Over the last year, the Pembroke Concentrated Fund (“PCF”) has declined along with the market, as a combination of inflation, interest rate, recession and geopolitical fears have pressured financial assets globally. However, on a relative basis, the PCF meaningfully outperformed its benchmark, the Russell 2000 Index (“R2000”), both over the prior 12 month and 3-month periods*.
* All performance metrics stated for PCF A-Class units in CAD. Detailed performance by class and currency listed below.
| 1-Month | 3-Month | YTD | 1-Year | 3-Year | Since Inception, annualized | Since Inception, cumulative | |
|---|---|---|---|---|---|---|---|
| PCF A, CAD | -4.56 | 4.81 | -23.55 | -20.28 | 8.20 | 10.52 | 59.51 |
| PCF A, USD | -9.16 | -1.90 | -29.64 | -26.53 | 6.85 | 7.90 | 42.60 |
| PCF F, CAD | -4.66 | 4.52 | -24.20 | -21.18 | n/a | 6.56 | 20.98 |
| PCF F, USD | -9.26 | -2.17 | -30.23 | -27.36 | n/a | 5.23 | 16.41 |
| R2000, CAD | -5.47 | 4.04 | -19.02 | -17.70 | 5.49 | 4.94 | 25.22 |
| R2000, USD | -9.58 | -2.19 | -25.10 | -23.50 | 4.29 | 2.52 | 12.30 |
| S&P 500, CAD | -5.08 | 1.18 | -17.69 | -9.06 | 9.41 | 9.67 | 53.83 |
| S&P 500, USD | -9.21 | -4.88 | -23.87 | -15.47 | 8.16 | 7.14 | 37.96 |
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
Since its inception in January of 2018, PCF has compounded value at approximately 10% per annum compared to the R2000 at roughly 4%. That being said, the experience over the prior 12 months and the most recent quarter has been significantly more challenging. While the PCF has continued to comfortably outperform its benchmark in these periods, the Fund’s 18% decline over the last year and 12% decline during the second quarter of 2022 are disappointing.
As we experienced last quarter, the prevailing macroeconomic backdrop has not favoured the PCF, or small capitalization stocks more generally. High levels of inflation and the resulting rise in interest rates have pressured both growth and premium-priced stocks. They led the market to ponder recession risks and central bank actions, which could further threaten corporate earnings. Adding in elevated geopolitical risks puts additional context around the “risk off” action from the second quarter.
Furthermore, our sector exposures continued to create a headwind to performance. The top-performing sectors in the second quarter were consumer staples, utilities and energy—sectors where we have no exposure. Conversely, technology, healthcare and consumer discretionary were among the worst performers, and they are segments where the Fund has significant weight.
While the sector moves were dramatic, they are also typical of periods when investors fear inflation, rising rates and economic slowdown. Over longer periods, we believe our companies’ pricing power, high-quality business models and growth prospects should enable them to thrive in various economic backdrops.
On the positive side, the Fund’s holdings are generally executing well, with the vast majority growing inline or better than expectations, and not experiencing deteriorating competitive positions. As we have articulated since we launched the PCF, we believe a portfolio of high-quality businesses is well suited to strong and weak economic environments.
In difficult periods, like the present one, our businesses can leverage their balance sheet strength to go “on the offensive” against weaker competitors. The PCF’s superior growth profile means its businesses generally grow when the economy is shrinking, and compound off a higher base when the economy picks up.
Our focus remains on selecting high-quality growth stocks that can compound value over the long-term. This approach has rewarded Pembroke investors over the firm’s 54-year history, and we believe it can continue to do so going forward.
Portfolio Management Commentary
We did not initiate any new position or exit any positions in the second quarter. However, we did reallocate capital from three names that have outperformed over the trailing year (Chart Industries, Albany International and WNS) into three names that have underperformed (Trex, Installed Building Products and Sprout Social).
Trex and Installed Building Products have underperformed because of their proximity to the U.S. residential housing market, which, despite struggling with excess demand and insufficient supply, is an interest rate sensitive pocket of the economy. They are both high-quality businesses with enormous market opportunities, sustainable competitive advantages, and aligned management teams. We remain confident in their ability to create substantial value over the long-term and welcomed the opportunity to add to our positions at the current depressed levels.
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 rising markets. Our holdings generally show faster growth, higher margins and higher returns, and are better financed and more aligned with investor interests, as compared to the market.
| Metric | Strategy | Russell 2000 |
|---|---|---|
| Price/NTM Growth | 25.4x | 17.8x |
| NTM Sales Growth | 12.6% | 11.9% |
| Standard Deviation | 27.2% | 25.3% |
| Return on Equity (ROE) | 14.3% | 7.5% |
| Return on Invested Capital (ROIC) | 11.2% | 4.5% |
| Net Debt to NTM EBITBA | 0.1x | 2.1x |
| Market Cap (Weighted Average) | $6.1B | $2.6B |
| Insider Ownership | 7.4% | 4.2% |
Source: Pembroke, Bloomberg, Earnings and revenue data based on Bloomberg next twelve months consensus estimates. Standard deviation and beta calculated over a 1-year period. The beta of the portfolio is calculated against the Russell 2000 Total Return Index. Data as of March 31, 2022 in USD retrieved on April 5, 2022.
Two stocks that made positive contributions to returns of the Fund over the past 12 months
Shares in long-time holding WNS Holdings (“WNS”) have performed admirably in a difficult stock market environment over the past year. WNS helps its customers move back-office processes to low-cost jurisdictions, such as India. WNS has strong relationships with its customers, leading to ongoing cross-selling opportunities. The company has also consistently added six to eight new customers per quarter, setting the stage for long-term growth. During the pandemic, some of WNS’ customers in the travel industry saw major revenue shortfalls, leading them to cut back on the services they use from WNS. That revenue is now coming back. Moreover, WNS acquired Vuram in recent weeks , which should further boost its industry-leading profit margins. Given the company’s history of healthy revenue growth, stable profit margins and robust free cash flow, and taking into the account the ongoing demand for its services from large companies around the world, WNS remains a core holding in Pembroke’s US growth portfolios and the Pembroke Concentrated Fund.
Shares in Albany International Corp. (“AIN”) declined roughly 11% over the last twelve months, compared to a 26% decline in the Russell 2000 benchmark. Albany’s relative outperformance over the last year is attributable in part to the strength of its core paper machine clothing business, and the steep growth curve in its aerospace business. On the machine clothing side, AIN is the clear leader in a modestly growing market with high margins, cash flow and a defensible competitive position. The cash from this segment funds its growth in aerospace, where the company sells lightweight, energy-efficient composite materials, and is benefiting from a rapid production ramp in narrowbody aircraft at Boeing and Airbus. Furthermore, AIN trades at a reasonable valuation given its quality and growth prospects. It remains a core position in the Pembroke Concentrated Funds and our US growth funds.
Two stocks that made negative contributions to returns of the Fund over the past 12 months
Trex Company (“TREX US”), a manufacturer of composite decking products, is a long-time Pembroke holding that had positive developments over the last year. Given strong demand for its products, 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. Industry demand for decking products remains strong as more and more consumers embrace outdoor living. Additionally, Trex has been gaining market share at the expense of wood alternatives. Despite these positive news, Trex’s stock has declined precipitously since December, along with other housing-related stocks. Part of the reason for this is that investors fear higher inflation and rising interest rates will hinder demand for home renovation products, such as those supplied by Trex.
Altus group (“AIF”) is a leading real estate software and services company. The company’s primary focus is software for the brokerage and asset management part of the industry, which helps users manage valuations. The company also has a tax consulting practice that has a leading position in Canada, the UK and the US. The shares sold off in the second quarter of 2022, following the general trend in the US technology sector and, more specifically, the software stocks. The company also had some lumpiness in its earnings reports, which contributed to the compression in the multiple. At current prices, the risk-reward equation looks very promising.
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.
Other Articles Of Interest
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.
