IE fund manager of the year: Looking for fledgling companies

Date: Friday, January 15, 2010
Author: Jade Hemeon, Investment Executive

Lamarche is no index hugger

When Normand Lamarche, senior portfolio manager with Front Street Capital in Toronto, looks for investment opportunities, he tries to visualize the future composition of the S&P/TSX composite index. And if he is astute enough to identify even some of the emerging companies that will make up the index in a few years time, he will continue to be one of the brightest stars in Canada’s mutual fund management business.

“The index is dynamic, and its composition down the road will be driven by the industry themes, geopolitical themes, economic themes and government policies,” says Lamarche, who is also co-founder of Front Street. “Where there is a profit opportunity, companies and management teams will be motivated to take advantage of it.”

Lamarche has been selected Investment Executive’s Fund Manager of the Year for 2009 based on a sizzling 10-year performance record that has put his $280-million Front Street Special Opportunities Canadian Fund at the top of all investment funds ranked by Morningstar Canada. The fund showed a 10-year average annual return of 25.8% as of Oct. 31, almost double the 13.2% gain of the median Canadian natural resources equity fund tracked by Morningstar Canada, and far ahead of the 6.4% gain experienced by the S&P/TSX composite index.

Lamarche manages about $1 billion for Front Street, about half of the firm’s assets under management. Also included in his purview are Front Street Growth Fund and Front Street Small-Cap Fund, as well as some flow-through, offshore and narrowly based resources funds.

Although Lamarche likes to imagine what the composition of the S&P/TSX composite index will be, that doesn’t mean he is an index hugger. Instead, he has achieved his enviable track record by betting heavily on his favourite companies and staying away from sectors in which the opportunities aren’t exciting enough.

The Special Opportunities fund is categorized as a Canadian resources fund because of the makeup of its portfolio, but it has a mandate to invest across all sectors and in companies of all sizes. Lamarche takes advantage of the 10% he is allowed to invest in private companies, and sometimes makes use of his authority to go short in up to 20% of the fund. The fund has soared during the past year of volatile markets. For the year ended Oct. 31, it showed a gain of 102.7%, compared with 29.2% for the median resources fund and 15.7% for the broader market index. “It’s a fund every fund manager would love to run,” says Lamarche. “It can invest in anything. Decisions are driven both by broad industry themes and by pure bottom-up situations that come along and drive you to invest. We’re constantly looking to see how the landscape is changing, then moving to take advantage. The fund is a melting pot of new ideas.”

A lot of the “special opportunities” have been found in energy, mining and agricultural companies. Lamarche describes himself as “a guy who knows his limitations”: if he’s going to invest in technology companies, for example, they will likely be involved in a technology that applies to situations with which he is familiar. If he’s going to invest in financial services firms, his holdings typically will not be in the big banks, although he wasn’t afraid to step in when valuations fell during the recent financial crisis. Instead, the fund’s financial stocks lean toward the more entrepreneurial GMP Capital Inc. and Gluskin Sheff & Associates Inc.

Among Lamarche’s newer ideas are lithium-producing companies. Lithium is used in the batteries that power electric cars, and Lamarche expects demand to increase as cars move toward cleaner, more fuel-efficient designs.

“I don’t limit myself to any particular market cap,” he says. “And although, historically, I’ve been pegged into small-cap, I don’t get caught up [in that sector]. I’m driven by opportunities.”

The best opportunities tend to be found in what he calls “emerging situations” — fledgling companies in the early stages of their development. Because of Lamarche’s long history in the investment business, including the formative years he spent as a fund manager at Toronto-based Altamira Management Ltd. between 1987 and 1995, he has established a network of relationships with people who have been successful in the resources industry. Talented people may leave companies for various reasons, but will reappear at the helm of promising new ventures. Often, Lamarche will get involved when these companies are still private, providing early-stage financing before they approach public capital markets.

“Norm is in tune with commodities markets; it is very much his strength,” says Dan Hallett, president of Windsor, Ont.-based fund analysis firm Dan Hallett & Associates Inc. “His funds have financed a lot of junior resources firms. And he’s done well in the small- and micro-cap space.”

Lamarche says much growth and stock appreciation takes place in the early stages of a company’s development, but that is also the most risky stage. That’s why his top three criteria when looking at junior companies are “management, management, management.” The right managers will identify lucrative opportunities, get them funded — either with the support of banks or capital markets — and if they run into difficult situations, they have the skills and experience to find their way out. “When you get experienced management teams at ground zero, if they’ve run big companies before, they often demonstrate a tremendous amount of growth,” Lamarche says. “There’s a lot of management leverage in the early days. That doesn’t mean they will always be successful, but they bring the intellectual capacity — and that’s compelling.”

The focus on junior companies means Lamarche’s funds are more volatile than those that focus on staid blue-chips. Investors wishing to reap the superior returns that Lamarche can generate need to be prepared for a rocky ride. The Special Opportunities fund has been volatile, but with more volatility on the upside than the downside. Since inception, the fund’s best 12-month return has been a gain of 136.5% for the year ended Nov. 30, 2003; its worst has been a loss of 46.3% for the year ended Feb. 28, 2009.

The Special Opportunities fund has made a stunning recovery from the market dip of earlier this year: anyone who bought into fund at its low in February would have doubled their money. Lamarche attributes this gain to a decision to invest in companies with the best ability to recover once it became apparent that major world governments were going to prop up the financial system. This meant staying away from firms with excessive levels of debt, as well as those that were less leveraged but had debt coming due and would be forced to refinance in illiquid markets.

Because of the massive sale of securities that drove down prices, Lamarche’s fund was able to pick up shares in companies for less than the value of the cash on their balance sheets, which meant that the fund was getting machinery, equipment, resources in the ground and all the other assets for free. “As the world normalizes and we move toward higher growth, the replacement value of all these company assets will ultimately be reflected in their [stock] prices,” he says. “We feel comfortable about tomorrow; we will all continue to get out of bed every day and the world will ultimately need resources and agricultural commodities. Valuations got ridiculously cheap and did not reflect the cost of doing business, and prices are still playing catch-up.”

If there’s one thing that’s changed since Lamarche’s Altamira days, he says, it’s time he spends in solitude to reflect on the analysis that he reads and to contemplate the trends that are taking shape. At Altamira, he says, his office became a “revolving door” where he would be talking to people from early in the morning until late at night, with no time to digest what he was hearing: “Now, I like to sit back and think things through — and that means a lot fewer calls. I’m probably one of the hardest guys to reach on the Street. I read a lot of research material, but I don’t want to talk to all these analysts and sales guys. You can’t own everything, so I try to stay focused on the best companies and do a good job of harvesting them.”

Lamarche likes to keep a tight lid on his funds’ holdings, limiting them to 50 or 60 names. Currently, the top 10 holdings make up about half of the Special Opportunities fund’s assets and there is only about 8% foreign content in the portfolio. But he estimates that the lion’s share of the operations of the fund’s holding is happening outside Canada in such areas as Mongolia, Albania and China. Lamarche travels to these locales to meet with management and get a sense of the properties and the economic and political pulse.

“I love flying, and for me those long hours of air time are reading time,” he says. “Sometimes, I wish I could book a flight to nowhere and back — just to have time to read.”