IE’s pick for 2004 has built an enviable 10-year performance record — and he has done it with no hype or hoopla

By James Langton | December 2004

Investment executive usually knows better than to offer financial advice, but here’s a hot tip nevertheless: in the next few months one of the best-performing mutual funds of the past 10 years will close its doors to new money.

Brokers and planners willing to step away from the heavily marketed, brand-name funds should check out IE’s Fund Manager of the Year for 2004 — Francis Chou, of Toronto-based Chou Associates Management Inc.

The publicity-shy Chou, 48, has quietly been running Chou RRSP Fund since 1986. In that time it has consistently produced solid, market-beating returns, the sort of numbers needed to earn IE’s annual award.

Despite its name, our award focuses on funds with superior 10-year track records. We look for funds with strong, consistent performance and relatively low risk profiles. We screen all funds with a 10-year record on a purely quantitative basis, using data from Morningstar Research Inc. — awarding points based on relative annual returns, quartile rankings, cumulative return, MER and beta.

Chou’s funds are just the type of standout performers our screening model is designed to highlight. Chou RRSP Fund has returned almost 400%, cumulatively, over the 10 years ended Oct. 31. In that time, it has had just one down year, a modest 6.7% retreat in 1999 — a year in which the overall market lost all rationality and dumped heavily on the sort of dogs that Chou prefers in favour of wildly overvalued Internet stocks.

Including the blip of ’99, the fund has beaten out the average Canadian equity fund and been first- or second-quartile in six of the past 10 years. It ranks in the first quartile over the three-, five- and 10-year periods ended Oct. 31, and its average annual compound return for the decade is 17.3%, compared with 9.4% for the S&P/TSX composite index. All this and an MER of just 1.83%.

Proving that it’s not a fluke, Chou has produced similar results with his U.S. equity offering, too. Chou Associates Fund returned about 350% in the same 10 years, beating the average U.S. equity fund and ranking it in the two top quartiles six times. It boasts a 10-year average annual compound return of 16.2%, compared with 9.9% for the benchmark Standard & Poor’s 500 composite index, and carries an MER of 1.87%.

More recent additions to the Chou lineup — a fund focused on Asia and one that targets Europe —haven’t been around long enough to put them in the same company as the flagship funds. If past performance has any predictive value, however, Chou will have even more winners.

How does he do it? By flying beneath the radar, in terms of both stock selection and marketing. He focuses on highly undervalued companies and keeps the fund small, which ensures that smart calls are rewarded by having a meaningful impact on the portfolio.

Chou screens about 2,000 names and looks at basic financial metrics, including price/earnings and price/book ratios and strong balance sheets. He may find 20 to 30 names that he deems “worth looking at.” He then looks for opportunities in which firms are 40%-50% undervalued.

Undervaluation alone isn’t enough, however. Chou also demands a “margin of safety,” ensuring that while a company may be undervalued, it has the genuine intrinsic value of either solid earnings power or hard assets that aren’t depreciating. Some undervalued companies are undervalued for good reason, but others have real assets or earnings to back them up.

Even then, he is very strict about buying only bargains. “Will I pay up for a stock? Absolutely not!” he laughs. “I would rather lose half my unitholders than lose half my unitholders’ money.”

Adhering to such discipline also means that Chou feels no need to be fully invested. The RRSP fund recently had about 40% in cash. Nor are you likely to find any big-bank stocks in his portfolio. Top portfolio holdings, according to the fund’s latest regulatory filings, include MCI Inc. (the former WorldCom), Royal Boskalis Westminster NV (a European dredging contractor), retailers Liquidation World Inc. and Danier Leather Inc., and Descartes Systems Group Inc.
Chou has also traded the troubled Hollinger Inc. in the Canadian fund, and the recently restructured Kmart Holding Corp. in the U.S. fund.

In dallying with such names, Chou also makes bets on management. Apart from all the quantitative analysis that goes into assessing a company, good management is also key when playing the value game.
While Chou claims no industry specialization, he may have some special insight into telecom firms such as MCI, given that he worked as a technician for Bell Canada before he took to managing money in the early 1980s. He has since earned a CFA designation.