Despite assurances from the U.S. Federal Reserve that it is willing to help besieged investment banks deal with illiquid mortgage-backed securities, the mood on Wall Street remains gloomy. While a crumbling financial services sector makes the headlines, it’s important to remember that the U.S. is still home to many industries that are underrepresented in Canada.

Undaunted investors looking to bargain hunt across the border may want to consider the following two U.S. equity funds.

Even with a surging Canadian dollar, Toronto-based McLean Budden Ltd. ’s $628-million McLean Budden American Equity Fund rose 13.6% in 2006 after a 1.8% gain in 2005. This past year saw a bit of a stumble, with the fund delivering a 5.7% loss. But it still eclipsed both the median fund and the S&P 500 composite index benchmark for the five years ended Feb. 29. So far this year, however, the fund is down almost 9%.

A much smaller alternative is the $168-million Dynamic American Value Fund sponsored by Dynamic Mutual Funds Ltd.of Toronto. A top-quartile performer in 2005 and 2006, when it returned 11.4% and 16.3%, respectively, the fund pulled further ahead of the pack in 2007, producing a 5.1% gain, vs a 10.5% loss for the S&P 500. Year-to-date, the fund is down roughly 8%.

The fund’s average annual compound return for the five years ended Feb. 29 is a shining 11%, well above the median fund’s 2.6% and the market as a whole, landing it in the first quartile.

By contrast, the McLean Budden fund has produced a five-year average annual compound return of just 3.9%, which nonetheless places it in the first quartile. As a result, both funds receive five-star rankings from Morningstar Canada.

Like many institutional managers, McLean Budden uses a team approach to portfolio construction, with all decisions made by the firm’s investment committee. This group represents one of the longest tenured management teams in this category, says Morningstar. Brian Dawson, for instance, has been associated with the fund since its inception in 1989. He joined McLean Budden following a brief stay at SEI Financial Services as an analyst.

Team members and analysts use various valuation techniques to estimate buy and sell targets, ranking each stock according to its expected rate of return. Important characteristics include strong balance sheets, earnings growth and stability, and healthy return on equity. Portfolio construction tends toward a blended style rather than a particular growth or value tilt.

The Dynamic fund, on the other hand, is under the primary direction of David Fingold, a manager who spent the first part of his business career in private industry with a family-owned merchant-banking firm. Fingold joined Goodman & Co. Investment Counsel Ltd. in 2002, assuming responsibility for this particular Dynamic fund in October 2004.

A contrarian, Fingold’s deep value style leads him to unpopular sectors that have been beaten down — something that’s not difficult to find these days. This sees him looking for stocks that have low price/earnings ratios, strong and growing free cash flows, and strong franchises. Right now that means consumer staples and health-care stocks, with an emphasis on multinationals that do a lot of their business overseas.

By reducing his financial services position a year ago, Fingold was able to avoid much of the turmoil associated with leveraged loans. Recently, the fund had a scant 8% exposure to financial services stocks with a 17% tilt toward large consumer stocks including Proctor & Gamble, Coca-Cola Co. and Altria Group Inc. He has another 18% in energy, 11% in materials and about 15% in technology. Cash is 17%, which is high historically.

The McLean Budden offering is slightly heavier in financial services stocks, yet also much less than its benchmark. It, too, has made a big bet on consumer stocks, with an above-average weighting in industrial and technology stocks. Major holdings include Microsoft Corp., Cisco Systems Inc., Alcoa Inc. and Caterpillar Inc. Cash is 11%.

The rise of the C$, or rather the continued fall of the greenback, has hindered both funds. But most observers think the worst currency risk is over. Only the Dynamic fund hedges this risk, leaving McLean Budden vulnerable if the US$ continues to depreciate against the loonie.

Running a fairly concentrated fund, Fingold has about 50% of assets in the top 10 holdings, whereas the McLean Budden fund has roughly 30%. The Dynamic fund holds about 38 positions, while the McLean Budden fund tracks about 50.

@page_break@Both funds favour larger-cap stocks, with an average market cap quite similar to the index. However, the Dynamic fund’s P/E and price/book ratios are somewhat higher. Portfolio measures on the McLean Budden fund are largely in line with the benchmark and median fund in the category.

The Dynamic fund, largely because of its concentrated portfolio, doesn’t look much like the benchmark at all. Its five-year R-squared measure is 55 (the closer to 100, the higher the correlation), vs 91 for the McLean Budden fund, an offering that always has the S&P 500 in sight.

The two funds also exhibit different risk profiles. The Dynamic fund posted a five-year standard deviation of 11.1, much higher than the 9.8 posted by the benchmark, while the McLean Budden fund registered 9.9, placing it among the least volatile funds in the category in the past five years.

But Fingold’s fund has clearly made money in a tough market. While more volatile than its peers, its risk-adjusted return over the period moves it far ahead of the pack. The fund’s five-year Sharpe ratio of 0.71 pushes it ahead of the McLean Budden fund’s 0.11 by a healthy margin.

Consequently, the nod here has to go to the Dynamic fund, even though the McLean Budden team offers lowers fees — its management expense ratio of 1.25% is less than half the category average — and has demonstrated solid performance over the long haul, particularly on the downside, notes Morningstar.

Realizing that Fingold often shuns the most popular stocks in this efficient sector, investors comfortable with some increased risk and willing to swallow a much higher MER will find the Dynamic fund an excellent diversifier to a growth–oriented portfolio. IE