Looking back over the past 15 years, Canadian small- and mid-cap equity funds were up an average of 13.3% annually, significantly ahead of the 10.6% average annual return reported by large-cap Canadian equity funds. But some analysts believe the outlook for Canadian small-company stocks is uncertain as investors reassess the sector because of growing concerns about global credit woes.

Where does this leave lower-cap stock funds such as Chou Associates Management Inc.’s $318-million Chou RRSP Fund and the $195-million Mackenzie Ivy Enterprise Fund offered by Mackenzie Financial Corp. ? (Both are based in Toronto.)

It’s hard to say.

Although the Chou fund’s results are impressive over the long run — it’s still a first-quartile performer for the 10 years ended Sept. 30 — it has delivered only a 11.4% average annual compound return over the past five years, compared with the category’s median return of 15.3% for the same period.

The Chou fund’s calendar 2006 return was 9.6%, which lagged the median fund’s 15.5%. Both 2005 and 2004 were average, with annual returns of 15.7% and of 13.4%, respectively, compared with the pack’s 15.6% and 14.9%. The fund has lost 4.4% so far this year.

The Ivy fund, however, has performed even worse over the past five years, with an average annual compound return of 6%, including annual returns of 6.7% in calendar 2006, 0.3% in 2005 and 9.9% in 2004. So far this year, it has been a break-even proposition.

As a result, both funds receive dramatically different risk-adjusted rankings from Morningstar Canada, with the Chou fund earning three stars and the Mackenzie fund just one.

Publicity-shy Francis Chou has quietly been running Chou RRSP Fund for the past 20 years after initially launching it as an investment club. His long-term record earned him Fund Manager of the Decade accolades at the Canadian Investment Awards in 2004.

During that time, he also was vice president of Fairfax Financial Holdings Inc., a relationship he severed recently to devote his full attention to managing the fund.

Chou is a conservative money manager who focuses primarily on capital preservation, looking for undervalued stocks that have low debt/equity ratios, solid earnings power or, at least, hard assets that aren’t depreciating.

Generally, he won’t buy a stock unless he can get it at a sharp discount to what he estimates its true value to be. He prefers to invest in a smaller number of these companies in which he has a high degree of conviction.

Right now, that means planting roughly 70% of the assets in the fund’s top 10 holdings, resulting in a rather strange portfolio, packed with companies many investors would be scared to touch, such as beleaguered pharmaceutical companies Biovail Corp. and King Pharmaceuticals.

The Chou fund has no exposure to energy, information technology or utilities, and holds only small positions in materials and consumer staples. Its largest weightings are in consumer discretionary, health care and financial services stocks. Cash is roughly 15%.

Mackenzie Ivy Enterprise Fund’s manager, Stephanie Griffiths, joined Mackenzie in 1997, after building her expertise as an analyst at Sprott Securities Ltd. She has been managing this Ivy fund since 2002 and uses an approach that is much different from Chou’s. Using a blended value/growth style, Griffiths seeks companies that have the potential to grow in any market, independent of economic cycles.

Recently, resources-related stocks have been top performers in North American small- and mid-cap markets.

However, Griffiths rarely invests in these, as their value depends on commodity prices or technical innovation, volatile variables over which she has little control. Instead, she has been overweighted in the health care, industrials and technology sectors with an 18% cash cushion.

The Ivy fund has major stakes in Astral Media Inc. and Ritchie Bros. Auctioneers. Newer names include Idexx Laboratories Inc., which markets a wide variety of veterinary services and supplies, and Daktronics Inc., which manufactures digital signs and displays.

Although both funds are categorized as Canadian small-cap funds, they have less than half of their portfolios in Canadian equities right now.

For instance, 43% of the Ivy fund is in U.S. securities — unhedged — which has created a significant drag on performance.

In the Chou fund’s case, 33% of the portfolio is invested outside Canada, split fairly equally between Europe and the U.S. No hedges are in place, although Chou does manage currency movements on occasion.

@page_break@The Ivy fund carries a higher P/E ratio than the benchmark and is at the higher end of the range compared with many similar funds in Canada. Correspondingly, its dividend yield is much lower than other funds in this category. In these regards, the Chou fund lands right in the middle.

The Ivy fund has proven to be the less risky of the two funds, with a standard deviation of 7.1 for the past five years. The Chou fund’s standard deviation is 7.6. Measures for both funds register considerably lower than the median.

The relative five-year Sharpe ratios of 1.1 for the Chou fund and 0.4 for the Ivy fund tell a different story, however, indicating that the Chou fund has been the better risk-adjusted performer of the two, slightly eclipsing the median fund in the category.

Although the Chou fund was a bit of a laggard during the commodities buildup, its longer-term record makes up for these poor years. As a result, even though the firm does virtually no marketing or promotion, it remains a strong contender for small-cap mandates, Morningstar suggests.

It’s also an inexpensive fund, with an MER of just 1.8%, 70 basis points less than that of the median Canadian equity fund and significantly lower than its Ivy counterpart.

The Ivy fund does offer brand-name recognition and the sales support that many advisors require, but the case for investing in it remains murky. However, its recent mandate change allowing it to invest mainly in North American stocks, not strictly Canadian stocks, may help returns. IE