Q1 2021 Review: An Atypical Quarter Class F

byAndrew Garschagen

 

The Class F of the Pembroke Concentrated Fund (“PCF”) returned 0.43% in Q1 compared to the 11.31% return of the Russell 2000, and 4.87% for the S&P 500.  

 The following table provides a detailed look at PCF’s performance relative to the market:

	Q-1 2021	1-Year	3-Years	Since Inception
Pembroke Concentrated Fund - Class A	0.74	72.74	19.79	21.10
Russell 2000 Total Return in CAD	11.31	72.71	13.81	13.79
Difference	(10.57)	0.04	5.99	7.31
Pembroke Concentrated Fund - Class F	0.43	70.73		26.03

Note: For Class A units, performance is reported in Canadian Dollars, net of transaction costs and net of all other fees, excluding management fees. For Class F units, performance is reported in Canadian Dollars, net of transaction costs and net of all other fees, including 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.
* Pembroke Concentrated Fund was converted from a pooled fund to a mutual fund on April 1, 2020. For the period this Fund was a pooled fund, the expenses would have been higher if the Fund was a prospectus mutual fund.
* Beginning of operations for the Pembroke Concentrated Fund - Class F is October 15, 2019.
*All performance metrics in this letter are expressed in CAD, net of transaction costs and all other fees, excluding management fees (except for Class F units which include management fees). The Fund’s inception date is 1/31/2018. Beginning of operations for Class F is 10/15/2019.

While we remain pleased with our long-term performance, the market’s unusual behaviour in Q1 is worthy of some discussion.  As we will demonstrate, our performance versus the market is largely due to the rally in low-quality stocks as opposed to any problems with specific holdings. 

To illustrate, the relative contribution of our top 10 winners was 654 basis points in the quarter, while our top 10 laggards only detracted 552 basis points.  Our worst laggard only represented a 114-basis point headwind; about the same as our best winner. 

So how dramatic is this junk rally?  The following chart details the Russell 2000’s Q1 performance by key Style Factor.

Style	Factor/Market Driver	YTD Return
Value	Sales/Price (1-Year Forward	35.15%
Volatility	90 Day Beta	24.98%
Leverage	Net Debt to Equity	24.14%
Volatility	1-Month Volatility	12.08%
Variability	5-Year Op. Income Variability	10.95%
Profitability	EBITDA Margin %	-10.99%
Profitability	ROE (Prior 5-Years)	-12.71%
Profitability	ROIC (Prior 5-Years)	-14.89%
Size	Market Capitalization	-15.04%
Growth	Prior Sales Growth %	-19.64%

Source: Bloomberg; priced as of 4/1/2021; style factors of the Russell 2000.

The cheapest companies (seen in row 1, using a sales yield calculation) performed the best – up 35%, comfortably beating the Russell’s +12% move.  Other style factors that led the market’s gains were volatility, high balance sheet leverage, and low profit margins.  Said another way, the cheapest, slowest growing, most volatile, most indebted stocks performed the best.  Conversely, the style factors that lagged the market were high margins, high quality (as expressed through ROE and ROIC), fast sales growth, and larger market caps. 

 

Clearly, this unusual quarter was not favourable to quality growth portfolios like PCF.  Ours is a portfolio of high return, high margin, low leverage, fast growing, above average market cap stocks.  As one would expect, junk rallies tend not to last long, and cede leadership to quality. 

Portfolio Characteristics

Pembroke believes that a portfolio of stocks containing the following attributes, over the long-term, should better protect capital in down markets and outperform in up-markets.  Our holdings are faster growing, higher margin, higher return, better financed, more aligned, less volatile, and reasonably valued as compared to the market.   

Metric	Comment	Strategy	Russell 2000
EV/NTM EBITDA	Better Value	21.9x	22.5x
Price/NTM Earnings	Lower Value	35.7x	32.8x
Revenue Growth (%)	Higher Growth	17.1%	13.8%
Gross Margin (%)	Higher Quality	44.5%	26.9%
Operating Margin (%)	Higher Quality	9.6%	0.6%
Operating Cash Flow Margin (%)	Higher Quality	15.9%	9.8%
Return on Equity (ROE)	Higher Quality	8.4%	0.9%
Return on Invested Capital (ROIC)	Higher Quality	7.5%	1.5%
Beta	Lower Volatility	0.77	1.00
Net Debt to NTM EBITDA	Lower Leverage	-1.1x	4.1x
Insider Ownership	Higher Alignment	8.0%	4.3%
Market Cap (Weighted Average)	Larger Value	$5.84 B	$3.71 B

Source: Pembroke, Bloomberg.  Earnings data based on Bloomberg next twelve months concensus estimates.  Beta calculated over a 1-year period.  Data as of March 31, 2020 in USD.

 

 

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