John Kustec isn't interested in fair-weather friends. In seeking investments forBeutel Goodman Private U.S. Equity, he wants companies with a proven ability to survive the tough times.
"How companies survive hard times and respond to difficult environments is a key differentiator," says Kustec, vice-president at Toronto-based Beutel Goodman & Co. Ltd., who is also lead manager ofBeutel Goodman Private RRSP Balanced and provides input toBeutel Goodman Private North American Balanced. Although he's value-oriented, he's not a "deep value" investor, and isn't attracted to "broken down companies going into Chapter 11" bankruptcy protection. "Generally, a well-run company doesn't get into those situations," he says. "When a company is run with conservative projections about economic growth and prospects for the sector, it will be better prepared if adverse conditions hit."
Kustec, who's been running the $28-million Beutel Goodman Private U.S. Equity since early 2000, has fared well against his competitors. For the year ended May 31, the fund gained 22.1%, beating the median U.S. Equity mutual fund's gain of 15.0%. For the three-year period, the fund lost 4.7%, less than the median loss of 8.1%.
The fund's minimum investment is a steep $250,000, attracting a more committed investor than regular mutual funds with low minimums, Kustec says. That suits his long-term, bottom-up style. Typically, he's looking at a two to three-year holding period for stocks, and his annual turnover is about 30%.
He initially conducts a detailed analysis of a company, taking careful stock of such measures as return on equity, return on assets, and ability to generate free cash flow. "A company with free cash flow has the ability to reinvest in the business for future growth, or to pay shareholders in some form -- either with dividends or stock buybacks."
The initiation of a dividend or a dividend increase typically indicates that management has confidence in the company's ability to sustain cash flow, and that's good for the stock price, he says.
He puts a lot of weight on the quality of management, and seeks clear articulation of a long-term business strategy, followed up by execution. He's regularly in touch with companies he's invested in, and after a quarterly earnings release or significant piece of news, he typically puts in a call for a personal explanation.
Kustec focuses on small to medium companies with market capitalizations of US$2 million or higher. He likes to have 35 to 40 names in the portfolio, "enough for good diversification as well as the opportunity to be focused."
A full initial position in a stock would see it account for 3% to 3.5% of fund assets, and he would trim as it rose above 5%. If the company meets his original 50% target for total return (including dividends), it's usually becoming fully valued as it approaches a 5% weighting.
"When a stock hits our target price, it's a signal to reassess the business's potential going forward," says Kustec. "Hopefully, we've underestimated the company's ability to increase its value over time, and can continue to hold a position."
As a bottom-up investor, Kustec doesn't have any hard limits on sector weightings, but is unlikely to have more than 40% of assets in a sector. Currently, financials are his largest weighting at 30%, and although he wouldn't want to go much higher, he wouldn't turn down an opportunity. "Value opportunities tend to shift among sectors," he says. "Often an entire sector can be out of favour, not just an individual company."
Kustec graduated from Queen's University in 1985 with a BA in mathematics and economics. He worked at National Trust Co. in pension administration, and it was his exposure to pension fund managers that ignited his interest in investing.
After a series of jobs in pensions and trust operations, he earned his Chartered Financial Analyst designation and joined the investment management side of National Trust as an assistant portfolio manager. When Bank of Nova Scotia bought the company in 1998, he became part of a larger private client group as a portfolio manager/analyst specializing in U.S. stocks.
As part of his work for Beutel Goodman's U.S. equity team, he continues to specialize in financial and technology stocks. In fact, when he originally joined Beutel Goodman in late 1999, the firm was attracted by his expertise in technology stocks.
"The bubble was well underway, but as a value manager, the tech stocks weren't meeting my criteria, and we became underweight in the sector," he recalls. It was a difficult call to go against the crowd, but it paid off during the next few years when techs crashed and value investing enjoyed a resurrection.
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