Patrick Reddy believes that investment opportunities abound in the Canadian equity market. "Profits look more robust and valuations are at the lower end of the historical range," says Reddy, co-manager of the $117-million Leith Wheeler Canadian Equity Series B and vice-president at Vancouver-based Leith Wheeler Investment Counsel Ltd. "Interest rates are accommodating, both here and in the U.S."
Working within a value-oriented five-person team, Reddy notes that the fund differs considerably from the benchmark S&P/TSX Composite Index. For instance, it holds only 17.4% in the energy sector, versus 26.4% in the index. However, since Reddy believes it's hard to beat the index if the fund resembles it, he focuses on names that tend to be under-followed.
"If there wasn't a market for a particular stock, we ask ourselves, 'would we be happy owning this business for three, five or even 10 years?' This separates us from others who are trying to call short-term market movements."
One of the largest positions in the 5-star rated fund, in which individual holdings are limited to 8% of fund assets, is the dairy-products manufacturer Saputo Inc. SAP. It has been a holding since the initial public offering in 1997.
"Management owns about 35% of the shares, so their interests are aligned with ours. It has a strong balance sheet and a history of making accretive acquisitions," says Reddy, noting that Saputo has grown to become the 12th largest dairy producer in the world. "We expect them to grow their earnings by about 14% a year for the next three years."
Given the bias to small- to mid-cap names, another representative holding is Constellation Software Inc. CSU, which provides so-called "mission critical" software to a host of public-sector clients. The stock was bought on the IPO in 2006, and its price has since grown more than five-fold.
"It's not well followed," says Reddy. "One of the keys to generating out-sized returns is finding companies that are either out of favour, or not well understood. Since we bought the stock, it's had an annualized return of about 34%."
A native of Fort McMurray, Alberta, Reddy has been in the industry since 1999, when he graduated from Simon Fraser University with a bachelor of business administration, majoring in finance and accounting. His first job was in the back office at broker Raymond James. A year later, he joined RBC Direct Investing and worked in its call centre.
After two years, Reddy was hired by British Columbia Investment Management Corp., where he began as an assistant portfolio manager on the $8-billion Canadian equity product sold to provincial employees. Within a couple of years he was promoted to fund manager.
In April 2006, Reddy joined Leith Wheeler as an equity analyst specializing in energy companies. He also sharpened his focus on value investing. "I've always been interested in being a contrarian and looking for value where others don't see it," says Reddy, adding that he found a mentor in company founder Bill Wheeler.
Working within a team that includes Bill Dye, David Jiles, Richard Liley and Nick Szucs, Reddy says that all members conduct due diligence on names in the sector they follow, and then present their case. "We're market-cap agnostic and looking to build the best portfolio with the most attractive returns," says Reddy. "We're not a macro-driven shop. The bottom-up work we do on companies flows through to the portfolio. So we look different."
The fund, which is sold directly or through discount brokers, has been in the first or second quartile over all periods. For instance, over the three years ended April 30, it had an annualized return of 13.8%, versus 10.2% for the median fund in the Canadian Equity category. Over 10 years, it had an annualized 7.4% return, compared with 5.2% for the median fund.
In terms of the sell discipline, the team continuously monitors all the names and measures results against one- and three-year expectations. "When returns of a given stock narrow, we look to trim or sell it, and redeploy the proceeds in a name that has a better risk-return profile."
That's what occurred during the global financial crisis, when the team looked at the beaten-up energy sector and bought Baytex Energy Corp. BTE. The name is still in the portfolio, although its weighting is considerably smaller because the managers have taken profits.
Similarly, last winter the firm added to its holding in Progress Energy Resources Corp. PRQ because the stock had been hit by unusually weak natural-gas prices. "The company is out of favour with prices at levels not seen since 1998. But we're not buying it because we think it will go up in the next quarter," says Reddy, who expects the commodity price will recover within about three years.
"We like it because it's a well run business. We're getting a 3.5% dividend, so we're being paid to wait. But you have to be patient."
