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Time for a little unconventional thinking

Paul Sullivan

 

In my last column, I wrote about how growth is good, as in growth stocks, and I recall writing that it's no fun to "pick out the top-performing growth funds and assign some RRSP money to growth in a diversified portfolio that includes value stocks."

I damned the whole idea with faint praise, dubbing it "rational and sane." But seriously, there's nothing wrong with rational and sane, especially at a time when the market is in an alarmingly unstable frame of mind.

The main reason to look favorably on growth funds is that they allow you to pursue a growth strategy (that is, to find and buy companies that invest their revenues in expansion and therefore grow, at least in theory) with greater scope. You may know enough about one or two growth stocks, but even the most diligent investor doesn't have the time or resources to get around to all the opportunities, especially if those opportunities are offshore.

As well, growth funds are enjoying a bit of a renaissance after taking a back seat to value investing funds for the past five years, after being shredded by the tech meltdown of 2000.

Don't take my word for it: Here are a few choice quotes from experts around the world:

It may not be time to party like it's 1999, but it's a good time to engage in a little unconventional thinking. Investing in stable companies that pay dividends may be at the end of its cycle, according to Artemis, a British fund manager: "Although shares that can generate an income are still a good choice for the long term," it advised subscribers in a recent newsletter, "there are more opportunities to be found in companies that can invest for future capital growth."

A good argument for investing in growth funds is to look at the Canadian market with a steely eye. If you've been successful in the energy or the minerals sector, it's been a nice ride, but nothing lasts forever. It's a good time to look beyond the border to the U.S. or Asia and the farther you get from your own back yard, the more "rational and sane" it is to get behind a growth fund manager with a good track record.

It's instructive to see what some of those growth fund managers are up to. To me, the evidence reinforces the idea that it's time to extend our investment reach beyond the current Canadian trifecta of energy, minerals and gold. RBC has as recently as July changed the name of its $1.1-billion RBC Canadian Growth to RBC North American Growth, and unit holders have agreed to increase the allowable foreign content to 50 per cent from 25. That fund is run by Warner Sulz, senior VP of RBC Asset Management Inc. in Toronto, and he pursues a classic growth strategy for the fund — looking for emerging companies that may be riskier but have a greater potential performance.

If you've been reading Gordon Pape's estimable Weekly Insight on these pages, you'll note there's a trend among Canadian fund managers to take their profits from the Canadian market and start looking for bargains in the US, Asia and Europe. Gordon makes a case to go looking for top-quality U.S. stocks, and that's in accord with the thinking of Larry Puglia, who manages the $8.6-billion (U.S.) T. Rowe Price Blue Chip Growth Fund, who told Businessweek that the top 25 companies in the S&P 500 are as cheap as they've been in several decades.

If I have anything of value to add, it's that the much-heralded slowdown in the U.S. could be more of a belly flop than a soft landing, and those top-quality stocks may stay undervalued for the foreseeable future. When times get tough, the tough grow, and that's where to look for investment returns.

Growth investing is not for the faint of heart. Volatility increases because growth is all about revenue and if revenue declines, even slightly, there goes the stock. So you have to be prepared to stomach and manage volatility. Growth funds are less likely to lose all their value overnight. Diversification spreads risk across a number of industries or sectors. So if conditions are telling you to roam from the safety and familiarity of your own back yard and invest in unfamiliar territory, a fund may be a better idea than an individual stock.

Let me say that I still believe in investing in companies I know about and understand (trying the alternative — investing in companies of which you are ignorant and don't understand — seems ludicrous. So why do so many do it?) The next best thing is to invest in companies that a reputable fund manager knows and understands. Simply put, it's easier to evaluate the fund manager than the stock, when the stock is foreign, exotic, or otherwise unfamiliar.

We're looking for the same attributes in growth funds as we look for in growth stocks — market leaders, successful niche players, above average and sustainable earnings growth.

A word about MERs (management expense ratios), which are inordinately higher in Canada than in the U.S., a median of 2.53 per cent (according to Morningstar), and if you're only making 4 or 5 per cent, that cuts your returns in half. A good reason to buy individual stocks rather than funds, but that's only if you know what you're doing, which brings us back to the main purpose for looking for a fund in the first place. Index funds and ETFs (exchange-traded funds) are cheaper than actively managed funds, but they only work with the index in question is growing, which requires a bullish outlook at a time when the bears are back in town.

So all that remains is to go to www.globefund.com, and look for 5-star growth funds that aren't all about Canadian precious metals and energy. Remember, it's not what's hot today — it's what's going to be hot tomorrow…

Paul Sullivan is a longtime Vancouver journalist and president of Sullivan Media. He also writes for The Globe and Mail.

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