When Stephen Arpin takes profits in the $549-million Beutel Goodman Small Cap, he's not expecting to have squeezed out every last dollar of gains from a winning stock. Far from it.
"The discipline of taking money off the table, and harvesting that cash for new opportunities, offers downside risk control," says Arpin, vice-president and portfolio manager at Beutel Goodman & Co. Ltd.
The holding period for an individual stock at Beutel is characteristically three to four years, with the target price being equivalent to a 100% return. After automatically selling a quarter of the holding when it reaches the target price, Arpin and his colleagues reassess whether it makes sense to continue to hold the position or sell it outright.
Beutel's value-driven investment process is based solely on a bottom-up philosophy. The small-cap managers start with a universe of about 350 Canadian companies with market capitalization in the range of $100 million to $1.5 billion.
After intense fundamental and qualitative research, these names are narrowed down to between 30 and 50 holdings. Initial positions in the small-cap mandate are a minimum 1% weight, and the maximum position would be about 6% of the overall portfolio. The fund can include or exclude any sector with a maximum position of the greater of 25% or twice the weighting of the sector in the BMO Small Cap Blended (Weighted) Total Return Index.
Arpin has led the small-cap mandate since 2000 and has been involved with the fund since its inception in January 1995. He credits William (Bill) Otton, equity analyst and portfolio manager, for his essential role in the fund as a mining analyst. Otton, who has also worked on the fund since inception, officially joined Arpin as co-manager in January 2007.
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Under Arpin's tenure, the 4-star rated Beutel Goodman Small Cap D has an annualized five-year return to April 30 of 6.4%, compared with the median 1.3%. Over 10 years, the fund has returned 10.1%, compared with the median 7.6% in the Canadian Small/Mid Cap category.
Arpin, 43, has spent his entire career at Toronto-based Beutel. A graduate of Queen's University, he received a bachelor of arts (honours) in 1991 and then pursued further studies, receiving an MA from York University in 1993. Diploma in hand, he joined Beutel. He received the CFA designation in 1997.
When Beutel Goodman Small Cap was launched, Arpin came on board as an analyst and became a co-manager in 1999. Along with his portfolio-management responsibilities, he provides analysis on the energy sector for the firm, while Otton, 48, is responsible for the materials sector.
Discounted free cash flow is the focus of the Beutel team's approach to valuation. They build a financial model that details what the balance sheet is expected to look like in the future. The model factors in spending on new projects, when debts are due to mature, and interest rates.
Strong balance sheets and good cash-flow coverage are considered essential for small-caps, the managers say, because these companies have fewer lines of business and have less access to debt financing.
Winpak Ltd. WPK, a packaging company and long-standing holding, illustrates the Beutel investment approach. According to Arpin, the company has experienced a lot of adversity, with the rising Canadian dollar and concerns over the economic viability of their primary facility in Winnipeg. That didn't deter the managers from holding the company for years when it wasn't making any money for the fund.
Winpak invested in plant property, equipment, and packaging improvements, and began to see positive results. "Revenue growth has been about 5% to 6%," says Arpin, "and earnings growth has been well in excess of that." In addition, Winpak has a "clean balance sheet, no debt, they're in great financial shape."
Beutel Goodman Small Cap's cash reserve, currently around 11%, may be used tactically and has gone as high as 18% during the duo's tenure. While they prefer to be fully invested, "we're not going to force money into positions where we don't see returns," says Arpin, "because that's a recipe for disaster."
Arpin views volatility as an opportunity to buy something at a highly discounted price to what a company is worth. "There's no doubt in my mind," he says, "that in the materials and energy space we're definitely seeing a lot better value than what we were."
In positioning the fund, "we do have some excess cash, which indicates that we have had some difficulty finding new ideas," says Arpin. "But in the long run, small-cap has been an area that's generated significant outperformance. As a firm we think that equities are very attractive relative to bonds, and in our balanced funds we're maxed out on our equity weights."
