Top 10 performing funds, Part 4

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Remember when gold traded at $250 an ounce? Or oil fetched $9 a barrel? It wasn't so long ago. That was also when Nortel commanded a share price north of $120.

The world — along with market leadership — has changed since then, and some managers have made the most of the new environment. Front Street Capital's Norm Lamarche — whose Front Street Special Opportunities Fund has sported a 26.5% annualized return since he took the reins in 1999 — is one of them and he tops our list in the natural resources category.

Though he's had success in natural resources in the past, with Altamira in the early 1990s, Lamarche's track record has a unique distinction. He also manages the top-performing small cap fund in Canada, Front Street Growth, which has chalked up an 18.3% annualized return since he launched it eleven years ago.

The two funds are roughly similar in performance and sector composition — and risk and beta, with a standard deviation of 40% and a beta of 1.2 (against the BMO Nesbitt Burns Small Cap Index) for the Growth fund and 35% and 1.1 (against the natural resource peer index) for the Special Opportunities fund.

But Lamarche is trying to look beyond indexes. "The index is a representation of stocks that have been successful in the past," he says. "We're trying to identify what the index is going to look like in the future. And to look at the forces that have been reshaping the index."

His funds' success stems from this approach. "We're very much thematic. We've very much big picture, for both funds."

It's the themes that determine the future shape of the indexes, provided companies can capitalize on them, he points out. "You're trying to identify those big macro forces, whether they're economic, whether they're geopolitical, industry themes, technology themes, anything that's going to create these economic forces that will allow companies to do well and to outgrow their peers to the point where [they] would be included [in the index]."

While commodities have been the dominant investment theme of the 2000s — just as tech stocks were in the 1990s — themes change or become more refined, Lamarche adds.

"Sometimes it can be subtle changes, other times it can be significant changes. There have been some long-standing themes in the last 10 years that have had a predominant impact on how we've constructed the portfolio. For example, this whole industrialization of the emerging nations — the BRIC nations, China, India, Russia, Brazil — that's had a profound impact on the economic landscape worldwide. You look at the news today and one of the headlines is about how China has become the world's largest energy consumer, even beyond what America consumes. That's significant. No one would have thought that 10 years ago."

But relating themes to investments means foregoing big-cap stocks and sometimes reaching down to the Toronto Venture Cap Exchange for Lamarche, who runs fairly concentrated portfolios. The Growth fund is a small-cap portfolio, while the Special Opportunities fund digs a little deeper into riskier, micro-cap names — junior and emerging companies often started by industry veterans who become serial entrepreneurs.

"There are certainly a lot of names in the index that we don't own, but the ones that we do own, we own a lot of. For example, if I really like the asset management team and the opportunities in a certain company that could represent 0.2% of 1% of the index, I can tell you I'm going to own more of that." As a result, he says, "the top 10 holdings of the Special Opps fund probably account for 40% of the portfolio."

Lamarche's current task: looking for companies capable of ramping up production to meet demand faster than their competitors. "You want to own what people want and these emerging nations want a lot of basic materials," he explains. "You also want to be in commodities or in areas that are in short supply... If you can combine a great growth profile in a product or commodity that has some stickiness in supply, I think you've got a great double whammy there."

But can big caps deliver?. Oil, for example, is in great demand, but ExxonMobil, Shell and the other majors can't grow their production base fast enough. At the same time, commodity demand is cyclical.

"You look to invest in things that can outgrow cycles and not be dependent on cycles, to get your return over longer periods of time." That doesn't work for big caps. If you're investing in the big caps, you want economic growth to fuel higher commodity prices to make the game work. There's a higher correlation between share price performance and commodity price performance. I'm not interested in that kind of stuff. I'm happy to see commodity prices rise higher — but I want to be in companies that can grow their production even in a slack commodity environment."

His method includes staying with those companies, sometimes for a long time. "It's not unusual for us to hold on for five, seven, even 10 years sometimes. Now, we'll trade around core positions. Sometimes we think the valuation is euphoric and we'll let them go. The world also gets exaggerated on the downside as it did late in 2008 and in 2009, and so you buy some more. You're never right with respect to timing or names, but a lot of the core names we've owned for a long time. If management continues to deliver and if we continue to see prospects with the assets, there's no reason for us to exit the names. So we're sticking with good stories."

While Front Street may be a good story, "We certainly always suggest that people use our funds for a small part of their portfolio," says Lamarche. "We're patient investors. We invest in long-term themes that play out over periods of time. We invest in companies that are building businesses. It doesn't happen overnight and you're never always right. You've got to stick to your views, however painful it can be sometimes."

(07/23/10)