Arun Kaul

Uses a systematic, disciplined approach, without letting emotion get in the way.

Jade Hemeon 2 April, 2004 | 2:00PM
When it comes to investing, Arun Kaul, principal at Hillsdale Investment Management Inc. and co-manager ofHillsdale Canadian Performance Equity, considers himself more of a scientist than an artist. The fund, along with three Hillsdale alternative strategies funds and a portion of two multi-manager funds sponsored by BluMont Capital Inc., is run using a systematic, disciplined approach whereby decisions are based solely on what the computer says.

"We rely on a lot of data to aid in the construction of our portfolios," Kaul says. "We don't let emotion get in the way, as it can easily override a manager's judgment. There's no following of trends or trying to predict the next flavour of the day."

The $13.9-million Hillsdale Canadian Performance is the only "long" fund in the Hillsdale stable, and in the past year it far outdistanced the alternative strategies funds. With a focus on small-capitalization stocks, it gained 62.5% in the year ended Feb. 29, well above the Canadian Small Cap Equity category's median gain of 39.5%. Its five-year return of 26.3% also beat the category median of 14.5%. Kaul has been a co-manager of the fund since he joined Toronto-based Hillsdale in December 1996.

Kaul's formative experiences have been in black and white thinking, rather than creative expression. He graduated from the University of Western Ontario in 1989 with a bachelor of arts in finance and economics. Until 1993, he worked as an auditor for Prudential Insurance Co. of America in Toronto.

He then joined Computerized Portfolio Management Services Inc., a firm specializing in quantitative investment techniques, as an equity analyst. There he met Chris Guthrie, who left the firm to found Hillsdale in January 1996, and who shares the fund management role with Kaul.

Hillsdale Canadian Performance Equity was originally launched as a private pool in 1996, and became a publicly available fund in April 2003. It requires an initial minimum investment of $150,000, or $50,000 for investors deemed by provincial regulators to have sufficient assets or income to be "accredited."

Kaul admits that there is human judgment at work in developing the computer model. His screening process measures a broad selection of factors such as a company's earnings, future earnings estimates, earnings momentum and volatility, insider-trading activity, corporate governance ratings, and accounting practices. The relationship of stock price to cash flow, sales, book value, and dividends can also be quantified.

Typically, Kaul likes to hold 30 to 50 names. He picks his holdings from a universe of about 400 companies with market capitalizations of less than $1 billion. Companies are given a score according to their valuation, growth prospects, profitability, stock-price momentum and volatility.

Any combination of these factors can result in a high score. The companies in the top decile are "buy" candidates, and are held as long as they're in the top third of the database. "We don't require that every stock be perfect in every way, but on the whole our portfolio has favourable attributes that have allowed it to outperform the market over time," says Kaul.

His goal is to beat the BMO Nesbitt Burns small-cap index, but keep volatility at the same level. "We have taken some of the risk-budgeting techniques used in our hedge funds, and transferred them to the small-cap arena."

For example, the target position for a company at the time of purchase is 2.5% of fund assets. If successful, it could rise to 4.5%, but would then be trimmed if it continued to rise in price. The average holding period is about a year, with turnover in the 100% to 125% range.

"We want to avoid the Nortel effect, where a disaster in one stock can eat your portfolio," Kaul says. "We are constantly monitoring how much each position is contributing to the fund's overall volatility. One contract can make a big difference to the value of a small company, but a lot of risk comes from having too much weight in one position."

Kaul limits exposure to any one industry to about 20% of fund assets. "Funds that outperform in the short term usually have a bet on an industry or style, but we don't want to run a pseudo industry fund."

He is also "style neutral" and ensures the fund is balanced among stocks that look attractive according to growth and value characteristics. There is also a small weighting in momentum plays. "The result is a relatively stable fund that is not dominated by any one style. Overall, it demonstrates reasonable value with above-average earnings and top-line growth."

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Jade Hemeon

Jade Hemeon