A winning formula

During the 10 years ended Oct. 31, Dynamic Small Business Fund’s top-quartile average annual return of 17.7% has almost doubled the 8.9% average return of its peer group in Morningstar Canada’s Canadian small-/mid-cap equity fund category and handily beaten the 10.9% gain of its benchmark index, the BMO Nesbitt Burns Canadian small-cap index. And, surprisingly for a fund that specializes in smaller companies, the Dynamic fund’s volatility is roughly half that of its peers and the index, resulting in a safer, smoother ride for unitholders.

Belaiche, 55, has been managing the fund since 2002; he was joined in 2007 by GCIC vice president and co-manager Jason Gibbs, 39, whom Belaiche calls his “right-hand man.”

Belaiche adds: “We run a diversified portfolio, but are benchmark agnostic and disengaged from the index. We look for companies that can grow their free cash flow, which will ultimately make them more valuable.”

The BMO Nesbitt Burns Canadian small-cap index and many of the mutual funds that focus on small-caps are tilted more toward energy and metals than Dynamic Small Business Fund — hence, the divergence in performance, Belaiche says. However, the Dynamic fund minimizes risk by limiting exposure to any one sector to about 20% of the portfolio and keeping the weighting in any one company to less than 5%.

“It’s a stock-picker’s fund, and we seek high-quality companies,” Belaiche says. “Bottom-up analysis is more important than top-down, but we take sector and company exposure into consideration.”

Belaiche describes his investment process as “quality at a reasonable price,” or QUARP, and seeks low-volatility companies or business trusts that are able to grow their free cash flow — what he calls “owner’s earnings” — steadily and pay out growing income to shareholders through distributions or dividends.

When it comes to resources plays, Belaiche looks for proven resources and will invest only in companies that operate in safe jurisdictions, primarily North America. The Dynamic fund focuses on conservative businesses with strong balance sheets. Belaiche, who worked in the property-development business early in his career, has seen the devastating effects of overleveraging when real estate markets crash, so he takes care to avoid companies with a big appetite for borrowing.

“Belaiche and his team have been able to protect investors on the downside and also provide strong returns in a market rebound,” says Salman Ahmed, an associate director of fund analysis with Morningstar Canada in Toronto. “The fund shows consistency in the investment process and an ability to apply it successfully. Belaiche is not afraid to go to cash when market sentiment dictates, and having liquidity at certain points has worked in his favour.”

Belaiche is not a market-timer, but his process leads him to sell holdings when they become overpriced relative to his assessment of their underlying value. As a result, the  fund was holding a high cash position of about 40% heading into the financial meltdown of late 2008, which helped the fund hold up significantly better than the overall stock market. The fund lost 18% in 2008, compared with a drop of 35% for the S&P/TSX composite index. Currently, the fund has a cash weighting of about 20%.

“We don’t deploy the cash unless we find the right idea,” says Gibbs. “We’re not in a rush.”

The Dynamic fund focuses on buying shares in companies with a market cap of $3.5 billion or less — and sometimes these smaller companies have limited liquidity. Gibbs says the portfolio-management team takes its time building a position as well as getting out. Many holdings are held for the long term, and if they remain of high quality and continue to increase dividends, they will be held even after their market cap surpasses $3.5 billion.

Belaiche, who was born in France but raised in Toronto, broadened his global perspective when he took a year off to travel abroad in 1980 after graduating from the University of Western Ontario’s business school. After his travel adventure, he entered corporate banking at Canadian Imperial Bank of Commerce, but left after a few years to join a commercial and industrial real estate firm.

In 1990, he moved to Prudential Insurance Co. of America, for which he became vice president of property investments and later managed the sale of properties when the firm withdrew from the Canadian market in 1997. That same year, he moved to Dynamic Mutual Funds to manage its two real estate funds, later expanding his mandate to include Dynamic Diversified Equity Income and a handful of other funds that specialize in income securities.

Belaiche prefers to invest in familiar markets: 70% of the Dynamic fund’s holdings is in Canadian equities, about 10% is in the U.S. and a small fraction is in Australia. “We like to invest in what we can understand and evaluate,” he says. “And it’s easier to evaluate businesses in Canada because of our contacts and relationships across the country. It becomes harder as we look further afield.”

The universe of dividend-paying companies is increasing, Belaiche says, as investors’ rising need for income puts pressure on companies to pay out a portion of their free cash flow — and this is increasing his choices. Generally, he adds, firms that can afford to pay dividends and grow them tend to be more stable and mature than younger competitors.  IE