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Stephen Arpin is one of the managers of the Beutel Goodman Small Cap fund, which managed to beat its peers in 2016.

For fund managers who specialize in beating a slumping market, the Canadian small-cap space has provided the ideal backdrop in recent years.

Over a five-year stretch starting in early 2011, smaller Canadian stocks were mostly lost in the wilderness, at least on an index basis. The long fall in commodity prices dragged the small-cap space into a sustained correction that wiped half the value from the S&P/TSX SmallCap index.

Finally, 2016 delivered a year of decent returns. As commodities staged a rebound, Canadian small caps outperformed large caps for the first calendar year in six, and by a wide margin.

In both good times and bad for small caps, the Beutel Goodman Small Cap fund managed to beat its peers.

"They built a portfolio resilient enough to weather 2015's lousy environment … but with enough get-up-and-go to outpace its competitors in 2016's racier market," Morningstar wrote in a report naming the fund's managers, Stephen Arpin and William Otton, its Canadian equity fund managers of the year.

The Globe and Mail spoke with Mr. Arpin about how to play defence without missing out on too much of the upside.

How much different did 2016 feel after the prolonged crash?

We were fairly constructive coming into last year. But it was gratifying to see small caps outperforming. There has been valuation pressure on small caps for a fairly long period of time.

How challenging were those lean years?

For us, not that challenging. That's reflective of how we invest and our bias toward quality. We are long-term focused investors. We look for 100-per-cent potential return, or put another way, trading at a 50-per-cent discount to intrinsic. The other piece is our sell discipline. You need to take money off the table when a business gets to full value.

How does that process help limit downside exposure?

We have a focus on sustainable free cash flow and businesses with significant franchise value. That means you tend to be underweight resources. They don't have control over the price of the product they sell. The only advantage you can have is the cost structure. And in general, it's hard to find low-cost opportunities in the materials space, and particularly, the energy space. So we definitely look for a lot of opportunities outside the resource space.

How well did that work through the commodities correction?

It worked very well, and you can see that in our numbers. It's critical to avoid catastrophic loss. If you look back over time, there have been many small-cap managers in Canada invested in businesses that are overpriced or not sustainable. The result has been big, big losses for investors – 50-per-cent plus of going-in capital. Psychologically for investors that's hard to take. And they sell at the bottom. Our portfolio has excellent downside risk control. We were one of the best performers in Canada in 2008.

What were some of your best non-resource performers through the downslide?

Uni-Select and CCL [Industries]. Both are superior cash-flow generators and they have good balance sheets – just the kind of businesses we're looking for.

Where in the resource space have you found value?

In the energy space, we've been biased toward liquids-rich gas companies.

And in materials, it's led us to a significant ownership of packaging companies like CCL, Winpak and Intertape [Polymer Group].

As commodities have led the small-cap rebound, have you missed out on some of the upside?

In 2016, materials and energy returned 60 per cent. So it was difficult to outperform unless you were overweight those sectors. Most managers underperformed the benchmark.

Are you willing to forgo some returns in up markets in exchange for protection on the downside?

Yes, we've added very substantial value in down markets. And I think that preservation of capital validates being focused on good businesses trading at a discount to what they're worth and having risk controls at the company level.

Having put in a respectable rebound over several months, how is the small-cap space positioned now?

Economically, things are reasonably good, employment is relatively full, there's not a lot of risk in general in the U.S. in terms of big economic drivers like housing prices. So we're reasonably optimistic. Interest rates are still very low, so there's not a lot of competition with equities from the bond market.

This interview has been edited and condensed.

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