Canadian Small Cap Fund

Canadian Small Cap Fund Commentary

Portfolio Sub-Advisor: QV Investors Inc.

Fund Commentary - March 31, 2012

Equity markets posted strong gains in the first quarter of 2012.  In addition to climbing the proverbial wall of worry, gains arose from increased investor confidence, strong corporate profitability and a lack of attractive asset alternatives.  Increased investor confidence resulted from steady improvement in the US job market and relief related to the European Financial Crisis. Corporate profits continued to grow and corporate profit margins remain close to record levels. Near record low interest rates are providing minuscule bond yields for investors and cheap financing for companies. Access to credit has improved with junk rated companies in the United States selling more bonds in the quarter than during any other quarter over the past 30 years. The total return of the BMO Small Cap Index (unweighted) for the quarter was 7.7% compared to 4.4% for the S&P/TSX Composite Index.

Fund returns were broad based with all sectors of investment, except for the Healthcare sector, providing positive contributions. Benchmark gains were also broadly based. Technology was the largest sector contributor to Fund performance during the quarter, providing approximately one third of total gains. The Fund's Material sector holdings were also strong, contributing approximately one fifth of total quarterly performance. The Fund benefited from increased merger and acquisition (M&A) activity in the most recent quarter. A US competitor acquired fund holding Gennum Corporation and BCE Inc. announced the proposed acquisition of Fund holding Astral Media.    

Excess liquidity, improving corporate profits and reasonable equity valuations, especially when compared to bonds, are all sound reasons for the current equity bull market to remain intact.  However, the Portfolio Sub-Advisor must be mindful that the current bull market has now been in place for three years and they feel we are nearing the average length of time that bull markets historically endure. The volatility that has characterized much of the past several years is likely to continue as persistently high debt burdens for much of the developed world continue to amplify investment risks. The Fund continues to focus the majority of investments in stable business models that exhibit strong competitive positions. Although this defensive positioning can help in difficult markets, it will not eliminate the Fund's exposure to a broad based sell-off in equities if another financial crisis unfolds. 

The Portfolio Sub-Advisors expectation is that companies achieving steady cash-flow growth while trading at a discount to the overall market should continue to outperform. The valuation, growth, and balance sheet qualities of the Fund holdings remain strong compared to the overall market.  More than a quarter of Fund holdings have no net debt and approximately 80% of Fund investments pay a regular dividend. The dividend yield for the Fund at quarter end was approximately 2.5%. 

The Portfolio Sub-Advisor introduced Secure Energy Services (SES) and added to existing holdings Canadian Western Bank (CWB) and Stella Jones (SJ) over the most recent quarter. The Portfolio Sub-Advisor began building a position in SES during Q4 of last year and the weight is now sufficient in size that the Portfolio Sub-Advisor can provide comment on this purchase. SES provides Western Canadian energy producers with processing, recycling, disposal and drilling fluid supply services. Insiders at Secure are aligned with outside investors with approximately 20.0% ownership. The services that the company provides are cyclical in nature but appear to have attractive long-term growth prospects due to the growing trend towards deeper wells with long horizontal legs. This trend is resulting in growing amounts of completion fluids and drilling waste. The Portfolio Sub-Advisor has been impressed by the company's ability to grow cash flow on a per-share basis each year since its founding in late 2007 while maintaining a strong balance sheet.

The Fund's position in Canadian Western Bank (CWB) was increased to a top five holding over the past three months. The Portfolio Sub-Advisor feels they are taking advantage of recent share price weakness by increasing exposure to a fundamentally strong bank that improves most of the Fund's valuation and growth characteristics. CWB possesses industry-leading growth, buttressed by disciplined lending standards.

Stella Jones is one of North America's largest railway tie and utility pole producers. The valuation appears attractive with a price/equity ratio of less than 11.0x, complimented by a return on equity that has been in the double digits for each of the past ten years. The outlook for Stella Jones appears healthy, coinciding with what appears to be somewhat of a railway renaissance in North America as evidenced by record carload shipments and car shortages.The Portfolio Sub-Advisor exited the Fund's position in GLV Inc. during the quarter and reduced positions in Argonaut Gold and Uni-Select Inc. The sale of Gennum also closed before quarter end.