Ugly-looking stocks make contrarian strategy work

If you can tolerate double-digit losses like the ones we’ve seen recently, veteran fund manager Robert Tattersall suggests picking up a classic book on value investing and then just sitting tight.

Tattersall is executive vice-president of Howson Tattersall Investment Counsel Ltd., where his roles include serving as lead manager since inception of the $296-million Saxon World Growth.

The fund ended 2007 with a 21.2% loss, its second-worst calendar year ever since its launch in December 1985.

“If people say, ‘this is too slow for me, it’s just not sexy enough,’ well that’s okay,” says Tattersall. “It’s nature’s way of telling you that you’re in the wrong category.”

To stick to contrarian value principles, you also need to have an organization that supports portfolios with a fair amount of “ugly-looking stocks,” says Tattersall. As well, you need to do that long enough for it to work in your favour, he adds.

The shift away from value stocks has taken its toll, even on Tattersall’s longer-term track record. Saxon World Growth has an annualized 15-year return of 7.9%, lagging the median of 8.9% in the Global Small/Mid Cap Equity category, as of June 30.

Faring better in both relative and absolute terms is Saxon Small Cap, which Tattersall has managed or co-managed since its inception in December 1985. The fund has returned 12%, compared with the Canadian Small/Mid Cap Equity median of 9.2% during the same period. Both Saxon World Growth and Saxon Small Cap are Morningstar Canada Fund Analyst Picks, though they are currently under review because of a pending ownership change.

Since Tattersall’s beginnings at former Confederation Life, there has been a shift in the type of companies showing up on his valuation screens. Compared to 10 years ago, when most cheap stocks were small-capitalization companies, there is now almost a level playing field, he says.

Since the Saxon mandates are all-cap in nature, Tattersall and his colleagues have been buying more quality large-cap companies, such as Wal-Mart Stores, Inc., ING Groep N.V. and Royal Bank of Scotland Group PLC.

In researching value stocks, Tattersall relies primarily on in-house “numbers” analysis. His key criteria include low price-to-book value, low price to cash flow and a reasonably strong balance sheet.

He says his portfolios are widely diversified because not all of his picks are going to work out. Saxon World Growth holds a mix of 60 to 80 stocks with a maximum weight of about 5% in any one holding. The cash position is characteristically 3% to 6%. Tattersall doesn’t hedge the fund’s foreign currency exposure, which has hurt his returns.

Saxon World Growth’s current roughly one-third weighting in U.S. stocks is lower than usual for Tattersall, who admires the entrepreneurial spirit in the U.S. The rest of the portfolio is mainly spread out across Europe, Asia and Australia. From a sector point of view, “we’re probably most heavily weighted in consumer and industrials and modest in energy and resources,” he says.

Tattersall follows a buy-andhold philosophy. He estimates that on average his annual portfolio turnover is about 25%. His sell discipline is triggered primarily when a target price is reached, or when a company’s fundamentals have deteriorated.

Tattersall, 60, now emphasizes the word team, especially since the firm merged in 2003 with an investment management company owned by the Canadian Medical Association, with the CMA retaining a majority stake.

The latest development, announced on Aug. 5, is a friendly takeover offer by IGM Financial Inc. Under the terms of that deal, Tattersall reaffirmed the agreement originally made with the CMA – to remain with the firm until Dec. 31, 2010. Yet, succession planning has become a prime concern, so, Tattersall now works with three other managers on Saxon World Growth, and with two others on Saxon Small Cap.

Looking ahead, Tattersall expects a more favourable environment for value investing to emerge. “Value has been out of favour for a year or more and the market is being driven by an ever-narrowing group of stocks in Canada,” he says. “This is not sustainable and value stocks are the place to be today, precisely because they have recently under performed.”

Diana Cawfield is a Toronto financial writer