Jeff Clay

Sticks to corporate stalwarts with strong financials.

Jade Hemeon 20 August, 2004 | 1:00PM
Jeff Clay, vice-president at Vancouver-based Phillips Hager & North Investment Management Ltd., stays away from the risky territory of cyclical industries, turnaround candidates and small-cap companies. Instead, he chooses holdings for the portfolios he manages, includingPH&N U.S. Dividend Series A,PH&N U.S. Equity Series A andPH&N U.S. Pooled Pension Series O, from a pool of high-quality corporate stalwarts with impeccable financial track records.

For example, the broadly based PH&N U.S. Equity includes such household names as General Electric Co. ( GE/NYSE), Citigroup Inc. ( C/NYSE), Microsoft Corp. ( MSFT/NASDAQ), Wal-Mart Stores Inc. ( WMT/NYSE) and International Business Machines Corp. ( IBM/NYSE). Ironically, Clay's focus on the bluest of the blue chips has caused his fund to lag behind U.S. market benchmarks during the past few years as less established stocks showed more muscle.

"For the past few years the market has favoured cyclical stocks and small-cap companies of lesser quality, and we've been fighting a bit of a head wind," he says. "During this expansionary phase of the economic cycle people have been willing to invest in riskier companies. We expect that as the economy matures and growth slows down, our large-cap, high-quality companies should move into the sweet spot."

Clay's longer-term objective for PH&N U.S. Equity is to beat the Standard & Poor's 500 composite total return index by at least a percentage point after management fees. The fund has a relatively low management-expense ratio of 1.18%. With a three-year compounded average annual loss of 8.4% at July 31 relative to the index's annualized loss of 6%, he hasn't met his goal in the shorter term. The fund also lagged for the one-year period, gaining 3.2% while the index rose 6.9%.

Clay, who has managed the fund since October 2000, aims to generate superior returns by overweighting or underweighting stocks or sectors relative to the index, and buying when attractive companies are at the low end of their valuation range. "We look for companies that are already generating healthy cash flow, and are not relying on a change in management or an industry coming back into favour," he explains.

He focuses on companies with a market capitalization of at least US$1 billion, although most holdings tend to be bigger than US$5 billion. His maximum weighting in any one company equals its weighting in the S&P 500 index, plus four percentage points. Typically, he holds 50 to 70 stocks, and currently has 58. "As relatively smaller companies become more attractively priced we would own more names," he says.

With the S&P 500 divided into 10 sectors, Clay's sector weightings are plus or minus about 10 percentage points of their index weighting. For example, with materials stocks accounting for 3% of the index he could have 13% of fund assets in the sector, "but would also be comfortable having nothing." His turnover of actual names is about 50% a year, but he likes to trim or add around the edges of core positions as stock prices fluctuate, resulting in asset turnover of about 100%.

Clay has been studying stocks since his student days. He graduated from the University of British Columbia in 1988 with a bachelor of commerce. He was one of the initial participants in the UBC Portfolio Management Foundation program, which offers hands-on experience in investment research and fund management, as well as the chance to work with respected mentors in the local financial community.

The two-year program gave Clay a taste of the investment business, and he liked it. When he graduated in 1988, a year after the 1987 market crash, it was tough to get work in Vancouver, so he moved to Toronto to join Burns Fry Ltd. (now BMO Nesbitt Burns Inc.), working in corporate finance and mergers and acquisitions. In 1992, he landed a job at PH&N and returned to Vancouver. He's been involved with the U.S. equity team ever since, and became primary manager in 2000.

Clay says his funds can win in two ways, through growth in profits as well as expansion of the earnings multiple as companies regain popularity. He'll sell as a stock moves toward the high end of its valuation range, and it's not unusual for him to buy back stocks he's held previously if they return to a bargain price.

He determines a suitable price-earnings ratio for each company, based on its trading history, financial characteristics and the health of the industry in which it operates, and keeps this in mind when he makes buy and sell decisions.

"Some stocks deserve to trade at a discount or premium to the overall market price-earnings ratio," he says. "When we find a company at its low end of its individual fair value range, we'll determine if the situation is temporary and if it's something we might invest in. It's important to understand whether the reason it's undervalued is market sentiment or an actual change in the business model or competitive environment."

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Jade Hemeon

Jade Hemeon