This compares to a 49%

Lynn Miller:
Focus on Small Cap Funds
INTERVIEW/THE QUEENSBURY REPORT

by Joe Chisholm ~
This article first appeared in the March 2000 issue
of the CAIFA Toronto NEWS

DOES THE WORLD LEADING performance of the Canadian stock market revolve solely around Nortel? Not according to Lynn Miller, man ager of the AIM/Trimark Enterprise Small Cap Fund. Launched in June of 1999, this fund was up over 95% (at the time of this article going to press).

This compares to a 49% increase for the TSE 300 year-over-year and the "Nortel-less" Nesbitt Burns Small Cap index year-over-year of a meager 12%.

Lynn Miller started his career 15 years ago in a fund research pool with the Mutual Group (now Clarica) and soon was managing a small cap fund for the pension group. He later ran a small cap fund for Spectrum United Mutual Funds.

When C.A. Delaney Capital Management (Catherine (Kiki) Delaney and Lynn Miller) were contracted to Trimark, the Enterprise Funds were formed. These two funds were made available in both the Mutual Fund family and the Trimark Segregated Fund family (now closed to new investors). The following is a summary of an interview with Lynn Miller and his views on the Small Cap Market:

How do you define the universe of small cap stocks in Canada?

In Canada we define small cap as under $500 million. In the U.S. we look upwards to $1 billion. That said, there are some Canadian holdings in the $500 million to $1 Billion range that our team will debate as to whether it should be in the Enterprise or the Enterprise Small Cap but we have made a conscious decision not to overlap any holdings.

What do you do with a Small Cap holding that matures out of your definition of "Small Cap?" Do you migrate it to the Enterprise Fund?

Descartes Systems Group is a good example. Last year as we were acquiring the stock its market capitalization was about $200 Million, and right now it is $2 or $3 Billion. Would we initiate a position in Descartes now? No, not in the Small Cap fund. But from our perspective, we won't "shoot" something for being successful. We still see a great upside to this stock for earnings going forward and we will continue to let it run.

Will your fund participate in Initial Public Offerings?

Yes, I have no objection to IPOs if the numbers look right. In fact, about 75 holdings held in the fund may be up to 15 pre-public positions. They represent about 7 or 8% of the total portfolio.

You have out-performed your peer group and the index by a dramatic margin. To what do you attribute that out-performance? Are your holdings significantly different than those of your competition or were you just lucky in picking last summer to start the fund?

I have to believe that the holdings inside this fund are different although there would definitely be some overlap with other funds. Sure, if there was a right time to start this fund it was last summer and yes, luck was with us. We have hold-ings that have beaten our expectations but we have also picked stocks that have disappointed. We had a great run from inception to the middle of March. From mid-March to mid-August we had a tough period. From then until now we are on a roll again. Who knows what direction it will go in the short term.

With small cap stocks you have to have a long-term view. The cycles can be vicious on the down side and dramatic on the upside. 1998 was a dreadful year. I quite liked the stocks we owned in the Spectrum fund we managed but they kept going down in value. They picked up in '99 and when we started to create the new Enterprise Small Cap fund we picked many of the same holdings. Many of those same names that brought us down in '98 became recognized by the market and took off for us. The point is that you really need a longer perspective than just one year, especially with the Small Cap market.

What do you expect for the Small Cap market going forward?

Macro-economic fundamentals in Canada remain very positive. We expect the Canadian market to continue to reflect a powerful and broadly based earnings recovery. Small Caps, we believe, are coming out of a seven-year cycle of under performance. Smaller companies are less bureaucratic and more adaptable to changes brought about by competitive pressures or economic change. I feel that investors will be rewarded over the next 12 months for holding equities.

Large Cap funds have had a great run lately and in some cases, at the expense of smaller cap funds. A preponderant of Large Caps would say that this is a new economy where the big will keep getting bigger and there is no second place ribbon. What is your rebuttal to that?

Well, there is a lot of truth to that statement in certain sectors but not others.

For instance, you will find very little interest sensitive stocks in my fund. In the context of the Canadian market everything is big. There is very little to pick from in the small cap arena in financial services. The resource sector as another example, offers many attractive companies from a price to earnings, price to book or price to sales basis. You can be a very successful company in this sector and still be a small company.

You preach from the pulpit of the valuation when it comes to stock picking. Are you a traditional "value" manager?

I think "eclectic" would best describe our style. Going back to Descartes this wouldn't be a value play at its current price. But this is, in my mind, the best managed technology company in Canada. They are the world leader in what they do. Our expectations for future earning allow us to see more upward potential and in this case we can tolerate higher PE ratios. But that said, when the stock price started heading towards $100 we were uncomfortable enough that we sold some off only to buy back when the price was within our target range. Volatility has caused the turnover in our portfolio to be high. One day a stock price can be ridiculously high and we will sell. The next day it could be ridiculously low and we will buy.

As a portfolio manager you are a "tire kicker." You like to get out and meet the management team of the companies you buy. Is that why your foreign content is limited mainly to the U.S. where you can get out to see these companies?

Very much so. Even in Canada, it is rare to sit down with the management of any company, sit down and look at their three or five year plan and not see foreign markets as part of their marketing initiative. Our low dollar is an opportunity that many companies are seizing. So, whether the company head office is in Canada or the U.S. they often have revenue streams that are international in scope. Because there is so much to choose from in Canada and south of the border it is rare to see an international name in the Enterprise Small Cap fund. Right now my foreign content sits at about 14%. In March it was about 20%. I am not pre-occupied with foreign content. I buy on an "opportunity" basis and there are still lots of names that I am interested in here in Canada.

I buy companies and not just stock. We require the best information available and I feel that we are as good as anyone in the marketplace at interpreting that information. So to get the best information we have to visit and re-visit the management of our holdings or perspective holdings. This, I hope, will allow us to make better decisions.

Conclusion

This fund is well suited for investors with a higher than average risk tolerance and a long time horizon. Consider this fund for RESPs or for a young investor dollar cost averaging into the fund. Even in more conservative fund portfolios a modest position in small caps offers diversification that will ensure higher return and over a long enough time, provide less volatility. If you would like to find out more about this fund try www.aimfunds.ca where you can view a video interview where Lynn talks about some of his holdings and discusses his investment style. Also you can download advisor's comments, performance and current holdings.