indicatorFund Commentary

Sub Advisor Insights—Investment Strategies Q1 2022

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

By ATB Investment Management 3 February 2022 12 min read

Canso Corporate Value Mandate

Contributed by: Canso Investment Counsel Ltd.

The portfolio returned -2.7% in the quarter, ahead of the Benchmark (FTSE All Canada Corporate Bond Index) return of -6.4%. Yields rose across government and corporate bond markets, leaving prices in negative territory. The portfolio's short duration relative to the Benchmark mitigated the decline, resulting in outperformance of 3.7% in the period.

Despite its short duration, the portfolio was negatively impacted by the rise in rates. Short and mid term fixed bonds issued by Air Canada, Bombardier and Hertz underperformed in the period due to rising yields and modestly wider credit spreads. Limited recourse capital notes (LRCNs) also underperformed as spreads widened relative to more senior issues. The portfolio benefitted from the large allocation to floating rate securities, which are less sensitive to interest rate changes. In addition, the portfolio does not hold long bonds as we do not believe we are being compensated for the additional interest rate risk.

For the one year period, the portfolio returned 2.5% and over seven years the 7.0% return was 4.8% ahead of the Index. Since inception, the 9.2% return represents 4.6% of added value.


Canso Investment Grade Mandate

Contributed by: Canso Investment Counsel Ltd.

The significant rise in government yields in the quarter caused negative returns across the board for bonds. Longer duration securities incurred the largest drop in value. The portfolio underperformed its benchmark (FTSE Canada Universe Bond Index) by 0.2% in the quarter. Slightly shorter than benchmark duration was a small positive contributor to relative performance. Floating rate notes were strong relative performers. The portfolio's ~11% weight in LRCN's was the primary negative contributor to relative performance as these securities were down roughly 8% in price in the quarter. LRCN's continue to provide attractive income for the portfolio. The one year return is 0.6% ahead of the benchmark and the three year return of 2.7% is 1.5% ahead. Since inception, the portfolio's value added is 1.1%per annum.


Cardinal Canadian Equity Mandate

Contributed by: Cardinal Capital Management Inc.

The portfolio performed well as returns for the first quarter were up 9.56% beating the S&P/TSX by 574 basis points. All sectors in the portfolio posted positive returns in the quarter with the Materials and Energy sectors posting the largest gains. The benchmark also posted impressive gains in these two sectors but was hurt by the Information Technology sector, mainly due to weakness in Shopify, Inc.  

Highlights during the quarter: 

The impact of the Russian/Ukraine war has resulted in upward pricing pressures on oil and agriculture products.  This has resulted in stock prices for energy and agriculture related companies moving higher as well.  The holdings in these sectors had impressive gains in the quarter.   

The Industrial sector performance performed well versus the benchmark.  The two rail companies in the portfolio had solid returns in the quarter.  While the short-term outlook is mixed, the long-term view remains that these companies are the best-in-class rail companies in North America.   

Canadian Tire, the only Consumer Discretionary holding in the portfolio, provided a good return in the quarter and helped performance.  The company continues to show strong business fundamentals and the valuation remains attractive.   The Financial sector (largest weighting in the portfolio) also performed well versus the benchmark.  The outperformance was driven mainly from a few select companies, namely Intact Financial, Manulife and Bank of Montreal. 


Cidel Canadian Total Return Mandate

Contributed by Cidel Asset Management Inc.

The Fund posted a positive return of 2.5% in the first quarter trailing the S&P/TSX Index’s return of 3.8%. We remind investors that this is an incredibly short period to measure performance. Nevertheless, the reasons for the underperformance compared to the S&P/TSX Index was due to negative sector allocation. Positive security selection did provide a partial offset. 

The leading sector for security selection was Technology with the holdings in Open Text, Enghouse, Constellation, NUVEI and CGI all outperforming the Technology sector, which as noted was led lower by Shopify which the Fund did not own. Security selection was also strong in the Consumer Sector, with the holding in ‘all-weather’ Dollarama up 12% while the sector was down 8%.  Somewhat offsetting the strong security selection in Technology and Consumer Discretionary was security selection in the Industrial sector with the position in Boyd Group down 17%. Boyd continues to struggle near-term with weak margins due to pandemic related labour shortages and supply chains issues. Relief is coming with higher reimbursement rates from their insurance clients, but it will take time. We continue to believe that the issues are temporary with no change to our long-term thesis that with the ‘professionalization’ of the auto collision industry, Boyd has a long-term opportunity to deploy capital (i.e., acquire small operators) at attractive rates of return. 

From a sector allocation perspective, the underweights in the outperforming Materials and Energy sectors and the overweight in the underperforming Technology sector had the largest negative impact. As noted above the Russian invasion of the Ukraine drove commodity prices (and commodity related equities) sharply higher in the quarter. The Technology sector positions in the Fund have proven business models; they generate substantial free-cash flow with attractive long-term business fundamentals.


Mawer Canadian Equity Mandate

Contributed by Mawer Investment Management Ltd.

The Mawer Canadian Equity Fund (the “Fund”) returned 2.3% before management fees in the first quarter, resulting in relative underperformance against the benchmark (S&P/TSX Composite Index). The S&P/TSX Composite Index (the “TSX”) returned 3.8% during the first quarter. Areas of strength during the quarter included energy companies and banks. Canadian Natural Resources saw its shares rise as the company posted strong operating results and record production volumes. Suncor Energy did well over the quarter as the company saw a surge in revenues against the backdrop of rising oil prices and an improved business environment. Bank of Montreal saw an increase in share prices after beating analysts expectations for first quarter profits and seeing margin improvements on the back of expected interest rate hikes.  

Areas of weakness during the quarter included Information Technology companies. E-commerce platform provider Shopify saw its shares decline over the quarter as the company reported fourth-quarter earnings that narrowly beat expectations, and cautioned about revenue headwinds in the first half of 2022. Software company Dye & Durham saw some bearishness over the quarter as the company's revenue growth missed forecasts. Real estate broker and advisory company Colliers International saw its shares decline over the quarter but did post strong operating and financial results, with revenues up significantly across all business segments. 

Looking back over the full year ended March 31st, the portfolio was able to deliver strong returns that have nonetheless failed to keep pace with the benchmark. The companies we own have strong competitive advantages, are leaders in their markets, are able to allocate capital effectively, and benefit from structural growth opportunities. 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 -9.5% over the quarter, underperforming the S&P/TSX Small Cap Index by 17.9%. A perfect storm transpired leading to the notable underperformance of our Canadian Small Cap strategy. Lower quality commodities businesses led the market by a wide margin, while businesses with high quality characteristics experienced a significant pullback after relatively strong share price appreciation in recent years. In this environment, our strategy’s long-term focus on businesses with enduring competitive advantages was undoubtedly overshadowed by heightened shorter-term market volatility.  

After a strong 2021, the energy sector was propelled higher on the heels of soaring oil prices due to unfortunate circumstances of the Russian-Ukrainian war, with the environment leading to increases for metals and mining companies as well. Given our philosophy, we tend to have lower exposure to such cyclical and lower competitively-advantaged business models and as such, we have historically underperformed when these segments rally - especially given the high degree to which they comprise the Canadian small cap universe.  

Aside from our lower exposure to commodities businesses, a rising interest rate environment impacted our quality compounders over the quarter. Our technology holdings, whose cash flows skew further out into the future, have had their valuations more challenged by central banks’ signal to raise rates in the face of inflationary pressures. Meanwhile specific negative headlines have also impacted individual companies such as Dye & Durham, while the company continues to be fundamentally sound in its ability to create wealth. Longer duration technology stocks are not the only ones challenged by shifts in monetary policy however, other quality companies – whether it be real estate services company, Colliers International, mattress retailer, Sleep Country, and others, have experienced share price appreciation in the recent past but gave back some of those gains over the first quarter.  

While the first quarter of the year was weak for equities, we believe the portfolio is well-positioned given our long-term investment approach to which we remained committed.


Mawer US Equity

Contributed by Mawer Investment Management Ltd.

The Mawer U.S. Equity Fund (the “Fund”) returned -8.5%, before management fees, resulting in relative underperformance against the benchmark which returned -5.7% during the first quarter. 

Areas of strength were tied to health care companies as well as portfolio components benefitting from increasing economic activity: 

  • Drug wholesale company AmerisourceBergen reported an increase in revenues and gross profits during the quarter as well as upgraded its outlook for fiscal year 2022.
  • Medical technology company Becton, Dickson and Company reported strong business performance from all three segments of their operations and raised revenue guidance for 2022.
  • Elsewhere, chocolate maker Hershey Company, had strong stock performance as the company reported they delivered a record year of production and double digit sales growth and see momentum continuing throughout the year.

Areas of weakness during the quarter:

  • Paint company Sherwin-Williams declined over the quarter. The company saw pressure on their margins due to rising costs and supply chain disruptions but is focusing on minimizing the impacts to their business through innovation, valued-added services, and differentiated distribution.
  • Financial software firm Intuit experienced some share price weakness over the first quarter as the company posted earnings that missed expectations amid a slow start to the US tax-filing season.

Looking back over the full year ended March 31st, 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 underperformed its benchmark in the first quarter, driven largely by holdings that were impacted by the rise in discount rates. 

Wealth-creating companies, by virtue of the strength of their competitive advantages and the sustainability of their cash flows, are often priced at above-market price-to-earnings multiples to reflect this high quality and, as such, their valuations can exhibit greater sensitivity to rising interest rates. Given our approach, we own a number of these businesses and many of them de-rated at a faster pace than the broader market during the first quarter. Notable examples include luxury brand conglomerate LVMH, reference data provider Wolters Kluwer, Japanese IT consultant Nomura Research Institute, and specialty chemicals company Sika. Investments with higher growth rates such as investment fund distribution platform Allfunds and payments processor Adyen were also similarly hurt given their high duration profile. Shares of Japanese drug store operator Tsuruha and UK auto insurance provider Admiral Group, after thriving earlier in the pandemic, have reversed course as margins narrow in part due to higher inflation coupled with greater competitive intensity. 

The portfolio had some direct exposure to geopolitical events that unfolded during the quarter. Though we sold our investment in Russia’s largest bank Sberbank in January, we still held Russian digital bank TCS Group when Russia invaded Ukraine. Despite being a small weight in the portfolio pre-war, we’ve marked the shares we have been unable to fully liquidate in TCS at zero. Our holding in fintech company Kaspi also sold off materially given political unrest in Kazakhstan, where Kaspi is based and operates. 

At the same time, the Fund’s lack of exposure to companies in the oil & gas industry, as well as lower exposure to mining and banks, also weighed on relative performance given the market backdrop. 

Partially offsetting these negatives were holdings that may in fact benefit from greater inflation, such as copper miner Grupo Mexico given the dramatic rise in commodity prices, insurance broker Aon given its commission structure, Singaporean bank DBS, and exchange operator Deutsche Boerse which benefits from higher interest rates and rate volatility. 


Mawer Global Small-Cap

Contributed by Mawer Investment Management Ltd.

The Mawer Global Small Cap Equity Fund (the “Fund”) returned -12.3%, before management fees, resulting in -5.1% of relative underperformance against the benchmark during the quarter.

In our view, the underperformance is likely attributed to a confluence of market concerns around interest rates, inflation, and a potential recession - all of which resulted in commodities-related sectors benefiting the most.  

Given our approach of emphasizing wealth-creating companies, run by excellent management teams, trading at favourable valuations we tend to own more defensive businesses that are not direct beneficiaries of rising commodity prices but that should still exhibit pricing power over the long-run. 

In recent months there have also been rising concerns over shorter-term topics like a slowdown in industrial demand. Some of our holdings in the Industrial sector were affected by this sentiment, for example: industrial distributor Global Industrial Company, HVAC, plumbing and electrical installer Bravida.  

Shares of Japanese drug store operator Tsuruha and kitchen appliance company De’Longhi, also came under pressure as margins are expected to narrow in part due to higher inflation coupled with greater competitive intensity in the case of Tsuruha and geopolitical disruption along with increased brand building investments in the case of De’Longhi. 

Partially offsetting this, some lower duration companies saw some strength during the first quarter, especially those that lagged during 2021. These companies include technology solutions provider PC Connection, health care services company Fagron, and car insurance company Sabre Insurance.

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