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Small-cap funds review: First-half 2018

Greg Dean's picture

Dear fellow fundholders,

The purpose of this letter is to provide you with an update on first-half results across the Canadian and Global small-cap portfolios. But first, I’d like to start by discussing an important upcoming anniversary that serves to highlight two key things: the benefit of taking a long-term approach when investing; and the importance of well-reasoned decision-making.

September will mark 10 years since I joined the investment management industry which has been a fascinating and challenging journey thus far. The opportunity to help build the very talented team of investment professionals at Cambridge and positively impact the creation and preservation of financial wealth for over 390,000 Canadians has been an absolute pleasure. We value each client and treat your money in an identical fashion to our own – as we are also significant holders of the funds we manage. I look forward with great optimism to the future of this industry and our firm amid our ongoing efforts to earn the trust of our clients with each decision we make each day.

Speaking of 10-year anniversaries, March 6, 2019 will be 10 years since the S&P 500 bottomed-out during the financial crisis. At the time, no one knew that it marked the bottom or that over the coming 10 years the same index would rise fourfold at a compounded return of over 18% per year!

Let that sink in for a minute: Someone who invested $10,000 on March 6, 2009 would have over $40,000 today. This will likely be the best rolling 10-year return in the history of the stock market and should send a strong cautionary signal to everyone currently invested. I suspect the longer that stock market returns remain strong, the more engrained client expectations will become that these returns will continue. We have been here before and it is a good time to remind ourselves that over the very long-term the stock market has compounded around 8% not 18%. We need to appreciate how far we are from this long-term trend line.

Think about how clients will be feeling when every bus shelter and billboard in Canada is advertising how well investment XYZ did over the last 10 years. We must all remember that past performance has little predictive value in assessing future potential returns.

Even if corporate profits are to compound at the rate we’ve seen over the last decade, I would bet heavily against the stock market repeating the 18% feat given the multiple expansions we have seen. The price-to-earnings multiple of the S&P 500 has expanded to 18 times from 12 times forward earnings over that period. Unless the stock market is going to pay 24 times each dollar of corporate profit earned, we will need to lower our expectations of future returns.

Personally, I find managing our clients’ expectations to be one of the hardest parts of the job. It is far more about being a student of human psychology than it is about mathematics, business or investing. Managing emotions is a huge part of professional money management and is an area our team devotes a lot of time to as part of our continuing quest to become better investors.

We highly recommend each of our clients spend time thinking about their emotional state when making investing decisions. Consider creating a “decision journal”, for example, to understand the “why” behind hiring a manager, firing a manager or making a change to an investment solution. This can be a great teaching tool when used consistently over a long period of time. Many of us at Cambridge use this same tool when making decisions about investing in specific businesses with a similar goal – to learn from ourselves and help us make better decisions in the future.

Small-cap funds review: 1H 2018

Cambridge Growth Companies Corporate Class Fund

It was a challenging first half of the year for our global small-cap fund with several of our largest holdings impacted by short-lived issues during the period. I highlight a few of these holdings below:

RaySearch Laboratories: This healthcare IT company is based in Sweden and develops software that directly guides the use of radiation therapy in cancer treatment. Previously on our watchlist, the company’s 50% correction over the last year expedited its priority including our team travelling to Sweden for a follow-up meeting with the chief executive. We uncovered some supportive elements on this trip but also some areas of concern that resulted in reducing the position. With that said, we are monitoring RaySearch’s ability to develop a strong commercial organization to sell its products to another market of smaller-sized customers as it has so far relied on large, sophisticated buyers actively seeking out the best product. Progress here would give us more comfort in the company’s growth runway and cash flows in the future.

Middleby Corp: We have owned and followed the company – a global leader in the foodservice equipment industry – for many years, and it has been a tremendous long-term compounder of value for our clients. Earlier this year, Middleby announced a comprehensive restructuring of its supply chain that will deliver very attractive returns but will reduce margins in the short term. This additional investment was exacerbated by an overall slowing in restaurant capital expenditure with many restaurant owners needing to absorb significantly higher minimum wages and unable to spend as heavily on equipment. This is a short-term issue and we believe the long-term opportunity at Middleby is tremendous. We have been adding to existing positions and it is among the largest weights across several portfolios at Cambridge.

Alfa Software: This is a recent IPO that performed very well initially before having its first stumble as a public company. We sold down our position after the shares appreciated, but still owned some when the company reported sales growth below what we and the market were expecting, in addition to two customers deferring additional projects. The long-term opportunity for Alfa to take market share of the asset-finance vertical with a best-in-class solution is unchanged; however, its relatively short public-market history keeps us from adding to the position today. Our support for the CEO and founder post our discussion of the company’s recent results is strong, but we’d like to see management execute on its business plan for longer as a public company before considering adding to the position, despite the very attractive valuation today.

I do not recall a time since we launched this portfolio that so many of our highest-conviction ideas (largest weights) offered the discount to their intrinsic value that we see today. This should benefit current owners of this portfolio over the long-term and be a compelling leading indicator of future success.

Positive contributors (all in alphabetical order): Ascential, Autotrader, Burford Capital, Hubspot, Kusuri No Aoki, Numis Corp,

Negative contributors: Alfa Software, BK Brasil, Byggmax, Middleby, RaySearch Laboratories, Safestyle.

Cambridge Canadian Growth Companies Fund

Technology, energy and industrials drove much of the excess return for clients, but as you can see from the overall contributors (below), there are no “thematic” takeaways. The eclectic nature of our portfolios means the specific idiosyncratic risks and opportunities we invest in will always be the largest driver of returns over reasonable periods of time. This means that we may suffer at times when markets are strong, but also that we may perform quite well despite tougher markets, which has been the case in Canada so far this year. Tariffs and commodity prices may influence broad market indexes, but it’s going to be stock picking and the implementation of our bottom-up security selection process that drives returns for our clients.

Positive contributors: Autotrader, Great Canadian Gaming, Hubspot, Transforce,

Negative contributors: Athene Holding, Byggmax, Middleby, LendingTree, RaySearch Laboratories.

Cambridge Pure Canadian Equity Fund

Consumer, technology, energy and industrials drove the vast majority of the excess return for clients in what was not a great period for the Canadian small-cap universe. Our very modest allocation to the U.S. helped in the first half of the year with two of the five best-performing stocks in the fund coming from our U.S. software exposure, specifically software for small and mid-sized businesses.

We fundamentally believe in the long-term compounding opportunity of having a concentrated portfolio of high-conviction ideas focused in Canada. It is an inefficient market with a lot of dislocations that our team has proven over many years we can exploit through our fundamental investment process.

Positive contributors: Boyd Group Income Fund, Great Canadian Gaming, Transforce,, Storm Resources.

Negative contributors: Athene, ECN Capital, Middleby, Prairie Sky.

We remain focused on growing our global universe of stocks under coverage and continuing to hold ourselves accountable to the highest of investment standards in the pursuit of long-term wealth creation for our clients.

Please enjoy your summer holidays and I hope to see many of you at our various events through the remainder of the year.

Kind regards,

Greg Dean


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