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Update: Cambridge Growth Companies Corporate Class

Greg Dean's picture

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We’ve recently had several questions regarding Cambridge Growth Companies Corporate Class, and I believe it’s my duty to be transparent and candid about what we’re doing and why, especially when short-term performance is weak.

Since we wrote the first-half 2019 update at the beginning of July, a lot has changed. We celebrated our 5th anniversary of offering a global best ideas small-cap portfolio on July 31, 2019, and we have been very encouraged with our results.

When we launched the fund, my goal was to be in the top decile of fund managers in the global small-cap universe. We set high expectations for ourselves, and I’m pleased that so far (for the three- and five-year periods ended July 31, 2019) our performance has put us in the top decile of managers in the global small-cap universe.

As at July 31, 2019 1 Year 3 Years 5 Years Since inception¹
Fund return (Series F) -0.2% 9.0% 10.2% 10.2%
# of funds in peer group² 126 102 75 -
% of peers beaten 84% 92% 90% -

1 Since-inception date: July 31, 2014.
2 Peer group: Global Small/Mid Cap Equity.
Source: Morningstar Research Inc., as at July 31, 2019.

That said, investment excellence is a journey and not a destination. We are halfway to our long-term 10-year goal and we are excited to keep the momentum going.

Overview of the Fund

Cambridge Growth Companies Corporate Class is a concentrated portfolio of 30–50 businesses that we believe can deliver strong returns to clients over the long term. As you may appreciate, with this level of concentration comes the high probability of meaningful deviations in relative returns over short-term intervals (i.e., months) as we have experienced recently. Without these necessary pre-conditions it is not possible to compound wealth above the rate of stock market performance over long periods of time.

We focus on businesses that earn high returns on invested capital and can deliver strong compounding of cash flow and free cash flow over time while looking to avoid the use of significant leverage at the business unit level. There is always a strong quality bias in the fund, which remains the case today.

We seek to invest in companies that are leaders at what they do, have strong track records of superior capital allocation and are run by competent, ethical and ambitious management teams. Once we identify these qualities, we then look to pay reasonable prices to accumulate these investments.

Recent Events

From the time we wrote the six-month recap of the small-cap funds in early July, Cambridge Growth Companies Corporate Class has experienced a drawdown of approximately 10%. Since inception (July 31, 2014), this is the third drawdown of its kind in the fund (see chart below). This is a humbling reminder of how hard it is to be consistently excellent.

Cambridge Growth Companies Corporate Class F Growth Chart

Source: Morningstar Research Inc., as at August 23, 2019.

This is largely attributed to a few key holdings (more than half of the drawdown can be attributed to the four key stocks I discuss below) as well the impact of the currency exchange. Whether a stock performs well or poorly, we maintain our proprietary models, which includes conducting our own due diligence, building our models, and talking to competitors, customers, and management to determine the weights.

The big drivers of the recent underperformance are listed below.

Fund Detractors

Aston Martin Lagonda Global Holdings PLC (AML.LN) – Approx. 2% of fund

A British independent manufacturer of luxury sports cars and grand tourers often associated with expensive grand touring cars in the 1950s and 1960s, and with the fictional character James Bond.

Prior to its initial public offering (IPO) in October 2018, the company’s strong management team (led by its CEO and CFO) had built and executed on an ambitious growth plan since 2014. Our initial assessment indicated a great of opportunity for value creation. We initiated a position but at a smaller weight, since we felt that the firm was not as well capitalized as it could be and believed that the balance sheet wasn’t optimally positioned relative to public market comfort given the capital-intensive nature of the business.

Following the IPO, the stock experienced a decline of 35–40%. We followed our proprietary process to dig deeper in order to determine whether we wanted to make this a more meaningful position in the fund. In May 2019, we visited the company’s new manufacturing plant in Wales and met the CEO and CFO outside of London, and we left with a positive perception of the firm’s ability to launch its new SUV product. This was an important consideration since we wondered whether an auto manufacturer could reach the status of a self-funded free cash flow grower. We believe that a diversified product portfolio was the key.

I’ve been very surprised at how pessimistic the stock market has viewed the concerns surrounding the firm’s balance sheet and sales outlook for the forthcoming SUV.

We have accumulated shares in this business at prices we believe represent good long-term value but are much higher than the current market value. We believe this business has strong pricing power, a great opportunity to become self-funding and a very strong brand and margin profile and we remain committed to the business with the facts we have today.

Burford Capital Ltd. (BUR.LN) – Approx. 3% of fund

A finance and investment management firm specializing in providing legal and litigation finance to global law firms and Fortune 500 companies.

We first identified Burford Capital in 2015 and initiated a position of the firm in 2016 as we believed litigation finance market could become a large segment of private equity over the next 10 years due to the strong returns and lack of correlation to stock markets of these returns (akin to leveraged buyouts in the 1970s). Given the newness of the structure of the business, we were well aware of the challenges in being ‘the first and only,’ and the fact that litigation finance is still a very nascent asset class.

The main concern we had three years ago (which remains today) is the subjectivity of their accounting (size and timing of the fair value gains). While this is a new space, the structure the company uses in its accounting practices is similar to the system used by many other companies, including Brookfield Infrastructure Partners L.P. (another long-time fund holding). Since Burford Capital doesn’t have collateral or own an underlying asset, we reflect this in our valuation and required internal rate of return. We consider this a risk, but do not believe the business has a solvency concern or that any accounting impropriety has occurred (to the best of our knowledge).

Often when we travel, we like to meet with successful small company investors and try to learn from and build relationships with these firms. On a trip to England in May 2019, we met an interesting investor who disclosed to us their largest short position was Burford Capital. It was a very stimulating conversation, and given our opposite perspectives, we left wanting to investigate certain areas in more detail so we could fully appreciate where we could be wrong as shareholders. This is an essential part of our process at Cambridge Global Asset Management (“Cambridge”) – embracing where we could be wrong and having the willingness to explore the ‘weak aspects of the investment argument.’ As it turned out, the timing was good because a few weeks ago a very prominent ‘short seller’ released a very elaborate and salacious short thesis on Burford Capital, and it resulted in a 50% decline in the company’s stock over a matter of days.

Our opinion is that the ‘report’ didn’t uncover anything new about what the company’s current issues are and was mostly based on opinion as opposed to fact. We have been encouraged by Burford Capital management’s willingness to listen to our concerns around governance, and we believe the company will be a stronger entity on the other side of this very traumatic experience.

We remain committed to Burford Capital and we look forward to the business continuing to execute as it has done over the 10 years it’s been a listed company.

Byggmax Group AB (BMAX.STO) – Approx. 4% of fund

The largest low-cost, do-it-yourself building materials company operating in Sweden, Norway and Finland.

Byggmax has a significant leadership position in the market – they are nearly three times larger than their next competitor. After conducting our due-diligence process, we were interested in the firm but not the management. We initiated a position in the company once new management took over. I believe this is a good example of our willingness to be patient and wait until a low-valuation company with a strong potential to recover has the right people in place to deliver on that potential.

The firm had brought on a capable CEO with significant retail experience, who happens to be the ex-CEO of H&M Sweden and had a previous experience working at McKinsey & Co. as a consultant in retail. During our conversations with Byggmax’s CEO, we thought (and he agreed) that the business needed focus, which could be attained by rationalizing its underperforming stores and selling some of the brands that the previous management team had bought. We used a weak share price to become a large shareholder of the firm in March 2019.

Under the guidance of new management, the firm is driving positive change through organization, reducing its operating costs and opening new stores in high potential areas. That said, 2018 was not the year we hoped to harvest these benefits, as the summer was one of the worst on record and not a great year to renovate or build.

As at August 23, 2019, the business trades at approximately eight times earnings with a free cash flow yield north of 10%. The company has been using this to pay down debt and open new stores. We still own this company – in fact, it is one of our top 10 holdings, and we believe there’s a lot of underappreciated value if they can get back to executing, opening stores and growing same-store sales.

LendingTree, Inc. (TREE.US) – Approx. 4% of fund

America’s largest online lending marketplace, connecting borrowers with multiple lenders so they can find and compare competitive rates across an array of financial products.

We initiated a position in this business in the second half of 2018 at an average cost at just over $230 a share and the stock nearly doubled by June 2019. We believed this high-quality financial product lead generating company had been mispriced, stemming from the concerns around the slowing mortgage business and were overlooking the large acquisition they had recently made in the insurance space. Growth expectations got ahead of themselves after they reported in-line earnings in the second quarter of 2019, which hurt the share price, and the stock subsequently corrected by 30%. That said, year-to-date, the company’s stock remains a strong positive contribution to the Fund. We do not have any change to our thesis, our conviction in the management team or our view of the quality of the business.

Fund Contributors

While we have spent considerable time discussing the holdings that have had a negative impact on the fund’s portfolio in the short term, I also want to share some notable contributors to the fund’s performance over the same period.

AMA Group Ltd. (AMA.ASX) – Approx. 5% of fund

A leader in the collision repair market in Australia.

AMA Group is an Australian leader in the operation and development of complementary businesses in the automotive aftercare and accessories market. After holding a peer within the Canadian market, we wanted to explore similar opportunities on a global basis. Given the differences in the market, we spent considerable time learning more about Australia and met with senior management, where we discovered that despite being a very fragmented market, there are true benefits to scale and where cash returns on invested capital are very high. The board and the CEO have great confidence that the combination of the defensive nature of the industry, the company's proven acquisition strategy, their ability to increase revenues while containing cost, and the quality, high-performing people within the business will ensure the company will deliver strong returns into the future. The stock market quickly caught up to our thesis on AMA Group and we have recognized strong unrealized gains so far on our position in the company. We believe this is a business that can compound over many years and we see a long-term opportunity in AMA Group.

Smartsheet Inc. (SMAR.US) – Approx. 4% of fund

Developer of a software application used for collaboration and work management.

Cambridge Equity Analyst Jordan McNamee identified this opportunity. Smartsheet is a leader in the workflow management space. The U.S.-based company targets business users and currently has relationships with 60% of the Fortune 500 companies. The company has great products and employs an efficient ‘land and expand,’ go-to-market strategy that allows customers to test the product before paying for additional functionality. This strategy has shown success and should drive durable long-term growth and high margins over time. As the company’s attractive long-term prospects have become more widely appreciated by the market the stock has risen significantly. We recently cut the weight as it has appreciated in value such that the risk/reward is not as compelling as when we began accumulating the investment.

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We have a dedicated team at Cambridge who is available to answer your questions, as well as the support of the CI Investments team. Should you have any questions, please reach out to us and we will be happy to answer any and all of your questions.

Kind regards,

Greg Dean

Sources: Morningstar Research Inc. and Cambridge Global Asset Management, as at August 23, 2019.

 

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Published September 9, 2019.

We welcome your comments and questions for the Cambridge team and will respond as soon as possible. Please note that all comments are reviewed for their relevance to the topics discussed in the blog, and that comments may be edited.