Aubrey Hearn thinks it's unfortunate that some small-cap "concept" stocks, such as a biotechnology company that doesn't make any money, give the whole small-cap segment a bad reputation. "It's hard to sell the fund because of the perception," says Hearn, the lead manager of the $582-million Sentry Small/Mid Cap Income.
"People think it's just crazy whip-saw," Hearn says. "A lot of the companies that we own have been around for decades, and they pay dividends, so I think that helps lower the volatility." About 95% of the fund's holdings consist of "dividend-aristocrat type" names and the fund itself currently pays a 3.5% dividend yield.
Hearn is a vice-president and senior portfolio manager at Toronto-based Sentry Investments. His responsibilities also include lead manager of Sentry U.S. Growth and Income and co-manager of Sentry Canadian Income as well as other funds.
Though it's an equity mandate, Sentry Small/Mid Cap Income will hold bonds if the managers can find equity-like returns, such as a 7.5% to 9% coupon. But they're not finding too many of those right now.
Hearn is a value-style investor "but we're not interested in deep-value, cigar-butt type companies that aren't growing." He adds: "If we can buy a company for 50 bucks and you think it's worth $75, and have that margin of safety, we'll make an investment."
Sentry's screening process seeks to identify companies that are leaders in their industries, have gone through recessions and will be around for the next 10 to 20 years or more. The Sentry team favours companies that are in healthy industries and benefit from high barriers to entry of competitors, and that have strong free-cash-flow yields, preferably above 7%.
A "Warren Buffett guy," Hearn will hold approximately 60 names, but is cognizant that he won't always be right when making a pick. For that reason, an individual holding won't exceed 6% of the fund's assets. Portfolio turnover is "pretty low, 15% or so."
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Sentry Small/Mid Cap Income holds about a 44% weight in industrials, but within that sector there is broad diversification. Hearn and his colleagues avoid having heavy exposure to any one sub-sector.
In terms of geographic exposure, the fund currently has about a 25% weighting in the U.S., with a maximum weight of 35%. This provides Hearn with greater opportunities to invest in quality companies with dividend-growth potential.
During Hearn's tenure, the Morningstar five-star rated Sentry Small/Mid Cap Income has a five-year return of 14% compared with the median 1.3% in the Canadian Focused Small/Mid Cap Equity category.
Despite producing double-digit returns, "we've never had a 10-bagger, maybe had a two-bagger (a stock that doubles in price) occasionally," says Hearn. "It's just the discipline of buying really quality companies on the cheap, holding them a while, and getting cash back from the company in the form of dividends."
Hearn works with an associate portfolio manager and two analysts, with another analyst being added this year. He can also tap into the expertise of other sector specialists at Sentry. His hands-on research includes travels to the U.S. and across Canada, and meeting with management of most of the companies held in the fund about four times a year.
Among the top holdings, Progressive Waste Solutions Ltd. BIN illustrates Hearn's stock-picking criteria. "Canada's a real gem because there's not much competition here," says Hearn, "and there's some great long-term contracts across Canada." He considers Progressive Waste Solutions to be a stable business with potential for an uptick in volume. As well, the stock trades "at a cheap valuation."
Hearn, 33, is a graduate of Memorial University in St. John's, Newfoundland, where he received a bachelor of commerce degree in 2003. Keen to enter the investment industry, he moved to Toronto a week after graduation. He started off as a customer-service representative at what was then AIM Trimark Investments in 2003. A year later he became a salesperson for Hartford Investments, which was acquired by CI Investments Inc. He moved to Sentry in May 2005 and received the CFA designation in 2007.
In the current environment, finding value names is more challenging. "The quality of the names we're trying to look at," says Hearn, "those with good dividends, in some cases have been bid up too much." That being said, Hearn thinks "there's a lot of pent-up returns in the fund and a lot of names we hold are materially undervalued."
