Stephen Arpin, lead manager of the $218.8-millionBeutel Goodman Small Cap, credits strict risk management for outpacing his peers in the volatile small cap area for over a decade.
"I think what sets us apart is an unwillingness to hold companies that are overvalued and a willingness to have cash reserves when we can't find companies that are attractively priced," says Arpin, a vice president at Beutel Goodman & Co. Ltd. and team leader of the firm's small cap mandates.
That's not to say that he and his teammates won't take on some riskier situations, adds Arpin. But when they do, "it's very controlled, and we invest only on the TSX, no ventures, no privates," he says.
Along with the valuation parameters and cash strategy, other essential stock-picking criteria include a focus on balance sheets, and seeking strong companies with good management and an ability to generate free cash flow.
With small-capitalization companies, the focus is on the management redeploying the capital into the businesses, as opposed to using free cash flow to pay out dividends or buy back stock.
Management is considered so vital that the research process starts with qualitative screening before quantitative analysis. To determine if a company has the financial strength to grow and survive, the team looks for some kind of competitive edge -- such as a product that has barriers to entry -- that increases the prospect of success.
The hands-on research process includes meeting with up to 200 companies a year. According to Arpin, he throws away about 20% of his files every year because a lot of the companies don't make it or they get acquired.
One of the top holdings, Uni-Select Inc. ( UNS/TSX), meets the investment criteria. According to Arpin, the Quebec-based independent supplier of auto parts has an excellent long-term growth record. "The environment should generally favour people holding on to their cars and repairing them," says Arpin. The company has grown in the U.S. and has been quite successful there.
Beutel Goodman Small Cap consists of a concentrated 30 to 50 names in the small- to mid-capitalization range of $100 million to $1.5 billion, with an average capitalization of $1 billion. The bottom-up process offers maximum flexibility, but the fund does have parameters relative to the sector weights of the BMO Small Cap Index. The average individual stock holding is around 3% of the overall portfolio, so each name can have an impact.
If the team considers valuations in the market to be too high, it will use cash as a strategy even when it causes short-term underperformance. Such was the case last year when the fund ran cash as high as 20%.
The sell discipline is another risk management tool that "takes the egos out of it," says Arpin. That discipline is driven by a price-return prospect of 100% over a three- to four-year time horizon. If the target price is achieved, the managers sell 25% of the stock position automatically. Then they re-evaluate the business to determine if it will be worth more in the future and, if so, they'll hold the position. The future sustainability of the company is key.
The long-term discipline is reflected in the performance of Beutel Goodman Small Cap. During Arpin's tenure, the Morningstar four-star rated fund has an annualized 10-year return of 10.1% compared the median return of 5.6% in the Canadian Small/Mid Cap Equity category, as of June 30.
Arpin, who has spent his entire career at the Toronto-based firm, draws on 16 years of experience. He graduated with a bachelor of arts (honours) degree from Queen's University in 1991, then pursued further studies and received an MA from York University in 1993 -- the year he joined Beutel. Arpin received his CFA designation in 1997.
When Beutel Goodman Small Cap was launched in January 1995, Arpin came on board as an analyst. He became a co-manager of the fund in 1999, then lead manager in late 2000. William Otton joined him as co-manager in January 2007. Most recently, Arpin has been co-managing the $8.3-millionBeutel Goodman Canadian Dividend with Mark Thomson since April 2007.
Along with Arpin's portfolio management responsibilities, his duties as an analyst at the firm include covering companies in the technology, consumer discretionary and energy sectors.
Arpin is in a buying mode today. "When everybody wants to go in the other direction, it's time to buy, so you need to have a certain contrarianism to you," says Arpin. "We have been shifting into financials, we own a significant amount of natural gas -- it's extremely cheap. In the case of base metals, we're anticipating that things will improve over the next couple of years and then just across the board, so we're fully invested."