Over the past several days governments, companies, and individuals around the world have taken action to slow the spread of the COVID-19 virus. These actions have resulted in the closing of schools and businesses, the introduction of new regulations by governments and new guidance from health authorities. We expect new updates to continue with further changes in store for all of us. We are writing to let you know what Pembroke is doing to ensure the continuity of our business, the long-term strength of our investment strategies, and uninterrupted service to our clients.
Pembroke introduced several policies on March 12th designed to reduce risks for our employees, our stakeholders, and the firm. Most Pembroke employees are now working remotely. All business travel for at least the next month has been cancelled, all personal travel discouraged, and all meetings are taking place by video conference or telephone. We have redundancy in key areas such as trading and information technology and maintain physical separation between employees with shared responsibility for mission-critical tasks. The investment and sales teams are accustomed to working while on the road and these transitions, while forced on the firm at short notice, have not been difficult and have not interrupted our business or our communications with suppliers, clients, and other stakeholders.
The disruptions that have been forced on many of the companies in our portfolio are of a different order. The isolation that people around the world have been forced into has ground many businesses to a halt. Restaurants are closed. Movie theaters are closed. Trains and planes are empty. Weaker businesses will not survive many months of this new quarantine economy. On the other hand, companies with little or no debt, plenty of cash, and valuable product and service offerings will grow their market share through acquisition, competitor attrition, or both. This distinction between stronger companies and weaker companies is very important for active investors like Pembroke. In the stock market, every business has both an underlying value and a price. Active investors spend their time studying businesses and their values and comparing those values to market prices.
The stock market has another function, however, which has become increasingly important with the rise of passive investing. That function is liquidity. Before the rise of exchange traded funds (ETFs) and other readily available passive investment vehicles, equities were already the most liquid investment class for most investors. With ETFs for every major country index, every major sector, and every major factor, passive investors can convert their stock market exposure to cash with the push of a button. Since February 20, that is precisely what investors have done (Exhibit 1).
Exhibit 1: Price decline and breadth of decline in some US and Canadian indices since February 20th
| % decrease | Below -10% | Below -20% | Below -30% | |
| Russell 2000 | Number of companies
% of total |
1,866
95% |
1,818
92% |
1,486
75% |
| S&P TSX Composite | Number of companies
% of total |
213
93% |
196
85% |
138
60% |
| S&P 500 | Number of companies
% of total |
467
92% |
429
85% |
297 59% |
Source: Bloomberg March 16, 2020
For active investors, this type of selling, with 60%-75% of all companies down 30% or more, creates very rare buying opportunities. Our priorities in this sell-off have been first to review what we own. We have sold a small number of holdings that faced unusual risk in the current environment due to their smaller size or their early stage. Second, we have been adding to existing holdings and considering buying new positions in some companies that were previously too expensive or too large. Many companies have lost half their value in less than a month and become new candidates for our small and mid-cap growth mandates.
From a sector perspective there have been no material changes to our US and Canadian strategies. We entered the year with little or no energy exposure. The changes we are making are small and at the margin. Our portfolios are built for all seasons and remain fully invested. We are in close contact with our companies to understand the ramifications of this rapidly changing environment. Some management teams have told us they do not yet see material changes to their businesses. Some have announced large buybacks, signaling they do not see long-term impairment to their businesses. We expect most portfolio companies to face near-term headwinds including deteriorating demand and disruptions to supply chains. As a result, we expect earnings to decline for most companies in the portfolio this year. We also expect our portfolio holdings to grow through a full cycle, to gain market share, and to emerge in a better competitive position.
We encourage our clients to remain calm, to consider their own unique financial positions, and to avoid making precipitous decisions. If you have made a financial plan with an advisor or counselor, review it. Call your Pembroke representative if you wish to review your funds, their performance, or their fundamentals. The challenge presented to the economy and financial markets is significant and its magnitude and duration remain unknown. After more than 50 years of investing together with our clients we have been through panics before and we have not changed our views. Diversify, take a long-term view, and never try to time the markets. We will carry on with this strategy, with the pursuit of great long-term investments, and with the commitment to serve our clients.
We will continue to update you as the situation evolves. Do not hesitate to contact your Pembroke Private Wealth management representative for a discussion today.
Publication Date: March 16, 2020
