, the setting of a target price, and an estimate of what kind of return can be expected from the company.
At the end of Hewlett's first year as lead manager, he says his portfolio turnover was about 50% to 60%, and that's what he thinks can be expected over a typical market cycle. The turnover in the top 10 core holdings is much less frequent.
Hewlett, 35, has held the CFA designation since 2006, when he was an equity analyst with RBC Capital Markets. He joined RBC after graduating from Queen's University in 2001 with a bachelor of commerce degree. Initially, he was enrolled in the RBC Capital Markets generalist program, a two-year internship that covered areas in fixed income, currencies, investment banking and equity research.
After joining BMO Asset Management in 2007 as an equity analyst, Hewlett covered multiple sectors with a focus on small-cap equities. Starting as an analyst on BMO Special Equity (as BMO Canadian Small Cap Equity was then named) he was promoted to associate portfolio manager in early 2009 and became lead manager in January 2012. On March 28 of this year, BMO Special Equity was officially renamed BMO Canadian Small Cap Equity.
According to Hewlett, "we generally don't perform quite as well when there is no growth, as in a recession." Because the fund is growth-focused, it doesn't tend to have a lot of counter-cyclical type stocks. Another market environment, "where some of our companies might lag, is speculative, risky environments where the market is looking less at quality fundamentals," he adds.
However, performance over the past couple of years has been strong. BMO Canadian Small Cap Equity has a two-year annualized return of 11.6%. That compares favourably with the median 4.5% in the Canadian Small/Mid Cap Equity category, as of August 31.
Hewlett attributes the recent above-average performance of BMO Canadian Small Cap Equity to the firm's quality of investment analysis, and the decision to shift the portfolio toward more growth opportunities in the technology, industrials and consumer sectors.
One such company, added to the fund last year, is AutoCanada Inc. ACQ, the largest publicly listed owner of auto dealerships in Canada. "The management has proven they can grow a business," says Hewlett, "and there's a very high percentage of insider ownership."
Hewlett adds that AutoCanada has strong cash flow, and the auto industry is on the upswing. "We started buying the stock around the $12 mark, and the stock has almost tripled in a year, and we think that there is still a lot of runway for this company."
