Q: What is your research process? How do you identify a stock’s price momentum?

A: For 90% of the portfolio, our research process involves looking at the universe of Canadian mid-to-large cap stocks and scrutinizing their share price chart.

Our proprietary model was built with the help of Thomson Financial. Based on accelerating price performance we rank all the Canadian equities, income trusts and stocks from one to several hundred. We then pick the top 60 stocks. However, if we were to get into a bear market situation where there weren’t 60 stocks that had positive price momentum then we would own fewer than 60 and hold the rest in cash.

Next, in this list of 60 stocks we make allowances for sectors so that we are not unreasonably overweight or under weight in any particular sector. For example, through most of 2006 to 2007, the financial services sector performance was sluggish compared to that of energy and mining. Since we cannot be completely out of the largest sector in the country, we selected a few of the best performing among financial services stocks for our portfolio, although we were still dramatically underweight.

Again, if, on running our model we find there is a stock that qualifies because of its superior performance, but has just been the subject of a takeover, we will not consider such a stock because we are looking for companies that are still trading and will be likely to continue trading indefinitely.

Our model thus tells us the longer-term gains or momentum in price and also gives the recent short-term price momentum. It could be the stock price is lying to us but we would rather the stock price lie to us than the management. For instance, in the late 90’s, and early part of this decade, there were a lot of managements from whom we couldn’t get straight or accurate answers.

We believe the market probably knows better and is prepared to tell us what is going on in some cases, than the management. But again, we are not fully sure that a stock’s price momentum will continue. We are just playing the averages and so far, they’ve worked out in our favor.

Q: How do you go about portfolio construction?

A: Our portfolio comprises the 60 best performing stocks that are diversified across sectors, based on our proprietary model, allowing for reducing a few companies and adding a few just to provide some sector balance. In the last two to three years the fund was heavily weighted, about 60%, in resources. Lately however, this sector has fallen relative to others, to about 44%. The fund is bigger than market weightings in sectors like consumer staples, equal to market weighting in information technology and industrials and very low weighting in financial services. There are also a number of sectors that are relatively small, about 1% or 2% of the index.

In the portfolio, a position would initially start at about 1½% to 2%. We let our winners run as high as 5% of the portfolio. However, we remain disciplined and true to the chart and as long as the stock continues to be true to its track record, we’ll just keep letting it grow. Examples of momentum stocks are Sino-Forest, Major Drilling, and Petrobank Energy which would be our 2%, 3% and 4% respective holdings in the current portfolio.

We rebalance at least quarterly, sometimes more often, especially if there’s been a permanent change to a stock. For instance, if the company has been taken over or there has been a fundamental change in the company business, and likelihood of turnaround in the near future is remote.

Our benchmark is the S&P/TSX Composite Index. We’re really looking at the weighted average of a stock’s performance over two years with greater emphasis placed on the recent time periods. Therefore, we are hoping for a chart that looks like it’s concave, and with accelerating growth. By the time it comes into our model, it’s trading above a 200-day moving average. If we do this calculation for 60 stocks, a percentage of them may underperform the market and remain volatile. However, if we take the large majority of them in a market that has any sort of trend established then the majority of stocks will give a better-than-market performance.

Q: What is your buy-sell discipline?

A: Buy-sell decisions are strictly based on the price chart of the past two years. Therefore, we try to buy and own a stock that is already performing well, and continue to accumulate that stock. Our sell discipline is to get rid of any stock in our portfolio that has fallen out of our model while their competition was still showing growth.

Furthermore, when we decide to sell, we generally exit the entire position. This means, if we owned a stock for a long time and it has grown from 1½% to say 4% of the portfolio, when we sell, it would be that entire 4% position. If a few months later it reappears on our model, we will buy it back at the 1½% level again and let it work its way back to being a larger part of the portfolio.

Q: What kind of risks do you see and how do you measure them?

A: This fund is concentrated in Canada and is leveraged to what is performing best in the Canadian market. Therefore, in the bull phase our fund should fare better than most other funds. If Canada were to underperform, on a global basis the fund would also under-perform but we believe it will still continue to outperform the Canadian market.

However, we face a lot of sector risks because we are not index managers. We often cap sectors at 100% overweight relative to the index, which means if there is a lot of volatility in the sector that we’re heavily overweighted, the fund will be more volatile than the market as a whole. Therefore in a choppy market, likelihood of risk is greater. If however, the trend is relatively stable and stocks that are doing well continue to do so, then the fund is going to outperform the market.

There is also a risk containment strategy inherent in our investment philosophy. This is connected with our refusal to stick with a stock or a sector or the market as a whole, if they are not performing well. The fund will, in a bear market, have increasingly fewer holdings and nothing at all if the situation is really bad. This way we avoid our clients’ capital from eroding gradually over time. Our fund is thus designed to protect clients against risks arising from long term difficult situations like the tech bust, the geo-political events, and the Enron and WorldCom scandals.