Against a backdrop of increasing global uncertainty over slowing economic growth and a sustained golden age for the oil patch, most Canadian equity funds are on fire.
Some, however, are faring better than others — largely because of their take on energy prices.

One well-regarded Canadian equity fund is Franklin Templeton Investments Corp.’s $2.3-billion Bissett Canadian Equity Fund. It dropped 8.9% in 2002, when just about every other fund slid even further. But it subsequently failed to rebound as much as the benchmark index, delivering a disappointing gain of only 15.5% in 2003, vs a sharp rise of 26.7% for the S&P/TSX composite index. In 2004, the fund was up 13.3%, again lagging the benchmark. For the six months ended June 30, it has produced a 8.5% return.

An equally large alternative is TD Asset Management Inc.’s $2.2-billion TD Canadian Equity. The fund lost 15.6% in 2002, then jumped 23.7% in 2003 before rising 18.9% last year, eclipsing the benchmark significantly. Year to date, it is up 8.7%.

The Bissett fund earns a three-star ranking from Morningstar Canada, while the TD fund rates four stars, suggesting it has been the stronger performer in recent years.

Bissett Canadian Equity manager Fred Pynn
is a former accountant and that experience allows him to evaluate companies with a critical eye. After several years at what was then Price Waterhouse, he joined Bissett as comptroller in 1987, switching to the money-management side in 1993. Including the period prior to the Franklin Templeton takeover, Pynn has been co- or lead manager of the fund for the past decade.

John Smolinski joined TDAM five years ago, following a career at Royal Insurance and Mackenzie Financial Corp. Using a bottom-up approach, he looks for companies with a record of earnings growth in excess of 10% a year, high free cash flow and dividend growth. Smolinski is willing to pay a higher multiple for certain stocks, particularly cyclicals.

When he took over the fund four years ago, Smolinski sharply reduced the number of stocks in the portfolio, concentrating on larger, higher-quality companies. Now more concentrated, the fund’s sector weightings are driven by individual stock selection, not the other way around. Recently he was underweight in information technology, telecoms and financials, favouring materials and energy stocks.

Holding predominantly large and mid-cap stocks, Pynn looks for companies that offer stable and consistent growth at reasonable prices. The reliability of a company’s future earnings and dividend growth are essential, as are high returns on equity. He tends to buy these companies following
unfavourable news. Although the portfolio is constructed from the bottom up, seven of 10 Toronto Stock Exchange sectors are generally present to ensure adequate diversification.

The commodity plays that have driven the Canadian market over the past few years tend not to satisfy Pynn’s criteria of stable, consistent earnings, dividend growth and low volatility, particularly when precious metals stocks continued their fantastic run in 2003. Currently, the fund is overweight in consumer products and financial stocks, while tilted away from resource stocks.

Although the Canadian dollar has spoiled
things recently, Canadian equity funds often use foreign content to boost returns. The TD fund has roughly 17% of its assets invested outside Canada, predominantly in the U.S.,
with the balance split between Europe and Japan. By comparison, the Bissett fund is keeping more of its money close to home, maintaining 12% offshore, roughly half of it in the U.S. Now that the RRSP foreign content rules have been abolished, the fund will probably invest more of its money in Canada, says Pynn, who as a result has slowly been selling off U.S. holdings.

Neither fund holds much cash as a rule, although the TD fund does hold some income trusts, an increasingly common subset within the Canadian equity category.

Geography aside, the two portfolios show some similarity, particularly among financial services holdings. The TD fund holds roughly 45% of assets in its top 10 holdings.
The Bissett fund holds 376 positions, whereas the TD fund holds half that, at least in Canada. The TD fund’s holdings are skewed by the fact its small foreign portion consists of about 90 stocks plus an exchange-traded fund, distorting the overall numbers considerably.

Although the Bissett fund can be described as a low-turnover option, the same cannot be said of TD Canadian Equity. Turnover was 156% in 2003, after it had been as low as 24% in 2000, the year before Smolinski took over the fund. An increase in trading expenses makes a fund less cost/tax efficient. These expenses are not included in the MER calculation.

@page_break@Both funds still favour large-cap stocks,
maintaining a slightly higher market cap than the median Canadian equity fund. Both are conservative funds with P/E measures that are largely in line with the median fund and lower than the index. Pynn, for instance, generally buys only stocks with P/Es between 10 and 20, believing that investors should not pay more for growth in any one sector.

These two funds exhibit dissimilar risk profiles. Bissett Canadian Equity posted a three-year standard deviation of 9.8, less than the 10.8 posted by the index, while TD Canadian Equity registered 11.8.

Despite this, the funds’ relative Sharpe ratios of 0.91 (TD) and 0.66 (Bissett) indicate that Smolinski’s fund has been the better risk-adjusted performer over the three-year period, better than the index and in line with the median fund.

That record, along with its recognizable brand and a management expense ratio lower than 75% of its category, suggests that TD Canadian Equity continues to be a sound choice for most domestic investors.

The more defensive Bissett fund has indeed lagged and sports a much higher MER than it did a few years ago. But a look at its longer-term, pre-Franklin Templeton numbers suggest that Pynn and his colleagues may bounce back as investors’ love affair with resource stocks begins to fade. IE