"Our foundation is in institutional accounts," says Thomson, senior vice-president, Canadian equities, and director of research at Beutel Goodman & Co. Ltd., "so preservation of capital is number one, which is congruent with value investing." He says some people can't resist taking advantage of a bull market in its final stages, "but the ability to capture bull market returns in Canada is very limited."
As head of the Canadian equity team, Thomson is responsible for the large-capitalization mandates. He has managed the retail version of his domestic mandate, Beutel Goodman Canadian Equity , since September 1999. He is also co-manager of Beutel Goodman Balanced , as well as Hartford Canadian Dividend and Hartford Canadian Value . His assets under management in Canadian large-caps total about $4.8 billion.
Thomson's conservative investment discipline may be a drag in heated markets, but he's more than made up for lost ground during market downturns. The fund's risk-adjusted performance has received a 5-star Morningstar Rating, and the fund has earned a spot among the Morningstar Fund Analyst Picks. During Thomson's 10-year tenure, Beutel Goodman Canadian Equity has returned an annualized 8.1% to Oct. 31, two full percentage points higher than the median return in its peer group.
Beutel's bottom-up investment process is significantly skewed to evaluating free cash flow, which Thomson says is considered the "greatest marker of quality" for any business. His experience has been that companies that generate free cash flow tend to have recurring streams of high dividends.
Accordingly, Beutel Goodman Canadian Equity's portfolio of 30 to 35 holdings is grounded in large and growing dividend-paying companies. Five of the fund's top 10 holdings are financial-services stocks. Thomson considers financials the most profitable businesses in Canada, and he says that as stocks they never get too expensive for the fund to hold. "Their industry we view as very foundational and core in building a portfolio," he says.
About 20% of the fund is held in the energy sector, with an emphasis on natural gas rather than oil. "That actually hurt us this year," says Thomson. "We think gas is very depressed relative to oil and we view EnCana Corp. (ECA ) as basically the best run company in Canada on the energy side. It's trading at a significant discount to what we think it's worth, even in this environment."
The 56-year-old Thomson, who grew up in the small town of Kitimat, B.C., has an unusual background for an investment management executive. He attended the University of Victoria for a year before transferring to Washington State University, where he earned a bachelor of fine arts in 1979. He then went to Mills College in Oakland, where he obtained a master's degree in fine arts.
After graduating in 1981, Thomson taught art at the college and practised as a sculptor. Pursuing a long-time interest in investing, Thomson joined a small investment firm in Seattle in 1984 as a broker, and then began training as an analyst within six months.
In 1986, he joined Pemberton Securities Inc. in Vancouver, working on product development. Within a year, he took over management of the firm's proprietary U.S. mutual fund. Then in 1990, he moved to Toronto, joining Beutel Goodman as an analyst and portfolio manager. During that year, he also obtained his CFA designation.
While Thomson gives the final nod on Beutel's equity buys, he emphasizes that the investment decisions are very much the result of discussions with his four teammates. He considers the in-depth research process by the team members, all of whom are senior analysts, a competitive advantage.
Thomson says the team's bias toward cheap, high-quality companies "tempers the downside significantly, and these names also tend to be much more defensive, mature businesses." Also working in the Beutel managers' favour is that they are not constrained by the weightings of the S&P/TSX Composite Index. If an individual company or an industry sector is expensive, they will simply avoid it.
Thomson says that since the Canadian large-cap universe consists of only about 90 names, Canada is not considered a difficult market to cover. With the team's collective experience, they know all the businesses, what they're worth and what risks they face.
If the discount to Beutel's target price is sufficient to "get our minimum 50% return over three years," they will buy the stock, Thomson says. When buying a stock, they'll go up to a 6.5% weight in the overall portfolio. If the stock continues to appreciate so that it exceeds a 10% weighting, the position will be pared back.
A key element of the firm's sell discipline is that when a stock hits Beutel's target price, one-third of the position is sold automatically. In explaining why he won't let his winners run, Thomson says it's hard to sort out emotions, both in bear and bull markets, so some mechanism is needed to counter over-exuberance.
Thomson expresses confidence that under current market conditions, his portfolios are well positioned for long-term performance. "The more defensive names are trading at single-digit multiples," he says. "We believe we have the best companies in Canada trading at valuations that, in a lot of cases, are as close to lows as they've ever been."