If 2008 was one of the worst equity markets in recent memory, it also created some of the best opportunities to buy stocks. That's how Hugo Lavallée, lead manager ofFidelity Canadian Opportunities 
, responded when the financial crisis swept through global markets.
"People like the sexiness of concentrated portfolios and very small-cap companies. But when a year like 2008 happens, you can get destroyed," says Lavallée, 30, a Montreal-based member of Team Canada at Fidelity Investments Canada ULC, who assumed the fund in September of that year.
Like his predecessor, Maxime Lemieux, Lavallée is flexible and moves around the Canadian market-capitalization spectrum, depending on the market cycle. At the start of 2008, the fund had an average market cap of $4.5 to $5 billion. "Some people said it was not a true small-cap fund. But that larger market-cap (focus) allowed us to protect capital when the market went down," he says.
By the spring of 2009, Lavallée believed stocks were so over-sold that it was time to load up on small companies that were selling at distressed levels. As a result of Lavallée's well-timed move, the fund's Series A returned 60.4% in 2009, compared with 50.7% for the median fund in the Canadian Small/Mid Cap Equity category. The fund mandate has about $800 million in net assets.
"There are cycles," says Lavallée. "If you look at the last 10 years, there are strong periods of outperformance and underperformance among small caps and microcaps. Our job is to be aware of where you are in the cycle, and know how to increase the exposure to small caps and microcaps."
As part of his investment process, Lavallée relies on Fidelity's extensive research team, including the corporate-bond analysts at its Boston headquarters. "The most important thing that made me bullish last year, was in January when the market was getting killed. Spreads on corporate bonds (versus government bonds) were actually coming down. Credit signs were getting more positive," says Lavallée. "It was time to be aggressive as a team and go through our list."
Some of the best performers in 2009 had some of the worst balance-sheet characteristics. Take, for instance, Livingstone International Income Fund LIV.UN. After restructuring and raising equity, the trans-border logistics company was sold to a consortium of CPP Investment Board and Sterling Partners. Its shares soared to $9.50 last January (from less than $4) when the buyout was completed and Lavallée closed the fund's position.
Other acquisitions, such as Canaccord Financial Inc. CF, had strong balance sheets. When the investment dealer saw its shares drop to $4 in February 2009, Lavallée recognized an opportunity because the company had a book value of $6.25 a share and $800 million in liquidity.
"Revenues were depressed, but they could rebound. We figured we could wait a year or two," says Lavallée. Today, the shares are $11. Lavallée has no stated target, but has taken some profits.
A Montreal native, Lavallée was attending McGill University when he met Lemieux, who was recruiting new talent for Fidelity. "I was interested in money management, something finance-related," recalls Lavallée. Although he was turned down initially, he got a call from Fidelity later, following a stint as a summer student working for the value manager Mario Gabelli in New York.
After graduating in 2002, with a bachelor of commerce degree, Lavallée joined Fidelity. He worked alongside Bob Haber, the then chief investment officer for Fidelity Canada, and analyzed technology and paper and forest companies, and later gold mining firms.
In 2006, Lavallée became an assistant to Lemieux on the Canadian small/mid cap fund. As markets began to deteriorate in 2008, they became more defensive.
Lavallée limits holdings to around 3% and runs about 130 names in total. Turnover in 2009 was very high at 328%. Yet, given diminished market volatility, Lavallée expects turnover will revert to the previous levels of 65% to 75% a year.
Given the sizeable gains in the past year, Lavallée admits that he has become more conservative. "There are not as many bargains as a year ago. That's why the average market cap is creeping up--and we own bigger, more liquid companies."
A case in point is Fairfax Financial Holdings Inc. FFH, the insurance and investment management firm that is run by Prem Watsa. "You can buy the stock today for one times book value," says Lavallée. "Watsa is one of Canada's finest investors. Plus, he runs a very decent property and casualty insurance business."
Yet in Lavallée's view the stock is unappreciated because investors do not expect prices will improve in the property and casualty market, and the stock lacks the appeal of a base-metals stock that is geared to China's growth. "Nobody cares right now."
Another top position is Great-West Lifeco Inc. GWO. Controlled by the Desmarais family interests, the life insurer escaped many of the travails that beset some competitors. "It's a conservative organization," says Lavallée, adding that the stock has a 4.5% dividend yield. "They think long-term and are extremely shareholder-friendly. That's the kind of stock I want to own nowadays."
