Avoiding falling prey to personal emotions is one of the toughest challenges faced by investors, says Kim Shannon, lead manager of the $4-billion CI Canadian Investment Fund and president of Toronto-based Sionna Investment Managers Inc. A veteran of almost two decades in the industry, Shannon says human psychology tends toward excesses and drives stock prices to extreme levels, up or down.

“One of the more fundamental ways is found in a phenomenon called ‘group think,’ in which we will behave more outrageously in a group dynamic than on our own,” says
Shannon. “That explains why individual stocks and markets as a whole will from time to time trade at euphoric highs and depressed lows. As value managers, we try to take advantage of that dynamic. We’ve constructed as disciplined a process as we can to help us stand aside from that fray of emotionalism.”

Shannon’s ability to maintain discipline is evident in the fund’s track record. CI
Canadian Investment, which she has managed since August 1996, has been in the first or second quartile almost every year, with the exception of 1999, when she avoided the technology mania. Nor has the five-star Morningstar Canada-rated fund had any losing years. For the five years ended August 31, it had an average annual compound return of
12.4%, vs 4.8% for the median Canadian equity fund. In the past three years, the fund averaged a 16.8% return, vs 13.7% for the median fund. In the last 12 months, it returned 29.1%, vs 21.8% for the median fund.

A bottom-up stock picker, Shannon looks at the long-term historical fundamentals of stocks and how they trade relative to the market. Then she estimates their true value and determines where they are relative to their historic norm. “Value investing is about reversion to the mean, which is going back to that long-term norm,” says Shannon. “We don’t ask stocks to do anything extraordinary; we ask them to do what they have tended to do in the past.” As long as there are no significant risk factors buried in a stock, she says, it should go back to where it has been. Conversely, if the stock is well above its historic norm, Shannon will assume it is likely to revert to the norm.

“In simple terms, we look for a dollar that is trading at 70¢ or less and then patiently wait for it to go back to a dollar,” she says, adding that her target return over two years is 30%, or 15% per annum.

The expectation is based on research by Peter Gibson, head of strategy at Desjardins Securities Inc. , who concluded that over the very long term the Canadian market average return is 9.5%. The additional 5.5% return that Shannon seeks is her margin of safety. “You want a fat margin of safety if you fall short — and only get 11%, say — but you should still be able to outperform over the long term.”

Shannon aims to deliver consistent performance and has succeeded. “We are pretty ‘steady Eddie’ and try not to lose money,” she says. “With this approach, we will tend to do well when markets are weak or declining, and tend to underperform when the market is strong.”

Curiously, both the market and the fund are doing very well. Yet Shannon does not regard it as anomalous. “We are in our ‘zone’ at the moment. Outperforming is always nice, much better than the alternative.”

Running a 50-name fund and holding about 8% cash, Shannon focuses on blue-chip Canadian large caps and tends to be sector-neutral. However, she also takes concentrated bets and has large positions in financials Royal Bank of Canada, Power Financial Corp. and Bank of Nova Scotia, and energy names, including Imperial Oil Ltd., Petro-Canada and Canadian Natural Resources Inc.

A long-term investor, Shannon keeps annual turnover generally at 22%-25%. She also likes to work around core positions. Consider, for instance, Empire Co. Ltd., the holding company that controls Sobey’s Inc. Shares were acquired in 1996 at about $11 a share; Shannon thought it could go to $18. When it reached that level, she raised her expectation to $25 a share. That target was reached too, but the company’s intrinsic value kept climbing. When the stock peaked at $64 in 2000, Shannon reduced her position and took profits. After the stock split two for one, and dropped, Shannon started accumulating again, at around $22 in late 2001. It is now at about $38 a share.

@page_break@In her quantitative analysis, Shannon looks for stocks that are trading at low price/earnings ratios and price/book ratios. “We look at the earnings ‘machine’ capability of the firm and its ROE, and ask, ‘What price are we paying for that earnings machine? Is it appropriate?’ From that, we calculate its intrinsic value.”

On the qualitative side, Shannon has a template of 20 questions — with many additional sub-questions — that she uses to develop a so-called “360-degree view” of a company. In looking at management, she asks whether the compensation is typical, excessive or modest. She also questions little things, such as a CEO’s luxurious office, which may hint at self-interest rather than concern with the company’s growth.

“There is a high degree of correlation between high compensation and aggressive accounting. That’s the biggest risk factor we look for,” she says. She also examines the quality of corporate governance and the independence of the corporate board. If she does identify aggressive accounting, she insists on higher margins of safety to compensate for the additional risk. The exercise, which she has passed on to the five-person team at Sionna, is a way of making “intangibles” more tangible.

Shannon’s entry into the fund industry was driven by pragmatism. The daughter of a Canadian air force employee, she attended the University of Toronto, from which she graduated in 1980 with a bachelor of science degree in zoology and anthropology. An activist on campus, Shannon turned to business at the suggestion of a friend.

In 1986, Shannon completed a bachelor of commerce in finance and economics and landed her first job as a trucking fleet insurance specialist. The experience of rolling over treasury bills prompted her to take some money-management courses and, ultimately, to sign up for the CFA program. Within a year, she moved to Royal and SunAlliance Insurance Group as a trader and analyst. She also met her mentor, John Di Tomasso, a deep-value investor and commodities specialist, who later established the Di Tomasso Group in Victoria, B.C.

In 1995, after five years of running the equity side of Royal and SunAlliance’s investment arm, Shannon moved to investment counsellors AMI Partners Inc. Soon, as head of large-cap Canadian equities, she began picking stocks for Canadian Investment Fund, which was distributed by Spectrum United Mutual Funds Inc. The fund had fallen on hard times.

Shannon helped to turn the performance around, and angled for the management assignment in 1996. “It had a large-cap focus, something I was comfortable with.”
Except for a six-month interim in 1999, she has been with the fund ever since.

That year saw her go through several management changes. Shannon joined Merrill Lynch Investment Managers Inc. in 1999, but the sale of the firm to CIBC in 2002 resulted in her becoming an employee at TAL Global Asset Management. In September 2002, she was approached by CI Investments Inc. , which had acquired Spectrum Investment Management Ltd., and asked to stay on. That gave her the opening to set up her own firm.

“I was very excited about the opportunity; it was the right time in my career,” Shannon says. Sionna’s assets under management have tripled to $6.4 billion. Most of the funds are in the CI stable, but there are some external accounts and Shannon hopes to attract institutional clients.

Looking ahead, Shannon admits she is worried and bearish about market prospects.

“We are in a very challenging market, but as a value manager my market-timing skills are poor. Value tells us what the market will do, but doesn’t say when it will happen,” says Shannon, noting that multiples are above-average and risks are on the rise worldwide. She is wary of hazard, and is “putting in all the ballast for the potential challenges.”

Shannon gets high grades from analysts such as Gordon Pape, a Toronto-based commentator and publisher of Internet Wealth Builder. “Unlike a lot of other value managers, Shannon doesn’t resort to having a large cash cushion in tough markets. She manages to produce above-average returns in both good and bad markets,” says Pape, adding that he’s given the fund his top $$$$ rating. “They don’t come much better than this.”

Dan Hallett, president of Windsor, Ont.-based Dan Hallett & Associates Inc. , expresses concerns that the fund has almost tripled in size in the past 12 months. “The large asset base could impose some constraints in our relatively small market,” he says. “But that issue aside, Shannon is an excellent manager. In the face of a huge growth in assets, she has managed to put up out-performance type of numbers. Equally important, on the risk side, she has done a good job in providing a cushion on the downside.” IE