Martin Ferguson, director and portfolio co-manager of Canadian small-capitalization equities with Calgary-based Mawer Investment Management Ltd., always keeps one eye on the horizon, scanning for the next generation of up-and- coming small-cap opportunities. The other eye is firmly fixed on the portfolio he has in hand.
“The world of small-caps is dynamic, and company business models are changing and maturing quickly,” says Ferguson, Investment Executive‘s 2013 Mutual Fund Manager of the Year. “Small companies have the potential to grow faster than large-caps, but there’s also more risk and they are harder to value. Small-caps are exciting – and more analysis is required.”
The $1.13-billion Mawer New Canada Fund, which Ferguson has steered since 1996, has had an impressive run under his guidance. As of Oct. 31, the fund’s 15-year average annual return was 16%, a far superior performance to either the 10.4% return generated by Morningstar Canada‘s median small-cap fund or the 6.9% earned by the BMO Nesbitt Burns small-cap index. The Mawer fund also outperformed the index and the category over one-, three-, five- and 10-year periods and has a history of low volatility. Its management expense ratio is a relatively slender 1.43%.
Mawer New Canada Fund is no longer open for new investments. With $2.1 billion in assets under management (AUM) in Mawer’s Canadian small-cap portfolios, Ferguson must watch that the fund doesn’t gather so many assets that he cannot invest in the small but less liquid companies that have yielded such strong returns.
“Limited liquidity is one of the weaknesses of small-cap stocks, but it’s also a strength,” says Ferguson, 53. “It can be hard to buy and sell certain stocks quickly. We now are of a size where we have big feet and need to be on guard against getting trapped in a company. The good thing is that there are fewer eyes on small-cap stocks – they are not widely covered by analysts. There are more inefficiencies in small-cap pricing than in widely followed large corporations, which means there are more opportunities to find undervalued situations.”
Ferguson defines his small-cap universe as companies with a market cap of about $50 million-$1.4 billion. There are roughly 500 companies in this universe, but he restricts his portfolio to 40 to 60 stocks because he likes to take meaningful positions in individual companies. He also combs through the larger “hunting ground” consisting of the hundreds of companies with a market cap of less than $50 million, looking for potential candidates that may “percolate” and eventually qualify for his fund.
Simply put, Ferguson looks for “wealth-creating companies with a strong competitive advantage.” Candidates for investment must be able to generate a return on capital superior to their cost of capital over time.
As part of Ferguson’s risk-management regime, he won’t allow any company to account for more than 6% of the Mawer fund’s AUM, and limits his exposure to any one industry to 20%. He’s not concerned about matching the benchmark index weightings, and will avoid a sector entirely if he doesn’t see attractive opportunities.
“We’re bottom-up investors and do extensive due diligence,” Ferguson says. “We also do scenario analysis to evaluate a company’s vulnerability to changing conditions. We want companies that will survive in almost all scenarios and excel in most scenarios.”
Ferguson is willing to own a big piece of a firm; thus, the Mawer fund holds more than 10% of 17 of the 51 companies in its portfolio. Holding these large positions requires meeting some regulatory disclosure requirements on Mawer’s part, but Ferguson believes the paperwork is worth it.
Before Ferguson makes investment decisions, he likes to meet with a target company’s managers and assess their abilities, looking for an alignment of interests with the firm and consistency in word and deed. Says Ferguson: “Honesty, openness and transparency all play into it. We look at management’s strengths and weaknesses and try to judge how [the investment] will play out. Some people are great operationally or may be great salespeople but may not be financially astute or they may lack a good support team.”
Once Ferguson decides to invest in a company, he prefers to hold it for the long term. (His average holding period is slightly more than five years.) Although small-caps typically trade at a discount to large-caps, he says, the discount narrows as the revenue and earnings increase, creating additional positive forces on the stock price.
“The good companies grow over time,” says Ferguson. “And as they get bigger, they pick up more analyst coverage and are better followed. Liquidity improves and the discount disappears. It all works in small-caps’ favour.”
Ferguson entered the investment business by joining Alberta Treasury (now Alberta Investment Management Co.) after graduating from the University of Alberta with a degree in business administration and commerce in 1982. He later worked for the Principal Group of Cos., a financial conglomerate that collapsed in 1987, for two years, then returned to Alberta Treasury. By the time Ferguson left Treasury to join Mawer in 1996, he had expertise in both U.S. and Canadian stocks.
At Mawer, Ferguson originally managed both large- and small-cap Canadian stocks. In 2000, he turned his focus exclusively to small-caps.
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