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April 2009

It was an erratic quarter for small-cap stocks. Following a miserable start to the year, North American markets enjoyed a strong rally late in the quarter. Thanks to strength in gold and resource stocks, the small-cap market (as measured by the BMO Small Cap Blended Index) advanced modestly in the quarter, gaining 1.3%. Over the past 12 months, however, the index is still down considerably, having fallen 43.2%.

The Small-Cap fund lost 6.2% in the quarter. Over the past year, it was down 31.3%. Looking back two years, the fund was down 12.9% per annum during a period when the BMO Small Cap Blended Index dropped 27.8% per year.

In a gloomy economy, a healthy balance sheet and profitability are key to survival, particularly for smaller businesses that have limited access to credit. By and large, the fund’s portfolio of 15 businesses continues to generate strong profits, despite stock prices which suggest otherwise. But value is never recognized overnight and it can often take a number of years for a small company’s stock price to catch up to its true worth. Moreover, returns in the small-cap market often come in unpredictable patterns, which is why we re-inforce that investors should have a suitable investment time horizon (at least 5+ years) and a high tolerance for volatility.

There were no material changes to the portfolio during the quarter. While there were some attractive opportunities in early March when the markets were touching new lows, the manager of the fund (Wutherich & Company) was quick to point out that the portfolio was already full of screaming buys. To paraphrase, ‘there’s no need to go after a faster horse when you’ve got a stable full of thoroughbreds’. Clearly, Wutherich & Co. likes the current line-up. That said, there are some names in the bullpen that they are narrowing in on. They’ve maintained a fairly high cash position (14%) with this in mind.

The fund’s greatest burden on performance was Vecima Networks (-31%), a manufacturer of communications products that serve the broadband market. We’ve highlighted Vecima in past reports, as its stock price tends to fluctuate sharply due to its illiquidity. There were no alarm bells with the company in the first quarter. Indeed, management reported good numbers and the outlook for the business and industry remains positive.

Badger Income Fund and Stantec also had a rough quarter, falling 22% and 24%, respectively. The two infrastructure-focused companies held up relatively well in 2008 (short-term volatility notwithstanding) but have thus far been unloved in ’09. They remain fundamentally sound businesses that continue to generate strong cash flows.

While there was nothing positive to report last quarter aside from the potential opportunities that were emerging, there were some advances worth noting this quarter. Hanfeng Evergreen (a specialty fertilizer company that was re-introduced into the portfolio last October) recorded a strong gain (+29%), while Hibbett Sports, the fund’s lone U.S. holding, also advanced (+22%). The sporting goods retailer has gained over 60% since last November.

Aside from Winalta, the manager purchased additional shares in every existing holding in the fund during the quarter. Wutherich & Co. has a lot of conviction in the portfolio and is comfortable adding to their best ideas at current valuations.

The fund’s cash position has edged up slightly and, as mentioned, now stands at 14% – a level that helps mitigate volatility and provides an ample reserve to add a new stock or two to the portfolio if desired.