indicatorFund Commentary

Sub Advisor Insights—Investment Strategies Q2 2022

Sub-Advisors for the Compass™ Portfolio program reviews the events in their underlying Investment strategies during the second quarter of 2022.

By ATB Investment Management 29 July 2022 11 min read

Canso Corporate Value Mandate

Contributed by: Canso Investment Counsel Ltd.

The portfolio returned -4.5% in the quarter, slightly ahead of the benchmark return of -4.8%. Yields continued to rise across government bond and corporate bond markets, resulting in negative returns for the year.

Despite its short duration, the portfolio was negatively impacted by widening credit spreads as lower quality credit underperformed. Short and mid term bonds issued by Air Canada, Bombardier, Spirit Aerosystems and other high yield issuers underperformed in the period. The portfolio benefited from its large allocation to floating rate securities, which are less sensitive to interest rate changes.

For the one year period, the portfolio returned -5.3% and over five years the 6.8% return was 5.8% ahead of the Index. Since inception, the 8.7% return represents 4.6% of added value.


Canso Investment Grade Mandate

Contributed by: Canso Investment Counsel Ltd.

The portfolio returned -4.7% in the quarter, slightly ahead the benchmark return of -4.8%. Government yields continued to increase and corporate spreads continued to widen, driving negative price changes in all but a select few securities. Long duration BBB holdings including AT&T, Enbridge, Pembina Pipeline and Shaw Communications were among the most impacted by the rise in yields. The portfolio’s weight in LRCNs was also a drag on performance. The portfolio benefited from its allocation to less interest rate sensitive floating rate securities which mitigated the negative performance to some degree. For the one year period, the portfolio returned -10.1%, even with the benchmark and over seven years the 2.5% return was 1.3% ahead of the Index.

Since inception, the 2.8% return represents 1.0% of value added.


Cardinal Canadian Equity Mandate

Contributed by: Cardinal Capital Management Inc.

The weakness in the markets, particularly in the month of June, pushed all sectors in the benchmark into negative territory.  Weakness in the Information Technology sector for the second consecutive quarter lead the benchmark lower.  In addition, the Materials sector also added to the benchmark’s weak performance.  In the portfolio, these two sectors provided good relative performance as the portfolio does not currently have positions in the Information Technology sector and the relative outperformance of the Materials holdings were among the largest contributors to performance. 

The portfolio’s energy exposure also provided a lift to the portfolio.  Suncor Energy benefited from Elliott Management taking an activist stake and the pipeline positions had good relative performance.   

The weakest area of the portfolio was the Real Estate sector. This was largely due to dual concerns of rising interest rates and recession fears.  Rising rates would negatively impact property values and drive financing costs higher plus recessions fears would impact rent growth and occupancy.  Despite these fears, the portfolio holdings remain attractive as we believe that there is some inherent value that is not currently being recognized in the market.


Cidel Canadian Total Return Mandate

Contributed by Cidel Asset Management Inc.

The Fund posted a negative return of 9.9% in the second quarter outperforming the S&P/TSX Index’s decline of 13.2%. We remind investors that this is an incredibly short period to measure performance. Nevertheless, the reason for the outperformance compared to the S&P/TSX Index was due to positive security selection. Negative sector allocation was a partial offset to the outperformance. 

The leading sector for security selection was Information Technology with the holdings in Open Text, Constellation Software, and CGI all outperforming the sector, what was led lower by Shopify, which the Fund did not own. Security selection was also strong in the Healthcare Sector, with the holding Chartwell Retirement Residences ‘only’ down 9% compared to the sector decline of 50%. Dollarama in the Consumer Discretionary sector continues to perform well up 4.6% in the quarter. Somewhat offsetting the strong security selection in Technology, Healthcare and Consumer Discretionary was security selection in the Real state sector with the position in Boardwalk REIT down 29%.  Fortunately, there was only a small remaining position in Boardwalk in the second quarter.

From a sector allocation perspective, the underweight in the underperforming Materials sector had the largest positive impact. However, the large overweight in the underperforming Information Technology sector more than offset the benefit of the Materials positioning. The Information Technology sector positions in the fund have proven business models; they generate substantial free-cash flow with attractive long-term business fundamentals and have compelling valuations.


Mawer Canadian Equity Mandate

Contributed by Mawer Investment Management Ltd.

The Mawer Canadian Equity Fund (the “Fund”) returned -11.0% before management fees in the second quarter resulting in relative outperformance against the S&P/TSX Composite Index’s -13.2%.  

Suncor Energy posted a surge in earnings that saw its shares rise as the war in Ukraine and energy supply fears drove oil prices higher. Industrial equipment auctioneer Ritchie Bros did well as it is viewed as a defensive business model that can benefit from periods of slower economic growth as businesses adjust their equipment needs. Specialty label printing company CCL Industries saw an increase in share price after reporting strong earnings and healthy organic growth due to the economic reopening and subsequent demand for commercial printing services.  

Some of this positive performance was offset however by our Bank holdings. Bank of Montreal reported better-than-expected profits during the quarter but forecasted higher expenses and loan-loss provisions. BMO is also exposed to capital markets and wealth management which are facing headwinds given broad market weakness. TD Bank had stronger revenues, though these were somewhat offset by higher non-interest expenses, insurance costs, and credit loss provisions. In addition to the banks, Finning, a dealer of Caterpillar construction equipment and heavy machinery, hindered performance of the Fund as its shares declined on macro concerns despite improving earnings and profitability.  

Over the one year period ending June 30th, the portfolio posted a negative return but outperformed the benchmark which fared worse.


Mawer Canadian Small-Cap Mandate

Contributed by Mawer Investment Management Ltd.

The portfolio returned -13.7% over the quarter, outperforming the S&P/TSX Small Cap Index by 7.1%. As the Canadian Small Cap market sold off during second quarter of 2022, our respective portfolio holdings weathered the storm relatively better, accounting for much of the strategy’s outperformance. 

LifeWorks was the portfolio’s strongest individual performer due to its acquisition by Telus Communications, which came with a notable premium paid. While LifeWorks has been underappreciated by the market more recently, the company’s value as a leading health and wellness services provider was an attractive complement to Telus’s own health segment. Element Fleet Management was a top performer for the quarter following strong quarterly results; however, the company is indicative of a broader story: company turnarounds at the helm of new management takes time and as a result requires patience on the part of investors. In the case of Element Fleet Management, a multi-year effort including but not limited to, effectively managing costs and focusing on feasible areas of growth, has seen benefits come to fruition only more recently.  

Given increasing concern and probability of recession, more cyclical businesses such as those within metals and mining experienced sharp declines over the quarter. Our lack of exposure to such materials businesses, which we believe are typically less competitively advantaged, had a positive impact. Owning businesses that process materials as opposed to producing them (such as Winpak and Richards Packaging) also contributed to performance.  

Negatively impacting portfolio performance was the underweight to energy, which continued to perform well from a relative standpoint. The portfolio’s technology holdings also detracted from performance as they remained challenged due to investor sentiment and the rapid rise in interest rates.


Mawer US Equity

Contributed by Mawer Investment Management Ltd.

The Mawer U.S. Equity Fund (the “Fund”) returned -10.7%, before management fees, resulting in relative outperformance against the benchmark which returned -13.4% during the second quarter.  

Health care companies in particular posted strong performance during the quarter: 

  • Managed healthcare company UnitedHealth Group reported revenues that grew year over year with double digit growth in some of their business segments. Earnings growth was led by the Optum Health division due to its positive impact for patients and the accelerating expansion of its value-based care delivery initiatives.
  • Laboratory instrument company Waters Corp did well as the company reported better-than-expected earnings during the quarter and raised its full-year guidance.
  • Elsewhere, variety store chain Dollar General reported an increase in net sales during the quarter and increased their sales outlook for 2022, despite ongoing headwinds due to supply chain pressures and heightened inflation.

Components of the portfolio that lagged during the quarter were:

  • Amazon declined as the company posted revenues that met estimates but marked a slower growth rate than what investors are used to. The company is attributing much of the slowdown to macroeconomic conditions and Russia’s invasion of Ukraine.
  • Google parent company Alphabet experienced some share price weakness as the company’s revenue fell below analysts’ expectations. The company has been dealing with slowing revenue growth as advertisers cut back on spending due to a slowdown in consumer demand amid the current inflationary environment.

Over the one year period ending June 30th, the portfolio posted a negative return but outperformed the benchmark which fared worse.  Our philosophy and process orient us toward businesses that are enduring, that have the ability to exercise pricing power through the value propositions they provide to their customers, and that are run by able and honest managers. The portfolio remains intentionally tilted toward higher-quality companies with more recurring business models. 


Mawer International Equity

Contributed by Mawer Investment Management Ltd.

The Fund underperformed its benchmark in the second quarter in a continuation of those themes that impacted relative performance in Q1. 

As a result of our investment philosophy, we are focused on high-quality, wealth-creating companies. The portfolio’s return-on-equity of 26%, a proxy for quality, is considerably greater than the benchmark’s 17%. Our philosophy also demands that we purchase stocks at a discount to their intrinsic value, which is evaluated in the context of business quality. Well-managed, profitable, and durable businesses often tend to command premium valuations, reflecting the strength of their business models and competitive advantages. See: the portfolio’s forward price-to-earnings ratio of 17x vs. the benchmark’s 12x. 

As in the first quarter, the portfolio’s underperformance continues to be driven by companies with higher earnings multiples and therefore greater mathematical sensitivity to rising discount rates. Some of the more prominent laggards include companies that need to sustain high growth rates in order to justify their valuations: payments processor Adyen, fund distribution platform Allfunds, and warehouse automation company AutoStore. 

Poor stock selection has played a role too, particularly with AutoStore. After having IPO’d last year, the company has faced a number of headwinds: steel cost inflation, a potentially slowing economy, ongoing patent litigation with rival Ocado, as well as the aforementioned discount rate impact. We have been reducing our position in the company given the negative news flow.

More recently, as worries about slowing economic growth have risen, it is no longer just inflationary concerns and discount rate sensitivities that are impacting stock prices, but top-line considerations too. Portfolio holdings such as chip manufacturer TSMC and rental construction equipment company Ashtead have seen their stock prices slip … less due to recent results, and more due to the economic outlook and the associated demand for their products. 

That said, as recession worries grow, companies with more stable, boring, and recurring businesses—with moats that allow them to exert pricing power in the face of inflationary pressures without impairing demand for their products or their competitive positions—may be in a better place to endure. Relative performance in the latter half of the quarter has reflected this trend, as has recent activity in the portfolio which, on balance, has directionally shifted toward a more defensive posture.


Mawer Global Small-Cap

Contributed by Mawer Investment Management Ltd.

The Mawer Global Small Cap Equity Fund (the “Fund”) returned -11.1%, before management fees, resulting in 3.3% of relative outperformance against it’s benchmark, the MSCI ACWI Small Cap Index, during the quarter. 

We saw particularly strong performance from the Industrial holdings in the fund. For instance, industrial equipment distributor Global Industrial Company posted record quarterly revenue and profits. The company attributed the financial performance to its efforts to improve customer experience through digital commerce, improvements in freight operations and costs, and increased sales of higher-margin private label products. Package delivery company Aramex was another positive contributor having significant and sustained growth in their freight-forwarding and logistics business which supported profit growth as well as stabilizing margins driven by improving cost and operational efficiencies. Aramex also appreciated following the removal of the foreign ownership limit, allowing more international investors to buy the stock. In addition, human resources and business solutions company Insperity saw excellent first quarter results and provided a strong outlook for 2022. The company has a new five-year plan that has the potential for robust returns as they strive to capitalize on the healthy demand in the marketplace for their HR services. 

Supply chain issues have been a negative factor for some of our companies. Amongst our largest detractors over the quarter were Delonghi and Atea. Small appliance manufacturer Delonghi saw its shares decline on the back of challenges posed by cost inflation and higher marketing expenses. 

Information Technology solutions company Atea saw a weaker share price as the company faced ongoing challenges caused by supply chain constraints in the electronics industry.  

In other situations, supply chain issues affecting companies are continuing but are being offset by gross margin gains and operational efficiencies which has been the case for RS Group, a long-tail distributor of industrial components. The company has been focusing on improving the customer experience and driving costs down which has helped translate into market share gains in their core regions.

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