Clad in faded blue jeans and a casual open-neck cotton shirt, Frank Mersch reflects on how his investment style has mellowed over the years since he rose to prominence in the 1990s as one of Canada's most aggressive mutual fund managers.
"I think I'm a little more patient and hold stocks longer today," says Front Street Capital's Mersch, whose performance during the glory days of the Altamira family of funds provided thrills, as well as some spills, to his unitholders.
"I try to reduce volatility, have larger-cap (holdings)" says Mersch of his Front Street mandates. While he was at Altamira, "it used to be to (try to) beat other managers -- the ego was the most important thing -- but now I don't pay attention."
A managing partner at Toronto-based Front Street Capital, the 55-year-old Mersch has managed the $125.2-millionFront Street Hedge Fund Series B1 since August 1999 and the $54-2-millionFront Street Canadian Equity Series A since June 2006. He is responsible for approximately $500 million in total assets under management.
Mersch considers Front Street Canadian Equity the most representative of his investment style. Though he uses large-caps to lessen volatility, he tends to favour small- and mid-sized companies. The fund is in the Canadian Focused Small/Midcap Equity category, and the current holdings place it in the mid-cap growth portion of the Morningstar Equity Style Box.
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Mersch notes that Front Street Capital is commonly thought of as an investment firm specializing in resources, but that this impression is inaccurate. While he and his colleagues identify sector-driven themes, they are not necessarily related to natural resources.
"This is more a commodity-biased cycle so it's obviously a strength we have," says Mersch. He says Front Street Canadian Equity still has a "reasonable" resource bias, and has characteristically held about 20% to 25% in materials, along with a 30% energy component.
Mersch likes to be well diversified by individual security. Currently he holds about 80 names in Front Street Canadian Equity, and the highest weight for a holding has been 8% of fund assets. Markets are fairly volatile and "you're riding a dragon half the time," he says, "but you also need two or three really good stocks to drive the rest of your portfolio."
Some of the biggest contributors to the returns of Front Street Canadian Equity or Front Street Hedge have been from the technology sector, says Mersch. He counts the large-cap Research in Motion Ltd. ( RIM/TSX) as among his favourite picks in recent years, but he's also bought up-and-comers like the wireless technology provider DragonWave Inc. (DWI/TSX). Based in Ottawa, DragonWave is "one of the few companies so far this year that has raised their revenue targets from six months ago," he says.
Mersch's sell discipline is primarily based on company valuations, but sometimes he'll lighten up on stocks if the market as a whole is getting too frothy. He says Front Street's managers always like to buy stocks at under four times cash flow and sell when prices exceed nine times cash flow.
As he has done throughout his career, Mersch will use cash reserves to mitigate risk and take advantage of opportunities. For example, heading into February 2009, his cash position rose to more than 30%, subsequently dropped to around 15%, and then in early June surged to 40%. Now it's less than 20%.
A graduate of the University of Toronto, Mersch received a bachelor of arts degree in 1975. After graduating, he worked for Crown Trust for four years before moving to National Trust for about a year. From 1981 to 1985 he was vice-president of investments at Morgan Trust Co. of Canada. While there, he earned his CFA designation in 1984. He then worked for Guardian Capital Group.
From 1987 to 1998, Mersch was a director and vice-president of Altamira Management Ltd., where the then flagship Altamira Equity (nowAltamira Canadian Equity Growth) that he managed beat the TSE 300 for eight years in a row, several times by huge margins.
Toward the end of Mersch's tenure his fortunes waned. His fund performance tailed off and he resigned under a cloud in May 1998 amid controversy over an Ontario Securities Commission investigation. A month later, in a settlement with the OSC, he received a six-month suspension for making deliberately misleading statements about his personal trades in a junior resources stock that he later bought for Altamira accounts.
In 1999, Mersch was active in providing angel financing to fledgling technology companies and co-founded Casurina Limited Partnership, a hedge fund, before joining Front Street Capital in 2001.
Intentionally unconventional, Front Street's rustic décor -- including a glass partition in the boardroom that's embedded with pussywillow stalks -- reflects the partners' wishes to bring the informal ambiance of their cottages to their workplace.
Nonetheless, Mersch and colleagues set ambitious goals in their pursuit of returns for investors -- including themselves. According to company policy, managers can't invest outside of their own funds. Collectively, the partners themselves are the largest investors in the Front Street funds, according to Mersch.
"My objective has always been to get a (minimum) 12% after-tax return," says Mersch, "Then after that, it's all gravy." While he has more diversification than his resources-biased partner, veteran Normand Lamarche, "Norm will give you the 90% return and 10 years ago that's what I was looking for," Mersch says.
