Canada Connection: Advantage, small-caps
At the half-way point of 2007, Canada’s small-cap fund managers have extended their winning streak.
For the third consecutive quarter, the country's small-cap managers outperformed their counterpart large-cap managers, according to Russell Investment Canada's report for the second quarter ended June 30. (Based in Tacoma, Russell Investment Group says it advises institutional clients with total assets of over C$2.0 trillion. Russell follows 31 small-cap Canadian funds and 75 large-cap ones.)
Kathleen Wylie, Russell's senior research analyst, said in her review that the median small-cap manager returned 7.1% during the most recent three-month period, compared with the median large-cap manager return of 6.4%.
That is largely because Canadian small-cap managers won out by having a smaller weight in the broadly underperforming Canadian financial services sector. Small caps had an average of 14% in that sector, compared with 30% for large cap.
As well, small-cap managers on average had roughly 12% of their portfolios in the positive consumer discretionary sector, compared with only a 5% weight by large-cap managers.
Wylie noted that despite the rally in resource prices such as oil and base metals in 2005 and most of 2006, small-cap managers still lagged their large-cap counterparts.
"However, we're half-way through the year and I'm still more encouraged by the active management environment (among small-cap managers) now than I have been in the last couple of years when the market was dominated by resource stocks," she said.
On average, small-cap managers were also helped by having more than double the weight in the outperforming industrials sector in their portfolios, Wylie said.
At the same time, Canada's most prominent small-cap resource sector – the oil industry – managed to raise C$10.2 billion in capital during the first six months of 2007. Ryan Ferguson-Young, an associate with Calgary's Sayer Energy Advisors, said this us up 40% from the US$7.3 billion during the same period in 2006.
Much of that was raised by small-cap energy producers in both debt and through Canada's royalty income trust or “RITS.” RITS have been popular among U.S. and Canadian investors since income is moved to investors in the form of dividends, which are taxed at a lower rate.
Ferguson-Young said the largest single equity issue in the first six months of 2007 was the C$200 million private placement by Bayou Bend Petroleum Ltd. (CVE: BBP), formerly Kit Resources Ltd.
Bayou is focused in the Gulf of Mexico shallow water shelf area and has interests in Louisiana near Marsh Island and holds interests in several offshore Louisiana and Texas leases. It trades at about C$2.00 and has a 52-week range of C$0.64 to C$3.00. Analysts have not pegged a one-year target estimate.
Ferguson-Young said other “notable” financings during the first half of the year were for Canadian small cap companies with an international focus.
First Calgary Petroleums Ltd. (TSE: FCP), with operations in Algeria, raised C$152 million in equity during the first half of this year. It trades at about C$5.50, closer to 52-week low of C$4.05 than its high of C$10.05.
Low Canadian interest rates prompted many small-cap companies to finance through debt rather than equity during the first half of the year. Debt financing by small cap Canadian oil companies totaled C$4.7 billion, up 74% from the C$2.7 billion during the same time period in 2006.
“Greater attention may be given to the attractiveness of utilizing debt over equity as debt continues to be relatively inexpensive despite the interest rate increase by the Bank of Canada on July 10th,” said Ferguson-Young. “With the Bank of Canada meeting again in September another hike may occur making the use of debt less appealing.”
