When peter puccetti, chairman and chief investment officer of Toronto-based Goodwood Inc., sets out to understand a company he is considering as an investment for the Goodwood family of funds, he is not talking about a casual encounter. Puccetti and his team take such great pains to read between the lines of financial statements and examine the business from every angle that corporate analysts often seek Goodwood’s perspective.

“The analysts like talking to us — we’re a good filter for their work and they bounce ideas off us,” says Puccetti. “When it comes to positions that make up 5% or more of our portfolios, we know the specifics of the company as well as or better than anybody in the investment business. Sometimes so well that we correct the analysts’ work.”

But with the traders at the brokerage houses, Goodwood is not as popular. Puccetti and his four fellow stock-pickers tend to move slowly and deliberately when accumulating and exiting their positions. “We don’t generate a lot of work,” Puccetti says.

Goodwood manages five investment funds: a mutual fund called Goodwood Capital, and four hedge funds — Arrow Goodwood, Goodwood Fund A, Goodwood Fund B and a Goodwood offshore fund.

Puccetti’s deliberate approach has paid off in superior short-term and long-term returns. Goodwood Capital Fund, which is accessible to small investors, has shown an average annual compound return since its 1999 inception of 14%. The oldest fund, Goodwood Fund A, has achieved a 22.3% average annual return since it was launched in October 1996. For the year ended Feb. 28, the latter fund had a gain of 21.9%, placing it 13th in a lineup of 95 alternative strategy funds tracked by Morningstar Canada. For the eight years ended Feb. 28, Goodwood A placed second in a much smaller group of 10 funds that have been around long enough to have an eight-year track record.

You won’t find a lot of household names in Goodwood’s portfolios but, instead, a concentrated list of special situations. Ideally, each fund holds 25 to 30 long positions, with heavy weightings in the team’s favourite ideas. Although Goodwood A is closed to new investors, Goodwood B, Arrow Goodwood and the Goodwood offshore fund employ the same long and short strategies. All four hedge funds are sold by offering memorandum and have a minimum investment threshold for Canadians of $150,000 (although this can drop as low as $25,000, depending on provincial regulations and whether or not the buyer meets the regulatory criteria defining an accredited investor).

The more accessible Goodwood Capital Fund, which is a regular mutual fund that can hold only long positions, has a significantly lower minimum initial investment threshold of $5,000. All funds are sold through the broker-dealer network, as well as directly by Goodwood.

Puccetti takes an “investment banker approach” to investing the firm’s $350 million in assets, with a heavy emphasis on financial statements. He looks for businesses trading substantially below their intrinsic value, and seeks a strong balance sheet, a low price/earnings ratio, a history of consistent earnings, a favourable growth outlook and an experienced and ethical management team. He’s willing to hold for a few years in order for potential to unfold, and often finds overlooked opportunities in an upcoming merger, acquisition, liquidation or restructuring.

“Puccetti is a deep-value investor, and the Goodwood funds are small and nimble enough that he can focus on some of the lesser known, illiquid situations,” says Dan Hallett, president of Windsor-based mutual fund service firm Hallett & Associates Inc. “He has weathered a couple of rough spots and has a strong long-term record.”

Looking for cushions

When selecting stocks, Puccetti is attracted by “cushions,” or the idea of getting certain assets for free when the market price of the company is less than its component parts. For example, when Sun Life Financial Inc. went public at $12.50 a share, he determined that the money-management business alone was worth $11.50, implying that buyers were getting the entire insurance business for $1 share. He bought the stock on issue and later sold at $24 a share.

With shorts, he seeks a negative catalyst that will cause the stock price to drop, such as overvaluation, misleading accounting or too much excitement and hype.

@page_break@“Shorts tend to be quicker trades for us, and they can make us nervous,” Puccetti says. “We put a stop-loss on all our shorts with greater than a 5% equity weighting. The possibility of infinite loss on shorts is a scary prospect, and there are always a lot of variables working against short sellers. For example, management is naturally working to turn the company around, which is the opposite of what we want to happen. And the company also has the power to influence the market through press releases.

“It’s a tough business and the market can rip against you,” he adds. “I have a healthy respect for the dangers of shorting.”

Typically, Puccetti is more long than short. In his hedge funds, which have virtually identical holdings, 56% of the portfolios’ equity is long, 6.5% is in short positions and the balance is in cash while he waits for a few of the companies he has his eye on to become available at favourable prices. He is conservative in regard to leverage, and also stays away from derivatives.

“We’ve achieved our returns without a lot of leverage,” Puccetti says. “If your shorts go up and your longs go down, too much leverage is not a good thing. Many hedge funds have blown up due to a combination of leverage and derivatives, and we’ve eliminated the two main causes of potential trouble.”

He has had some great success with shorts, including Nortel Networks Corp. in 2000 and Ballard Power Systems Inc. at various times. Puccetti does not make “macroeconomic calls” and spends no time trying to figure out what commodity prices will do. Instead, he looks for something unusual: “A mispriced security with potential to work its way back to normality.”

The hunt for new ideas

With the 30% limit on foreign content removed from his funds, which have always been RRSP-eligible, Puccetti is now spending more time scouring the U.S. for investments.

“Every person at Goodwood hunts for new ideas, and it’s natural to seek the longs that could triple, quadruple or quintuple,” he says. “But when the market hits a rough patch, it’s good for the portfolio to have some smart ideas on the short side. The tough thing is deciding what names you want to concentrate on. Until you take a good look, you don’t know if something is worth pursuing. You can squander a lot of time on a company and end up not being interested.”

Once he knows he is seriously interested in a prospect, he will meet with its management team.

“You can pick up a lot in a face-to-face meeting that you don’t get by reading the written text,” he says. “There are subtleties in terms of emphasis, and you can glean things from tone and attitude.”

Puccetti is not afraid to be an “activist” shareholder and has had some success initiating change at a handful of companies. For example, after two years of holding the stock of Canadian digital-imaging company Creo Inc., he became concerned about strategic direction and lack of attention to costs. Along with U.S. turnaround specialist Robert Burton, he launched a fight to replace the board and install a new president. The company responded by entering into an agreement to be bought by Eastman Kodak Co.

With U.S.-based food giant Great Atlantic & Pacific Tea Co. Inc., Puccetti was active behind the scenes, putting pressure on the company to sell its A&P Canada division and unlock the value. The grocery-store chain was bought by Quebec-based Métro Inc. last year.

Each of these efforts resulted in significant increases in the share prices. IE