U.S. Equity Strategies

When it comes to Pembroke’s American equity strategies, it is worth noting that small capitalization stocks outperformed their larger capitalization counterparts in the third quarter. For most of the past 15 years, large-cap U.S. stocks, driven by the “Magnificent Seven,”, have outpaced small caps, so it is easy to forget that smaller companies once led the market during the prior decade.

Based on the past, a combination of attractive valuations and falling interest rates should favour small caps going forward. However, given the ongoing geopolitical uncertainty and the undeniable power of the world’s technology giants, we are not celebrating yet. Nevertheless, we are hopeful that the market is starting to recognize that smaller companies offer a solid combination of innovation, growth and compelling valuations.

U.S. GROWTH STRATEGY

Pembroke’s U.S. growth strategy rose significantly in the third quarter, continuing its ascent following the lows set in April. Even so, the strategy modestly underperformed its benchmark during the period. While many low-quality stocks jumped off market lows and those benefiting from the artificial intelligence boom surged, Pembroke remains committed to investing in quality companies serving a range of end markets.

That said, the team has identified several companies that are well positioned to benefit from the unprecedented levels of spending on data centres, power and semiconductors by the world’s largest technology companies. However, we hold these companies to the same standard as the companies in all our other portfolios. These companies are well financed, generate free cash flow and have sustainable competitive advantages that should support their multi-year growth ambitions.

Monolithic Power Systems (MPWR), Pure Storage (PSTG) and AAON (AAON) all saw their stock prices rise as a result of AI-related spending, as did Modine Manufacturing (MOD). Importantly, none of them are “concept” stocks, and they have all seen their growth rates increase as a result of customers spending more on their products.

Furthermore, six of the top ten contributors to performance in the past quarter operate independently of the AI euphoria. For instance, Dorman (DORM) manufactures and sells aftermarket automotive parts, while Installed Building Products (IBP) is consolidating the insulation installation market in the United States.

Role in a Diversified Portfolio

This strategy provides targeted exposure to dynamic U.S. small- and mid-cap growth businesses. It seeks to capture the value created in the early stages of a business’s development, providing long-term growth potential and portfolio diversification alongside core large-cap U.S. equities.

CONCENTRATED STRATEGY

In the third quarter, the Pembroke concentrated strategy performed strongly in absolute terms as well as in relative terms compared to its benchmark, the Russell 2000 index. However, over the first nine months of the year, the strategy’s absolute gains trailed the benchmark’s returns.

This reflects the market’s tendency, in early cycle periods, to reward lower-quality investments more than high-quality businesses, which are the focus of Pembroke. Fortunately, quality tends to outperform during the rest of the market cycle. Evidence of this can be seen in the strategy’s significant outperformance compared to the benchmark since its inception.

The strategy is currently exposed to several interesting themes. As an example, the investment team has initiated a position in Manhattan Associates (MANH), a software company with a strong market presence in warehouse management and omnichannel logistics. Although several large customers have delayed implementations due to tariff-related uncertainty, causing management to provide a conservative revenue growth forecast for 2025, the company’s long-term revenue outlook is unchanged. In fact, the opportunity to cross-sell newly launched products has given Pembroke increased confidence in the company’s multi-year prospects.

Role in a Diversified Portfolio

This strategy provides targeted exposure to Pembroke’s highest-quality U.S. small- and mid-cap growth businesses. It seeks to capture the value created in the early stages of a business’s development, providing long-term growth potential and portfolio diversification alongside core large-cap global equities. Its concentrated nature is designed to generate incremental returns over the long run, but with a higher level of volatility.

POSITIVE CONTRIBUTION TO THE STRATEGIES

Resideo’s (REZI) stock price has almost doubled last quarter, driven by a series of announcements that have attracted the attention of investors to this previously overlooked and undervalued small-cap company.

In late July, the company announced the settlement of its long-standing indemnification agreement with Honeywell, an arrangement dating back to its spinoff in 2018. The settlement involved a one-off cash payment, but more importantly eliminated the annual recurring payments to Honeywell that had complicated the company’s investment narrative.

At the same time, Resideo revealed plans to split into two independent, publicly traded entities, a move expected to streamline its structure and increase shareholder value. Shortly afterwards, the company reported stronger-than-expected quarterly results and improved forward guidance, further reinforcing investor optimism. Adding to this momentum, one of Resideo’s key investors, CD&R, was actively accumulating shares in the open market, which likely amplified the stock’s upward trajectory.

The investment opportunity remains attractive, as Resideo is still in the early stages of realizing synergies from a recent acquisition. New product initiatives are also expected to drive growth and margin expansion for years to come.

NEGATIVE CONTRIBUTION TO THE STRATEGIES

Q2 Holdings (QTWO), which provides customer-facing software to regional banks and credit unions across the U.S., has seen its stock price fall in 2025. Although its growth rate has slowed since the surge driven by the pandemic in 2020 and 2021, the company is still growing at a healthy rate while also expanding profit margins impressively.

Its customers rely on Q2’s products to compete with the largest U.S. banks, and management is confident that the company has significant growth potential. In addition, Q2 is developing new products to sell to its existing customers, including AI offerings that should help small banks compete with major players such as JPMorgan Chase. So why has the stock price fallen? Many investors are concerned that AI will reduce the value of prepackaged software and make it easier for new competitors to challenge established companies like Q2.

While acknowledging these risks, Pembroke also considers the fact that Q2 serves a highly regulated customer base that is cautious about using unproven technology. The company integrates seamlessly with numerous back-end solutions used by hundreds of U.S. banks and has a proven track record in data security. Q2 also has a strong balance sheet and solid, growing free cash flow, and is currently trading at an attractive valuation. Given the AI overhang, the team has not aggressively added to its holdings, preferring to assemble and analyse more information before drawing a conclusion.