Compared to its benchmark, the Russell 2000 Index (“R2000”), the Pembroke Concentrated Fund (“PCF”) posted strong absolute and relative performance in the fourth quarter of 2021. For the year, PCF gained over 14% in absolute terms, and performed in line with the Russell 2000 Index.
| 3-Month | YTD | 1-Year | 3-Year | Since Inception, annualized | Since Inception, cumulative | |
|---|---|---|---|---|---|---|
| PCF A, CAD | 4.3 | 14.6 | 14.6 | 25.5 | 20.7 | 108.7 |
| PCF A, USD | 4.4 | 15.5 | 15.5 | 28.4 | 19.8 | 102.7 |
| PCF F, CAD | 4.0 | 13.3 | 13.3 | n/a | 23.9 | 53.5 |
| PCF F, USD | 4.1 | 14.2 | 14.2 | n/a | 25.6 | 57.2 |
| R2000, CAD | 1.6 | 14.3 | 14.3 | 17.1 | 11.8 | 54.6 |
| R2000, USD | 2.1 | 14.8 | 14.8 | 20.0 | 10.9 | 49.9 |
| S&P 500, CAD | 10.5 | 28.2 | 28.2 | 23.0 | 17.3 | 86.9 |
| S&P 500, USD | 11.0 | 28.7 | 28.7 | 26.1 | 16.4 | 81.2 |
FTSE Russell is a trading name of FTSE International Limited (“FTSE”), Frank Russell Company (“Russell”), FTSE TMX Global Debt Capital Markets Inc. and FTSE TMX Global Debt Capital Markets Limited (together, “FTSE TMX”) and MTS Next Limited. The Russell 2000 is a market cap weighted index that includes the smallest 2,000 companies covered in the Russell 3000 universe of US-based listed equities. The index is designed to be broad and unbiased in its inclusion criteria and is recompiled annually to account for the inevitable changes that occur as stocks rise and fall in value. Russell refers to the various indices copyrighted and trademarked by the Frank Russell Co. The S&P/TSX Composite is the headline index for the Canadian equity market. It is the broadest in the S&P/TSX family. The S&P/TSX Completion Index is comprised of the constituents of the S&P/TSX Composite Index that are not included in the S&P/TSX 60 Index. The index was formally the S&P/TSX MidCap Index. The FTSE TMX Indices comprise of a series of benchmarks which are designed to track the performance of bonds denominated in Canadian Dollars (CAD). The FTSE TMX Canada Universe Bond Index is the broadest and most widely used measure of performance of marketable government and corporate bonds outstanding in the Canadian market.
Performance Commentary
Following up a strong 2020, where PCF gained 37% and outperformed its benchmark by almost 20%, 2021 saw the Fund underperform in the first half, outperform in the second half, and finish the year roughly in line with its benchmark.
As we approach our four-year anniversary, we remind investors of our intended bottom-up performance hurdle for PCF holdings: to find stocks that can double over four-years. While not every PCF stock will meet this goal, we are pleased that the portfolio did. PCF launched with a net asset value (NAV) per share of $10 and ended 2021 with a NAV just under $20.
Our focus remains on selecting high quality growth stocks that can compound value over the long-term.
Portfolio Management Commentary
We added several new positions to the fund in 2021, the most significant of which were Altus Group, Tecsys, and Paycom. All three businesses are well known to Pembroke, and all three are high-quality franchises with competitive differentiation, growth potential, and shareholder-aligned management teams.
As we detailed last quarter, we took advantage of market volatility on several occasions to reallocate capital when one of our high-quality businesses declined due to what we perceived to be short-term factors. Generically, while short-term dislocations are seldom fun, the long-term potential gains from ignoring or even taking advantage of a myopic market can be significant.
We maintained a disciplined approach to risk management and sold two positions from the portfolio when they hit their automatic stop-loss triggers. While a mechanistic stop-loss approach will occasionally result in poorly timed sales, over a long period of time, we believe this will protect capital and prevent more sizable drawdowns for the Fund.
Portfolio Characteristics
Over the long-term, Pembroke believes that a portfolio of stocks containing the following attributes should better protect capital in down markets and outperform in up-markets. We intend to hold portfolios that will show faster growth, higher margins, higher returns on capital and that are better financed and more aligned with investor interests than the market.
Metric Comment Strategy Russell 2000
NTM Sales Growth Higher Growth 17.8% 16.7%
NTM Earnings Growth Higher Growth 20.6% 18.4%
Operating Margin Higher Margin 9.7% 5.0%
Free Cash Flow Margin Higher Margin 13.0% -0.4%
Beta Lower Volatility 0.64 1.00
Standard Deviation Lower Volatility 18.4% 22.0%
Return on Equity (ROE) Lower Volatility 17.8% 6.2%
Return on Invested Capital (ROIC) Higher Quality 13.2% 3.8%
Net Debt to NTM EBITBA Lower Leverage 0.3x 5.4x
Price/NTM Earnings Lower Value 36.4x 24.9x
EV/NTM EBITDA Lower Value 25.5x 14.8%
Insider Ownership Higher Alignement 8.1% 4.2%
Outlook Commentary
2022 is off to a choppy start with the market digesting the implications of significant near-term inflation readings, the start of a Federal Reserve rate-hiking cycle, and a macro backdrop quite different than any we have seen in decades.
While we build our portfolios from the bottom-up and eschew macro-oriented investment decisions, we find many reasons for optimism in the coming year. The economic outlook is robust, supported by a healthy consumer demand and strong underlying secular and cyclical demand in our key sectors (industrials, consumer, information technology and health care).
More importantly, the competitive situation of our companies is promising. We believe our companies largely control their own growth destinies and are well positioned to thrive in varying economic backdrops. Our quality bias leads us to own businesses that often have pricing power and can offset the impact of inflation over time.
Lastly, our portfolio is balanced between secular and cyclical growers. While the macro environment is difficult to consistently predict, our measured approach to stock selection and portfolio management avoids dramatic market calls and, instead, focuses on the specific outlooks of our companies. Looking out the next four years, we are as focused and optimistic as ever.
Q4 Contributors and Detractors
Two stocks that contributed positively to performance during the fourth quarter
Shares in A. O. Smith (“AOS”) returned over 40% in the fourth quarter as a combination of solid third-quarter earnings results and better-than-expected forward guidance dispelled fears that the company’s China exposure might derail its growth story. Some investors were concerned that excessive financial leverage in the Chinese construction industry would impact AOS’s residential water heater sales, leading to a 17% decline in the stock in September. Our due diligence indicated this fear was misplaced, and that new water heater sales growth was sustainable. More importantly, we remain focused on the long-term potential for this high-quality industrial business. In addition to high margins, high returns on capital, and multi-year growth, AOS is benefiting from the pricing power that its brand, technology, and consolidated market dynamics provide to stay ahead of raw material inflation.
Trex Company (“TREX”), a long-time Pembroke holding and manufacturer of composite decking products, had positive developments during the quarter, bringing its stock price to higher levels. The company announced the addition of a third production site, less than a year after the completion of a 70% capacity expansion project. Trex management wishes to stay ahead of demand and accelerate share gains after operating in a capacity-constrained environment in the last 18 months. Trex also announced very strong quarterly results driven by strong demand for its products. Both announcements reinforce our confidence in the factors driving consumer demand, namely continued interest in outdoor living, conversion from wood to composite decks, and market share gains from the company’s strong brand and low-cost manufacturing capability.
Two stocks that contributed negatively to performance during the fourth quarter
Shares in Sprout Social (“SPT”) declined 26% in the quarter, despite significantly exceeding quarterly sales and earnings expectations. The company continues to make solid fundamental progress in its quest to become the system-of-record for enterprise social media management software, a goal we believe is attainable. We attribute the decline in the shares to two interrelated factors. First, as near-term inflation data has climbed, interest rate expectations have also climbed. Rising interest rates tend to hurt fast-growing companies whose cash flow generation is expected in future years, as the implicit discount rates to those cash flows increase. Second, investors have rotated capital away from growth technology and from the last year’s best-performing stocks, two categories both applicable to SPT. Despite the Q4 selloff, SPT still gained approximately 100% in 2021. We expect the company to grow at a rate of at least 25% for at least the next several years. Its highly profitable software margin structure (more than 75% gross margins) offers the potential for robust free cash flow generation at scale. Management owns close to 20% of the business and has executed brilliantly thus far.
Shares in Chart Industries (“GTLS”) declined 17% in the quarter, amidst a combination of a supply chain- and labour-constraints and broad sector rotation away from clean energy names. Like many manufacturing businesses, Chart underperformed against a backdrop of rising input prices. While the company commands leading market shares in for many of its products, the speed of the input price inflation means that their pricing power may not provide a full offset until 2022. Furthermore, customer, component and port delays led to shipment holdups, which pushed some revenue father into the fourth quarter and into 2022. While this situation creates near-term noise, we believe that the long-term outlook for GTLS remains excellent.
Disclaimer
Commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in unit value, reinvestment of all distributions and do not take into account sales charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.
Performance is reported for both PCF A-Class and F-Class units in Canadian Dollars, net of transaction costs and net of all other fees, excluding management fees. Management fees are charged directly to unitholders based on their assets under management, except for Class F units, which are charged to the Fund. Periods greater than one year have been annualized. The performance for the portfolio and benchmark index are measured using the “time weighted” rate of return methodology.
The Pembroke Concentrated Fund was converted from a pooled fund to a mutual fund on April 1st, 2020. For the period this Fund was a pooled fund, the expenses would have been higher if the Fund was a prospectus mutual fund. The above information is for the purpose of providing some insight into the performance of the Pembroke Concentrated Fund. Commissions, management fees and expenses all may be associated with mutual fund and pooled fund investments. Investment performance assumes reinvestment of dividends and capital gains and is net of transaction costs and net of all other fees, excluding management fees. Performance results will be reduced by the fees incurred in the management of the fund. No assurance can be given that an investor will not lose invested capital. Past performance is not indicative of future returns.
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Disclaimer
This report is for the purpose of providing some insight into Pembroke and the Pembroke funds. Past performance is not indicative of future returns. Any securities listed herein, are for informational purposes only and are not intended and should not be construed as investment advice nor is it a recommendation to buy or sell any particular security. Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Pembroke seeks to ensure that the content of this document is correct and up to date but does not guarantee that the content is accurate and complete and does not assume any responsibility for this. Pembroke is not responsible for decisions or actions taken or made on the basis of information contained in this document.
