indicatorFund Commentary

Sub Advisor Insights—Investment Strategies Q3 2021

Sub-Advisors for the Compass Portfolio program reviews the events in their underlying Investment strategies during the third quarter of 2021.

By ATB Investment Management 26 August 2021 13 min read

Canso Corporate Value Mandate

Contributed by: Canso Investment Counsel Ltd.

The portfolio returned 1.7% in the quarter, ahead of the benchmark return of -0.1% (FTSE All Corporate Bond Index). Performance was led by high yield issues that benefited from a continued recovery in the market, a shorter duration and a rise in commodity prices. Limited Recourse Capital Notes (LRCNs) continued to perform well in the third quarter and the low duration of 3.2 years protected performance from the sello in long rates experienced at the end of the quarter.

For the one year period, the portfolio returned 22.0% and over five years the 9.4% return was 6.1% ahead of the Index. Since inception, the 9.8% return represents 4.6% of added value.


Canso Investment Grade Mandate

Contributed by: Canso Investment Counsel Ltd.

The portfolio return of 0.0% was ahead of the -0.1% performance of the benchmark (40% FTSE Canada Mid Term Corporate Bond Index & 60% FTSE Canada Short Term Corporate Bond Index). Performance was aided by spread tightening from Limited Recourse Capital Notes (LRCN) and Delta Airlines. This was partially offset by a drag from the increase in underlying government yields. The three year return of 6.0% is 1.4% ahead of the benchmark and since inception the portfolio has outperformed by 1.1% per annum.


Cardinal Canadian Equity Mandate

Contributed by: Cardinal Capital Management Inc.

For the quarter, the portfolio did perform better than the index. The portfolio finished up 0.40%, beating the S&P/TSX by 23 basis points. Year-to-date and one-year returns continue to top the index with outperformance of 1.90% and 3.47%, respectively. We believe the cyclical/value trade should continue to benefit the portfolio.

Energy shortages in Europe and Asia lifted energy prices with natural gas and crude oil prices rising in the quarter. However, other commodities such as industrial metals and gold stumbled on the back of rising interest rates.

With the weakness in gold (and mining as well), the Materials sector in the S&P/TSX was weak in the quarter. This sector was the best performing sector in the portfolio as Nutrien (the portfolio’s only holding in this sector) rose over 10% in the quarter. The Real Estate sector in the portfolio also performed well as some stocks had double-digit returns in the quarter.
The lagging sectors for the quarter were Consumer Discretionary, Industrials, Consumer Staples and Energy. One security in each of these sectors underperformed causing the sector to trail the benchmark.

As mentioned, double-digit gains were realized in the Materials sector and was the largest contributor to the overall Value Added in the quarter. The portfolio continues to have no weighting in the Health Care and Information Technology sectors and with performance of the sector being negative in the quarter, it had a positive contribution on the portfolio when compared to the index. The Real Estate sector also had a good quarter contributing to the portfolio.

The largest sectors detracting from the Value Added was Industrials and Energy. CP Rail in the Industrials sector and Suncor Energy in the Energy sector were the weakest stocks. With CP Rail, the on-again merger with Kansas City Southern resulted in the pull back of the stock price. Suncor also lagged despite the rise in energy prices.


Cidel Canadian Total Return Mandate

Contributed by Cidel Asset Management Inc.

The Fund posted a positive return of 1.7% in the third quarter outperforming the S&P/TSX Index’s return of 0.2%. We remind investors that this is an incredibly short period to measure performance. Nevertheless, the reasons for the outperformance compared to the S&P/TSX Index were both security selection and sector allocation.

The leading sector for security selection was Real Estate with the holdings in Boardwalk REIT, Colliers and Granite REIT all returning greater than 10% during the quarter.

Somewhat offsetting the strong security selection in Real Estate was security selection in the Energy sector with the position in Parkland down 10%. We note that Parkland, while being classified in the Energy sector, has more in common with its Consumer Staple peer Couche-Tard (fuel retailer and convenience store operator) than the companies in the Energy sector who extract oil and natural gas or operate related pipelines. As such, we remain patient with Parkland as valuation remains very compelling. Sentiment could change with a gradual return-to-normal as consumers require fuel for their vehicles and snacks for their passengers.

From a sector allocation perspective, the underweight in the underperforming Materials sector had the largest positive impact. The fund’s only position in the Materials sector is fertilizer producer and retailer Nutrien (up 10%) and thus avoided the negative returns posted by the hard rock miners.


Mawer Canadian Equity Mandate

Contributed by Mawer Investment Management Ltd.

The Mawer Canadian Equity Fund (the “Fund”) returned 1.9% before management fees in the third quarter, resulting in relative outperformance against the benchmark. The S&P/TSX Composite Index (the “TSX”) returned 0.2% during the third quarter of 2021. Areas of strength during the quarter included Information Technology companies. Software company Topicus posted stronger than expected quarterly revenues and continues to show attractive organic growth. Technology solutions and services company Softchoice saw growth across all IT solutions types and sales channels, led by software & cloud and services. The company continues to expect strong growth in gross profit driven by improving productivity of their salesforce, the continued ramp up of realization of benefits from key projects, and increasing wallet share with their customers as they broaden the IT solutions they are providing them. Grocery chain Loblaws saw its share rise as the company reported a solid earnings beat during the quarter. The company has an attractive market position, a healthy balance sheet and strong free cash flow generation.

Canadian Pacific Railway decreased over the quarter on concerns their bid to acquire Kansas City Southern would not go through however their bid was ultimately successful. Suncor Energy declined during the quarter as fears around the delta variant dampened expectations for oil demand.

Looking back over the full year ended September 30th, the portfolio delivered considerably strong returns that have nonetheless failed to keep pace with the benchmark. Fundamentally, the portfolio has proven more resilient through the pandemic: the revenues and operating earnings of our portfolio companies – in aggregate – have been less volatile than those of the broader market … both on the way down and on the way up. It is this consistency, along with a risk management approach that prioritizes resilience, that explains the portfolio’s behaviour and return profile relative to that of its benchmark.


Mawer Canadian Small-Cap Mandate

Contributed by Mawer Investment Management Ltd.

The portfolio returned 5.1% in the third quarter, outperforming the S&P/TSX Small Cap Index’s -2.5% return. While relative performance for the third quarter was notably different from that of the first two quarters of 2021, the portfolio’s focus remained the same. In recognizing that we cannot predict when certain segments of the market will fall in and out of favour, we have remained steadfast to our investment philosophy to find competitively-advantaged companies to own for the long-term. There were a few factors which contributed to the outperformance. Firstly, our overweight exposure to information technology companies helped as they were stronger over the quarter after being relatively weak performers during the first half of the year. Secondly, businesses in the Materials sector (most notably metals and mining companies) did not fare well and our absence from the industry helped our relative returns. Our real estate holdings which span different business models from service-oriented businesses such as Colliers International, Altus Group and FirstService to real estate owners such as Mainstreet Equity and StorageVault also performed well.

Softchoice Corporation was the largest contributor during the quarter. We initiated a position in this value-added IT reseller in the second quarter of 2021 when it went public. Since going public the company’s share price has shown strong share price appreciation as the company released positive results which showed growth across all IT solution types and sales channels. Colliers International, the commercial real estate broker, was another strong contributor as earnings grew due to a faster-than-expected recovery in transaction volumes and strong organic growth in its recurring segments. Finally, digital forensics software provider Magnet Forensics was another strong contributor as its share price increased markedly as the company experienced growth in its recurring revenues.

While many of our information technology holdings experienced strong performance over the quarter, Dye & Durham was the largest individual detractor in the portfolio as a previously announced take-private attempt by a group led by senior management failed to materialize. Element Fleet Management also declined over the quarter as an automotive semiconductor shortage (leading to fewer new cars being added to its managed fleets) and less miles driven by the company’s customers led to muted earnings.


Mawer US Equity

Contributed by Mawer Investment Management Ltd.

The Mawer U.S. Equity Fund (the “Fund”) returned 4.5%, before management fees, resulting in relative outperformance against the benchmark (The S&P500).

Areas of strength were tied to technology companies as well as portfolio components most exposed to re-opening:

  • The technology stocks we owned – notably Alphabet (Google), Intuit Inc, and Microsoft – benefitted given the prospect of greater economic activity. Alphabet (Google) continued its advance from the second quarter, buoyed by elevated consumer online activity and broad based strength in advertiser spending. Microsoft also continued to advance since the start of the year as it handily beat earnings expectations during the quarter. Intuit Inc, a financial software firm, advanced strongly as the company reported strong revenue growth during the quarter.
  • Elsewhere, global professional services firm Marsh and McLennan, had strong stock performance as the company reported better than expected quarterly earnings and revenue.
  • Data analytics provider Verisk, a top detractor last quarter, bounced back as the strength of their business model has been on full display since the start of the pandemic and continues in the recovery. The company’s transactional businesses have already returned to pre-COVID levels and they are confident this general trend can continue.

Areas of weakness during the quarter:

  • Aspen Technology declined over the quarter. The company was affected by a more constrained spending environment of its customers. This being said, they have confidence that they will return to double-digit annual spend growth over time as the macro environment continues to improve and spending budgets normalize.
  • AptarGroup, a manufacturer of consumer dispensing packaging and drug delivery devices, experienced some share price weakness over the second quarter as organic growth didn’t match investor expectations.

Looking back over the full year ended September 30th – a period of time entirely comprised of the bounce-back – the portfolio has delivered considerably strong returns that have nonetheless failed to keep pace with the benchmark. Fundamentally, the portfolio has proven more resilient through the pandemic: the revenues and operating earnings of our portfolio companies – in aggregate – have been less volatile than those of the broader market … both on the way down and on the way up. It is this consistency, along with a risk management approach that prioritizes resilience, that explains the portfolio’s behavior and return profile relative to that of its benchmark.


Mawer International Equity

Contributed by Mawer Investment Management Ltd.

The Fund outperformed the return to that of its benchmark (MSCI EAFE CAD Index) during the third quarter.

Despite owning several companies under the regulatory spotlight in China, the Fund has weathered the storm reasonably well so far and outperformed its benchmark during the third quarter given the ex-ante emphasis on risk management. For example, in recognition of the potential regulatory risks, when we initiated our position in after-school tutoring company New Oriental Education earlier in the year, we only targeted a 0.5% position. The business model was effectively eviscerated (along with most of its market cap) with new regulations announced in July banning for-profit activities in the industry, but the relatively low weight cushioned the impact on the overall portfolio.

While their returns weren’t quite as dramatic as New Oriental, our Chinese holdings with exposure to internet platform / e-commerce businesses (Alibaba, Autohome, Tencent), gaming (Tencent, NetEase), and baijiu (Wuliangye Yibin) also suffered negative returns over the period.

Yet, while Chinese securities comprise approximately 10% of the benchmark, our index-agnostic approach to risk management that focuses on assessing aggregate exposures in absolute terms resulted in a lower weight in China at 6.4%. This ultimately contributed to the portfolio’s outperformance over the period.

Looking beyond China, as the widespread optimism in equity markets that characterized most of the past year gave way to more caution in the third quarter, higher-quality companies (read: more recurring, stable businesses with durable competitive advantages) returned to favour.

Several of the portfolio’s top holdings are good examples of this phenomenon. Wolters Kluwer and RELX both provide critical reference information and tools to various professionals such as tax accountants, lawyers, and the medical field. Recent results have highlighted the strength and recurrence of their revenues, due to the mission-critical services they provide to their clients. And despite a $1 billion break fee, Aon walked away from its proposed acquisition of Willis Towers Watson; the stock reacted favourably. We were worried that Aon’s management might fall victim to commitment bias and agree to too many concessions with regulators in an effort to see the deal through at any cost. The decision to refrain from pursuing the deal any further highlights management’s capital allocation discipline, and the company can now re-focus on its standalone business, one that has been among the portfolio’s top holdings for many years.


Mawer Global Small-Cap

Contributed by Mawer Investment Management Ltd.

The Mawer Global Small Cap Equity Fund (the “Fund”) returned 2.6%, before management fees, resulting in 1.8% of relative outperformance against the benchmark. Overall, the pattern of returns in the portfolio has been consistent with our philosophy and expectations. The portfolio provided a positive return in the third quarter and exceeded its benchmark in a continuation of the themes that drove relative performance in Q2.

Areas of strength during the quarter were tied to portfolio components most exposed to economic re-opening. One example is IT infrastructure provider Softcat. The stock did well over the quarter as the company indicated that it delivered double digit growth in revenue and operating profit, and that the demand it saw was broad based in nature. On a similar note, technology consulting and engineering company Alten performed well during the quarter. Elsewhere, business solutions firm Insperity rose during the quarter as the company posted results that saw revenues increase and client retention remaining at historical high levels. In addition, Swedish digital solutions firm Knowit AB had a strong quarter as the company is seeing some good demand for their offerings and has thus resumed recruiting in expectations of future growth.

Conversely, areas of weakness during the quarter included less exposure to business models that we believe can be more cyclical on average, such as energy and more leveraged companies – all of which were among the best performing parts of the market over the period. Cembra Money Bank, a Swiss consumer finance bank, saw its shares decline over the quarter after not renewing a credit card partnership with Swiss retailer Migro. De’Longhi, an Italian small appliance manufacturer, we believe saw its share price decline due to elevated expectations despite delivering strong growth across all regions with management attributing this to increased consumer preference for higher quality coffee and kitchen machines. We note that any long term work from home trends may be a net positive for the company as consumers trade in their office espresso for one brewed at home. New Work, a German technology company offering online recruiting solutions for professionals, saw some softness over the quarter as the company’s revenue growth coming out of covid has likely lagged expectations.

Looking back over the full year ended September 30th – a period of time comprised of a rapid bounce-back – the portfolio has in our opinion delivered returns that while healthy have not kept pace with an even faster rising benchmark. That said, the portfolio has proven its relative strength through the pandemic which is consistent with our risk management approach that prioritizes resilience over a full cycle.

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