Despite the excesses of the credit markets and a rapidly slowing U.S. economy, some investors are still relatively upbeat about the prospects for the U.S. market. Although a strong Canadian dollar has masked its attractions, the U.S. is still home to many sectors and industries that are underrepresented in Canada.

Those clients and advisors who for the past few years have backed lagging U.S. funds — such as the $193-million AIC Value Fund, sponsored by AIC Ltd. of Burlington, Ont. — are among those hoping for better days. Those who backed more successful offerings such as the $272-million CI American Value Fund, sponsored by Toronto-based CI Investments Inc. , however, have actually made money.

Among U.S. equity funds, CI Value Fund has been one of the steadier performers, winning top U.S. Pooled Fund honours for the third consecutive year at the recent 2007 Canadian Investment Awards. The CI fund rose 10.4% in calendar 2004 before gaining 2.8% in 2005. The fund saw a steady rise in 2006, delivering a 16.1% gain, which eclipsed both the median fund and the S&P 500 composite index benchmark for the five years ended Oct. 31, placing it in the first quartile. So far this year, however, the fund is down roughly 3%.

The AIC fund, on the other hand, was once a top-quartile performer but has struggled over the past several years, dropping near the bottom of its peer group. It has sustained heavy redemptions as a result. After losing years in 2004 and 2005, when it dropped 1% and 2%, respectively, it rebounded dramatically in 2006, reporting a 22.6% gain. Year-to-date, however, the fund is once again down a startling 23%.

For the five years ended Oct. 31, 2007, this translates into an average annual compound return of 7.4% for the CI fund and a 1.7% drop for the AIC fund. Consequently, the AIC fund receives only a two-star risk-adjusted ranking from Morningstar Canada while the CI fund has an above-average four-star ranking.

Pat Naccarato took over the floundering AIC fund two years ago. Prior to joining AIC, he was a senior partner at Vancouver-based Phillips Hager & North Investment Management Ltd. He has also managed U.S. equity funds for TAL Investment Management Ltd. and Toronto-based Manulife Financial Corp.

Using a deep-discount value approach, Naccarato looks for companies that are out of favour but which offer a margin of safety through reasonable balance sheets and attractive free cash flow. This has led him to make a fairly big bet on the consumer sector, including homebuilders and furniture makers, as well as technology stocks.

Because he tends to shy away from cyclical stocks, the fund is light in the energy and materials companies that have been leading the market. Health-care stocks are also not in evidence. And although he quickly reduced the fund’s stake in financial stocks shortly after he took over, the 17% weighting has further reduced returns as credit concerns mount. Major holdings include media giant Interpublic Group and NeuStar Inc., a provider of telecommunications infrastructure.

William Priest, a 35-year industry veteran, has managed the CI fund for five years now, first with Steinberg Priest & Sloan Capital Management LLC and now as CEO of New York-based Epoch Investment Partners Inc. Prior to joining CI, he was CEO of Credit Suisse Asset Management Americas and its predecessor firm BEA Associates.

A value investor, Priest focuses on strong free cash flows rather than earnings, because cash is what keeps businesses afloat. He looks for companies that have excellent records of capital allocation through sustained dividend payouts, share buy-backs and ongoing debt reduction.

Believing that the impact of a weak housing market will curtail consumer spending and lead to slower economic growth, he continues to emphasize U.S. companies that will benefit from economic growth outside of North America.

The CI fund is slightly lighter in financials than the AIC fund, yet much less than its S&P 500 benchmark. It has a significantly larger tilt toward energy stocks, with an above-average weighting in materials and technology. Major holdings include Exxon Mobil Corp., Microsoft Corp., Oracle Corp. and Comcast Corp.

Running a more concentrated fund of 24 stocks, Naccarato has about 62% of assets in the top 10 holdings, whereas Priest’s fund of 56 names has roughly half that amount in the top 10. Both funds favour mid- to large-cap stocks, although the AIC fund has a lower average market cap than most of its peers and the benchmark. But, true to its deep-value approach, its price/book ratio is also much lower than the CI fund. Portfolio measures on the CI fund are largely in line with the benchmark and median fund in the category.

@page_break@The rise of the C$ has been a drag on the performance of both funds, although many analysts think the loonie has peaked. The two funds don’t hedge the currency risk, although AIC offers a hedged version in a parallel fund.

Neither fund looks too much like its benchmark. AIC five-year R-squared measure is 79 (the closer to 100, the higher the correlation), vs 81 for the CI fund.

The two funds also exhibit different risk profiles. The CI fund posted a five-year standard deviation of 8.7, much lower than the 10.4 posted by the benchmark, while the AIC fund registered 11.7, placing it among the more volatile funds in the category. The fund’s negative five-year Sharpe ratio of 0.35 falls short of the CI fund’s 0.52, a number that is higher than almost 90% of its peers, Morningstar reports.

Currency issues notwithstanding, the CI fund has done an admirable job for investors in recent years. The fund’s modest 2.34% management expense ratio, which is lower than roughly two-thirds of the funds in the category, is another plus since it imposes less of a hurdle for management to overcome, Morningstar says.

As for the disappointing AIC fund, Morningstar maintains there are better options in the U.S. equity category. The fund is quite tax-efficient, however, because of unused capital losses and the change in management two years ago. As a secondary consideration, taxable investors may welcome the fund’s ability to carry forward a $261-million tax loss to offset future capital gains. IE