Market conditions may be difficult over the next couple of months, says small-cap specialist Alex Sasso, co-manager of the $122.3-millionNorrep.
"Markets could be flat to down over the next little while," says Sasso, a Toronto-based vice-president of Hesperian Capital Management Ltd. "It all depends on how the numbers play out. Put it this way, I'm not in a rush to buy a bunch of high-beta stocks." Although he is a bottom-up investor, Sasso is watching macroeconomic developments, especially in the U.S. "Let's hope the Federal Reserve Board engineers a slowdown and not a recession. If it does, we will see a turnaround sometime in 2007," says Sasso, adding that markets could move up again once inflation expectations slip and earnings re-accelerate.
In selecting small-cap stocks, Sasso focuses on low-multiple stocks and companies with high returns on equity. "This protects us in times of weakness," he says.
Since small companies usually rely on a single line of business, they also depend heavily on management that can manage growth and meet client expectations, says Sasso. "In real estate, you hear that it's all about 'location, location, location.' With small-caps, it's all about 'management, management, management.'"
Hesperian also looks at the competitive landscape, profit margins and economic outlook, says Sasso. "They are critical. But they rank below the issue of management quality."
On the quantitative side, he and lead manager Randy Oliver, founder of Calgary-based Hesperian, study 17 variables.
The three quantitative criteria that matter most are: price-earnings ratios that are lower than the benchmark BMO Small Cap Index, returns on equity of at least 17% or 18% and positive earnings momentum. The latter is an important attribute since the first two characteristics are not enough to move a stock, says Sasso, who tracks more than 300 companies.
Gildan Activewear Inc. ( GIL/TSX) is a typical holding. A manufacturer of T-shirts, golf shirts and fleece-wear, it has benefited from low-cost operations in Central America. "It's a perfect example of a great management that is always ahead of the competition," says Sasso.
He notes that Gildan's products have also demonstrated superior quality over its U.S. competitors. "Its cost advantage has been so great that it's been able to differentiate itself." Acquired in late 2004 at an average cost of $20, Gildan stock has reached $55.
A native of Windsor, the 38-year-old Sasso has been in the investment business since shortly after he graduated from the University of Windsor in 1990 with a bachelor of commerce in economics and finance. He joined Altamira Management Ltd., where he began as an analyst and worked his way up to portfolio manager.
"I was trained by some of the best in the business," he recalls, noting that he worked with luminaries such as Frank Mersch, Normand Lamarche, Ian Ainsworth and Sue Coleman.
Sasso developed his expertise in small-caps while working from 1997 to 2000 with Coleman, who managed the $107.4-millionAltamira Special Growth. When Coleman left in 2000, Sasso assumed the fund and also managed the firm's small-cap pension assets.
"It's something that I always wanted to do. If you want to generate alpha [excess returns], your best bet is in small-caps because they are the most inefficiently priced," he says.
In August 2004, Sasso was recruited by Hesperian's Oliver, when the firm had only $140 million in assets. Since then, assets have grown to $700 million. The firm has also expanded to include four more funds. Last December, Sasso became manager of the newly launched $8.3-millionNorrep Income Growth Class, which invests mostly in income trusts.
Sasso tends to hold a concentrated portfolio of 35 names and limits positions to about 7% of fund assets. Turnover has been moderate, at 36% for Norrep in 2005 and 61% in 2004. It was of a similar magnitude for the $203.7-millionNorrep II, which differs slightly since it includes some names that were formerly flow-through oil and gas shares. Both funds are closed to new investors.
The five-star rated Norrep has been a top-quartile fund over one-, three- and five-year periods. The newer Norrep II has also performed well.
Some of the funds' impressive results can be attributed to a good dose of patience. In early 2005, for instance, Sasso acquired COM DEV International Ltd. ( CDV/TSX), a manufacturer of sub-systems for satellites.
Then the company hit a bump because it took on a large contract that necessitated the re-organization of its shop floor. This resulted in falling earnings that lasted about half a year, which sent the stock from $2.80 to $2.
But Sasso held on and has been rewarded, since the stock has rebounded to $5.50. "We still believed in the management team," he says. "Our thesis was right. It just took longer to play out than we expected."
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