Q2 2024 showed global market resilience, shaped by discussions on interest rates and inflation that significantly influenced investor sentiment. While major indexes like NASDAQ and S&P 500 saw gains, small-cap stocks in the U.S., Canada and Asia returned mixed performances, reflecting a cautiously optimistic outlook for the future.
Market Review
U.S. Market Overview
The U.S. financial narrative remained intensely focused on interest rates and inflation, driving market sentiment and investment strategies. Initial stronger-than-expected payroll data led to a market sell-off, pushing back the anticipated start of the U.S. Federal Reserve’s interest rate easing cycle. However, subsequent inflation reports later in the quarter spurred optimism for an interest rate cut potentially as early as September.
The Federal Reserve’s updated “dot plot” now indicates a planned rate cut later this year, with further reductions anticipated in 2025. Despite these monetary uncertainties, the major equity benchmarks like NASDAQ and the S&P 500 saw healthy gains, underscoring the resilience of the U.S. economy.
However, small-cap stocks continued their underwhelming performance, starkly contrasting with the gains of large-cap stocks driven by a few mega-cap technology firms.
This underperformance highlights a deepening disparity in the market, where top-performing stocks mask broader sectoral weaknesses, signaling a need for cautious investor strategies moving forward.
Canada: A Comparable Story
In Canada, the financial narrative closely mirrored the trends observed in the U.S., with significant attention paid to the trajectory of interest rates and inflation dynamics.
Similar to the U.S., later data showing a moderation in inflation revived optimism for upcoming rate cuts. The Bank of Canada, like other global central banks, began reducing interest rates, creating a favourable environment for investments. This was particularly beneficial for the small-cap market, where stocks outperformed larger companies for two consecutive quarters. The TSX Small Cap Index’s modest gains highlighted a gradual yet notable shift in investor confidence and market dynamics, suggesting a strengthening undercurrent in Canada’s financial landscape.
This period of adjustment in monetary policy could pave the way for sustained economic growth and stability, aligning Canada’s financial trajectory with broader global trends.
Asia-Pacific Dynamics
The Asia-Pacific markets presented a mixed but generally positive picture, with significant gains in countries like Taiwan, India, and Singapore. China managed to narrow its underperformance gap, showing strong market activities in April, although it softened towards the end of the quarter.
The region’s tech sector, especially semiconductors, benefited from robust AI capital expenditure, particularly from U.S. tech giants. Despite varying consumer spending trends across the region, travel and high-end services showed strong growth, signaling shifting consumer preferences towards more experiential spending.
The overall sentiment in Asia was bolstered by better-than-expected quarterly earnings, with China’s MSCI index achieving a 7.2% return, driven by selective tech stocks and traditional sectors like banking and utilities. This upward trajectory reflects an adaptive market that is swiftly responding to global tech advancements and changing consumer dynamics, positioning Asia as a critical player in the global economic landscape.
Key Q2 2024 Takeaways
The second quarter of 2024 illustrated a complex but cautiously optimistic global market landscape. Each region displayed unique challenges and opportunities, influenced by internal and external economic forces.
Moving forward, the focus will likely remain on inflation trends, monetary policies, and sector-specific performances, with technology and consumer behavior playing pivotal roles in shaping future market trajectories.
Quarterly results by strategy
Canadian Small Cap Equity Strategy
Investment Performance
The following table shows the investment performance of the Van Berkom Canadian Small Cap Composite, compared to the S&P/TSX Canadian Small Cap Index and the S&P/TSX Composite Index (as at June 30, 2024).
Returns are calculated using the time-weighted method and presented gross of management and trustee fees and withholding taxes. Returns are annualized for periods longer than 12 months.
*Note: Results are the BMO Small Cap Blended Weighted Index from June 30, 1992 to December 31, 1999 and thereafter the S&P/TSX Canadian Small Cap Index.
** Note : June 30, 1992
Portfolio Positioning
In the second quarter of 2024, our portfolio experienced a slight decline, underperforming the TSX Small Cap Index. Despite this underperformance, our year-to-date performance remains strong, closely aligning with the index’s return. The quarter presented notable challenges, particularly for Canadian small cap investors. While the materials and energy sectors enjoyed gains, our portfolio’s lack of exposure to these sectors created a 3.1% drag on our relative performance due to asset allocation.
However, our strong security selection has consistently added value, contributing an impressive 6% to our absolute return for the year. In Q2 alone, stock selection in the information technology and financial sectors enhanced our performance by 1.0%. This success is attributed to our investment in a carefully curated portfolio of high-quality companies. These companies not only show strong organic and inorganic growth potential but also trade at attractive valuations with prospects for trading multiple expansion.
Throughout Q2, several factors affected our portfolio holdings. A broad market phenomenon led to a contraction in valuation multiples across various sectors, impacting even our best performing portfolio holdings. Despite these companies posting robust financial results and maintaining or improving their yearly guidance, the reduction in valuation multiples held back their potential for higher returns.
Our portfolio strategy remains focused on capitalizing on these valuation disparities and continuing to identify and invest in undervalued companies with strong growth trajectories. As market conditions evolve, we are poised to adjust our holdings to maximize returns, reflecting our commitment to diligent portfolio management and strategic foresight.
Our significant contributors to performance include the following stocks:
- CWB Financial Group (+56.0%), following the announcement of its acquisition by National Bank, which offered a 110% premium on CWB’s shares.
- Computer Modelling Group (+30.2%), from robust organic revenue growth, particularly from energy transition products and from strong contribution from past acquisitions.
- Goeasy (+24.4%) from strong loan demand and favourable lending conditions.
- Sylogist (+16.7%) due to strategic enhancements in ERP and CRM solutions which boosted investor confidence.
- Element Fleet Management (+14.3%) due to its record earnings and strong market leadership in fleet services.
- Richards Packaging Income Fund (-14.7%) due to an oversupply and shifting consumer preferences in its food and beverage segment.
- AutoCanada (-28.5%) amid challenging market conditions and rising funding costs.
- Wajax (-20.8%) due to delayed equipment sales in anticipation of the attractive new equipment financing program rolled out by Hitachi.
- GDI Integrated Facility Services (-17.8%), hurt by project overruns and normalization from COVID highs.
- Badger Infrastructure Solutions (-17.6%), due to weak Canadian segment results as a result of project delays.
Portfolio Changes
We focused on enhancing the long-term quality and positioning of our model portfolio through diligent research and targeted activity. This quarter saw active investment decisions aimed at adding long-term alpha, reflecting significant stock price movements within the small-cap market.
Increased Holdings: We augmented positions in high-conviction holdings, such as Boyd Group Services, AG Growth International and Wajax, driven by their current valuations, which we believe do not reflect their potential for long-term organic and acquisition growth.
Reduced Holdings: Our positions in MDA Space, Computer Modelling Group and CWB Financial Group were trimmed to manage overall portfolio weight and respond to concerns over extended valuations. We reduced our holdings in Tucows due to portfolio rebalancing and strategy alignment.
Divestitures: We sold our stake in diversified global manufacturer Linamar, to reallocate capital to smaller-cap names presenting more favourable risk-reward profiles.
| Most Significant Purchases | Most Significant Sales |
| Boyd Group Services | Linamar |
| Terravest Industries | CWB Financial Group |
| AG Growth International | MDA Space |
| Evertz Technologies | Computer Modelling Group |
| Wajax | Tucows |
No new positions were initiated this quarter, as we maintained a focus on optimizing our existing holdings and capitalizing on shifting market dynamics to maximize returns. Our commitment remains on a focused, high-conviction investment approach backed by rigorous research.
Outlook
As we move into the second half of the year, investors face uncertainty regarding the trajectory of interest rates, inflation and overall economic performance. Several macroeconomic scenarios could unfold in the coming months, each with distinct implications for the market. If the Bank of Canada and the Federal Reserve initiate a series of interest rate cuts, this could be aimed at mitigating a potential economic slowdown, despite the current consensus among market experts that a recession is not immediately on the horizon.
If the economy maintains its stability, a key question remains whether corporate earnings growth can accelerate sufficiently to sustain further market gains. This acceleration is essential for providing solid returns to investors, particularly as some market segments have recently shown signs of weakness.
Historically, periods of interest rate cuts, like the early 2000s and 2008-2009, have seen Canadian small-cap stocks significantly outperform their large-cap counterparts. If a similar scenario were to occur in the coming year, our Canadian small-cap strategy is positioned to yield robust returns relative to large-cap stocks.
Despite company-specific fundamentals not significantly influencing small-cap returns in the first half of 2024, the outlook suggests a shift might be forthcoming. The extremely narrow market breadth observed earlier this year is expected to give way to a broader rally, favouring stocks of companies that can deliver outstanding financial results. As valuation disparities between market favorites and undervalued stocks widen, we anticipate that high-quality, overlooked companies will demonstrate strong performance. These companies typically offer consistent growth and high returns at more reasonable valuations, contrasting with the market’s more popular stocks.
Our current portfolio is composed of high-quality businesses that we believe are well-positioned for sustained growth, strong profit margins and robust returns on capital and equity. It is currently trading at an 8% discount to its intrinsic value, based on our conservative evaluations. After a period of relative underperformance, we are poised to return to a trajectory of exceeding our benchmarks, driven by solid company-specific fundamentals.
Additionally, our portfolio benefits from a 14.5% weighted-average ROE, modest leverage with a net debt to EBITDA ratio of 1.2x, and high profit margins, positioning it well for the upcoming quarters.
Reduced Holdings: Our positions in MDA Space, Computer Modelling Group and CWB Financial Group were trimmed to manage overall portfolio weight and respond to concerns over extended valuations. We reduced our holdings in Tucows due to portfolio rebalancing and strategy alignment.
Divestitures: We sold our stake in diversified global manufacturer Linamar, to reallocate capital to smaller-cap names presenting more favourable risk-reward profiles.
| Most Significant Purchases | Most Significant Sales |
| Boyd Group Services | Linamar |
| Terravest Industries | CWB Financial Group |
| AG Growth International | MDA Space |
| Evertz Technologies | Computer Modelling Group |
| Wajax | Tucows |
No new positions were initiated this quarter, as we maintained a focus on optimizing our existing holdings and capitalizing on shifting market dynamics to maximize returns. Our commitment remains on a focused, high-conviction investment approach backed by rigorous research.
Outlook
As we move into the second half of the year, investors face uncertainty regarding the trajectory of interest rates, inflation and overall economic performance. Several macroeconomic scenarios could unfold in the coming months, each with distinct implications for the market. If the Bank of Canada and the Federal Reserve initiate a series of interest rate cuts, this could be aimed at mitigating a potential economic slowdown, despite the current consensus among market experts that a recession is not immediately on the horizon.
If the economy maintains its stability, a key question remains whether corporate earnings growth can accelerate sufficiently to sustain further market gains. This acceleration is essential for providing solid returns to investors, particularly as some market segments have recently shown signs of weakness.
Historically, periods of interest rate cuts, like the early 2000s and 2008-2009, have seen Canadian small-cap stocks significantly outperform their large-cap counterparts. If a similar scenario were to occur in the coming year, our Canadian small-cap strategy is positioned to yield robust returns relative to large-cap stocks.
Despite company-specific fundamentals not significantly influencing small-cap returns in the first half of 2024, the outlook suggests a shift might be forthcoming. The extremely narrow market breadth observed earlier this year is expected to give way to a broader rally, favouring stocks of companies that can deliver outstanding financial results. As valuation disparities between market favorites and undervalued stocks widen, we anticipate that high-quality, overlooked companies will demonstrate strong performance. These companies typically offer consistent growth and high returns at more reasonable valuations, contrasting with the market’s more popular stocks.
Our current portfolio is composed of high-quality businesses that we believe are well-positioned for sustained growth, strong profit margins and robust returns on capital and equity. It is currently trading at an 8% discount to its intrinsic value, based on our conservative evaluations. After a period of relative underperformance, we are poised to return to a trajectory of exceeding our benchmarks, driven by solid company-specific fundamentals.
Additionally, our portfolio benefits from a 14.5% weighted-average ROE, modest leverage with a net debt to EBITDA ratio of 1.2x, and high profit margins, positioning it well for the upcoming quarters.
U.S. Small Cap Equity Strategy
Investment Performance
The following table shows the investment performance of the Van Berkom U.S. Small Cap Composite (in U.S. dollars), compared to the Russell 2000 Small Cap Index and the S&P 500 Index (as at June 30, 2024).
Returns are calculated using the time-weighted method and presented gross of management and trustee fees and withholding taxes. Returns are annualized for periods longer than 12 months.
* Note : June 30, 2000
Portfolio Positioning
The second quarter saw mixed results for our U.S. small-cap strategy, characterized by an initial outperformance in April followed by challenges in May and June. This period’s performance was heavily influenced by a market shift back to thematic investing, particularly around artificial intelligence (AI), which favoured a narrow segment of the market and adversely impacted our broader portfolio.
Our performance was particularly affected by our positioning within the Information Technology (IT) sector. Despite matching the benchmark in terms of sector weight, our specific exposure within the sector differed significantly. We favoured software companies over semiconductors and hardware due to their higher-quality business models, which typically offer recurring revenue, high customer retention and superior profit margins. However, a general slowdown in IT spending, driven by macroeconomic uncertainty and a re-evaluation of corporate strategies concerning AI, led to deceleration in growth and a contraction in valuation multiples for our holdings in this sector. Beyond IT, our portfolio selections in Financial Services, Healthcare and Industrials contributed positively, showcasing our robust security selection process. However, these gains were insufficient to offset the significant underperformance within IT.
The resurgence of retail investor activity influenced by platforms like Reddit and a continued preference for momentum investing contributed to market volatility and impacted the performance of stocks that do not align with our investment criteria based on quality attributes.
Despite challenging market conditions, the fundamental strength of our portfolio was evident during the recent earnings season. With 93% of our holdings exceeding earnings expectations, our portfolio demonstrated resilience. However, the positive earnings results did not translate into expected stock price appreciation due to the overall market dynamics.
Significant contributors to performance in Q2 2024:
- Primoris Services (+20.3%), benefiting from its successful pivot to utility and telecom maintenance and its growing presence in the solar farm construction market.
- Globus Medical (+27.8%) post-Nuvasive acquisition, showing solid integration progress and unlocking synergies.
- Victory Capital (+14.3%) after acquiring Amundi’s U.S. assets, enhancing its asset management scale and securing a strategic distribution agreement.
- Planet Fitness (+17.6%), Ormat Technologies (+8.5%) and Brady Corp. (+12.4%), supported by positive investor sentiment and strong quarterly results.
Stocks that detracted from our portfolio’s performance in Q2 2024:
- Cerence (-74.9%), due to significantly reduced earnings expectations for the year.
- DoubleVerify (-41.8%) due to disappointing revenue forecasts and competitive five fears pressuring the stock’s valuation multiples quite significantly
- Five9 (-29.4%) affected by skepticism about its revenue growth reacceleration and potential AI disruption.
- Grocery Outlet (-21.3%) due to ongoing IT system issues affecting profitability.
Portfolio Changes
Despite modest overall market returns, significant price movements in select stocks presented valuable investment opportunities, leading to strategic portfolio adjustments.
Portfolio Additions:
- We added CCC Intelligent Solutions to our portfolio due to its strong position in the P&C insurance ecosystem, impressive growth metrics and significant R&D investment. CCC’s network effects and high customer ROI underscore its long-term value.
- We increased our stake in Five9 as its valuation became more attractive following market pullbacks, enhancing its risk-reward profile.
Portfolio Reductions:
- We sold our holding in Universal Health Services after a successful 20-year investment, capitalizing on the stock’s performance, as it traded above our DCF valuation. The decision aligns with its mature market position and moderated future growth expectations.
- We exited our Cerence position due to consistent underperformance and operational challenges that clouded financial recovery prospects.
- We took profits or reduced stakes in Envestnet, Brady Corp., Primoris Services, Planet Fitness, Houlihan Lokey, Installed Building Products, Victory Capital, StoneEx, and Federal Signal following strong performances and valuation expansions, recalibrating the portfolio towards opportunities with greater upside potential.
These changes reflect our ongoing commitment to optimizing portfolio performance and capitalizing on emerging opportunities, guided by thorough research and strategic market positioning.
Outlook
Investors face the remainder of the year with continued uncertainty regarding the trajectory of interest rates, inflation and the broader economy. Various macroeconomic scenarios could unfold, potentially influencing the U.S. Federal Reserve to implement interest rate cuts to mitigate an economic downturn—a situation not widely anticipated by market analysts. The critical question remains whether the economy will sustain its current stability, which most economists predict, and whether this stability can translate into accelerated corporate earnings growth, essential for further stock market gains.
The limited impact of company-specific fundamentals on small-cap stock returns in the first half of 2024, combined with uncertain economic and market prospects, suggests a potential shift in investment focus. We expect the narrow market breadth observed earlier this year to broaden, moving away from thematic investing toward equities that offer strong financial performance and reasonable valuations. The increasing valuation disparities between the market’s favored stocks and those overlooked may correct as high-quality companies that have lagged begin to demonstrate their inherent value through consistent growth and higher returns at more attractive valuation levels.
Our portfolio is strategically positioned with high-quality businesses that have demonstrated resilience and growth potential. These companies are currently trading at an approximate 10% discount to their intrinsic value, calculated through a conservative and detailed analysis. Given this underperformance relative to our benchmark, we anticipate a return to our historical pattern of exceeding benchmarks based on robust company-specific fundamentals.
As we look ahead, we remain confident in our investment strategy and portfolio composition. We continue to focus on identifying and capitalizing on opportunities where intrinsic value is not fully recognized by the market. This approach is expected to drive strong returns and contribute to portfolio performance in the upcoming quarters, aligning with our long-term investment objectives and commitment to generating shareholder value.
- We increased our stake in Five9 as its valuation became more attractive following market pullbacks, enhancing its risk-reward profile.
Portfolio Reductions:
- We sold our holding in Universal Health Services after a successful 20-year investment, capitalizing on the stock’s performance, as it traded above our DCF valuation. The decision aligns with its mature market position and moderated future growth expectations.
- We exited our Cerence position due to consistent underperformance and operational challenges that clouded financial recovery prospects.
- We took profits or reduced stakes in Envestnet, Brady Corp., Primoris Services, Planet Fitness, Houlihan Lokey, Installed Building Products, Victory Capital, StoneEx, and Federal Signal following strong performances and valuation expansions, recalibrating the portfolio towards opportunities with greater upside potential.
These changes reflect our ongoing commitment to optimizing portfolio performance and capitalizing on emerging opportunities, guided by thorough research and strategic market positioning.
Outlook
Investors face the remainder of the year with continued uncertainty regarding the trajectory of interest rates, inflation and the broader economy. Various macroeconomic scenarios could unfold, potentially influencing the U.S. Federal Reserve to implement interest rate cuts to mitigate an economic downturn—a situation not widely anticipated by market analysts. The critical question remains whether the economy will sustain its current stability, which most economists predict, and whether this stability can translate into accelerated corporate earnings growth, essential for further stock market gains.
The limited impact of company-specific fundamentals on small-cap stock returns in the first half of 2024, combined with uncertain economic and market prospects, suggests a potential shift in investment focus. We expect the narrow market breadth observed earlier this year to broaden, moving away from thematic investing toward equities that offer strong financial performance and reasonable valuations. The increasing valuation disparities between the market’s favored stocks and those overlooked may correct as high-quality companies that have lagged begin to demonstrate their inherent value through consistent growth and higher returns at more attractive valuation levels.
Our portfolio is strategically positioned with high-quality businesses that have demonstrated resilience and growth potential. These companies are currently trading at an approximate 10% discount to their intrinsic value, calculated through a conservative and detailed analysis. Given this underperformance relative to our benchmark, we anticipate a return to our historical pattern of exceeding benchmarks based on robust company-specific fundamentals.
As we look ahead, we remain confident in our investment strategy and portfolio composition. We continue to focus on identifying and capitalizing on opportunities where intrinsic value is not fully recognized by the market. This approach is expected to drive strong returns and contribute to portfolio performance in the upcoming quarters, aligning with our long-term investment objectives and commitment to generating shareholder value.
Greater China Growth Strategy
Investment Performance
The following table shows the investment performance results of the Van Berkom Golden Dragon Greater China Growth Composite (in U.S. dollars), compared to the MSCI China and the MSCI Golden Dragon Small Cap Indices (as at June 30, 2024).
Returns are calculated using the time-weighted method and presented gross of management and trustee fees and withholding taxes. Returns are annualized for periods longer than 12 months.
* Note : December 31, 2011
Portfolio Positioning
In the second quarter, our portfolio saw diverse performance across sectors and regions, particularly in the Asia Pacific Japan region. Despite varied results, strategic adjustments and selective positioning helped us navigate a complex market landscape.
Our Taiwanese holdings paused after a strong performance, with anticipation building for a resurgence in the fall. This outlook is buoyed by the expected rise in consumer uptake of Edge AI devices, projecting an increase in AI PC market penetration from 5% in 2024 to 20%-25% in 2025. This growth is likely to be further catalyzed by the end of Windows 10 support and a consequent wave of corporate upgrades, coinciding with the fifth anniversary of heightened PC purchases during the COVID-19 pandemic.
In China, our investments in property management firms yielded a robust 10% return, exemplified by our stake in ESR, which delivered a 24% return. ESR’s ongoing discussions to go private, involving major stakeholders like CPPIB and Star Capital, reflect a strategic depth in our investment approach, aligning with broader market movements and the participation of Middle Eastern sovereign wealth funds.
However, the quarter also brought challenges, particularly with some Chinese consumer stocks underperforming due to a broader pessimism impacting consumption patterns. This shift saw capital flowing disproportionately towards high-yield, low-growth assets such as state-owned enterprises in banking and utilities. Despite these headwinds, we recognize that the downturn is more reflective of market sentiment than fundamental weaknesses, as evidenced by the double-digit earnings growth in six key consumer companies.
Responding to these conditions, we adjusted our portfolio to maintain substantial exposure to these undervalued consumer stocks, while also introducing Atour, a promising new entity, to capitalize on comparable growth at attractive valuations. This move is part of a broader strategy to enhance our position in high-potential sectors and prepare for market recovery.
Our top five contributors to portfolio performance in Q2 2024: Hua Hong Semi (+46%), Trip.com (+9%), China Overseas Property (+10%), ESR Group (+24%) and Yuexiu Services Group (+9%).
Our top five detractors from portfolio performance in Q2 2024 : Samsonite (-19%), Yum China (-21%), VIPSHOP (-21%), DADA (-38%) and Li Ning (-18%).
Overall, our portfolio strategy this quarter has been characterized by a careful balance of maintaining strong performers while strategically rotating into opportunities aligned with emerging market trends and consumer behaviours.
As we look forward, our focus will remain on leveraging these insights to optimize portfolio outcomes in the dynamically evolving Asia Pacific landscape.
Portfolio Changes
In this quarter, our portfolio strategy focused on leveraging technological advancements and shifting market dynamics in the Asia Pacific region, particularly in response to evolving consumer behaviour and technological integrations.
Chinese market dynamics: Our portfolio in China experienced mixed results, with property management companies delivering strong returns. However, broader consumer sentiment remained tepid, influenced by a cautious outlook on Chinese consumer spending. Despite this, strategic investments in sectors like property management (notably ESR, which saw a 24% return) demonstrated the potential for selective market engagement.
- Strategic exits and rotations: We adjusted our holdings to better align with the current economic landscape. This included exiting positions in sectors with diminished growth prospects and rotating into areas showing resilience and potential for appreciation.
- New additions and adjustments: The addition of Atour highlights our strategy to tap into changing consumer preferences in China. Atour, known for its innovative hotel management approach, aligns with our focus on service-oriented investments and is poised to benefit from the shift towards experience-driven consumption.
Overall, our portfolio positioning this quarter was designed to navigate through the uncertainties of market volatility while capitalizing on specific growth trends, particularly in technology and consumer services. This approach is intended to safeguard our investments against transient market downturns and to foster long-term growth as we head into the latter half of the year.
Outlook
Overall, our outlook remains cautiously optimistic as we navigate through the complexities of the current global economic environment, supported by a strategic focus on high-growth opportunities and a disciplined investment approach that prioritizes long-term value over short-term market fluctuations.
There has been a cautious return of capital to Chinese markets, which remain underweighted by global investors awaiting clearer macroeconomic signals. In addition, India’s market sentiment is tempered by high valuations and political uncertainties following recent elections.
Looking ahead, the next two years are expected to see robust tech spending as economies aim to boost productivity in response to an aging global population. This trend underscores a potentially vibrant period for technological investment and growth.
In China, optimism is cautiously returning, supported by improving corporate fundamentals among large internet companies, which are reporting higher-than-expected profits and engaging in significant buybacks. The stabilization seen in the real estate sector has also helped mitigate systematic risks, enhancing the focus on corporate performance rather than external geopolitical or economic uncertainties.
Currently, the MSCI China index trades at a compelling valuation, marked at 10x forward P/E, and stands at a 20% discount compared to the MSCI Emerging Markets index. This valuation gap, coupled with a gradual resolution of policy directions post the mid-July Plenum, provides a strategic entry point for informed investors.
Our portfolio remains well-positioned to capitalize on these trends, maintaining a focus on robust corporate fundamentals and clear growth trajectories. Notably, our exposure includes sectors that are less influenced by immediate macroeconomic shifts, providing a buffer against short-term market volatility.
Furthermore, our strategy continues to avoid the recent trend towards high-yield, low-growth dividend stocks, which have dominated investor preferences in recent quarters. Instead, we are enhancing our portfolio with new additions that promise higher growth potentials, aligning with our long-term growth target of 25% at an attractive valuation of 13.8x forward earnings.
- Strategic exits and rotations: We adjusted our holdings to better align with the current economic landscape. This included exiting positions in sectors with diminished growth prospects and rotating into areas showing resilience and potential for appreciation.
- New additions and adjustments: The addition of Atour highlights our strategy to tap into changing consumer preferences in China. Atour, known for its innovative hotel management approach, aligns with our focus on service-oriented investments and is poised to benefit from the shift towards experience-driven consumption.
Overall, our portfolio positioning this quarter was designed to navigate through the uncertainties of market volatility while capitalizing on specific growth trends, particularly in technology and consumer services. This approach is intended to safeguard our investments against transient market downturns and to foster long-term growth as we head into the latter half of the year.
Outlook
Overall, our outlook remains cautiously optimistic as we navigate through the complexities of the current global economic environment, supported by a strategic focus on high-growth opportunities and a disciplined investment approach that prioritizes long-term value over short-term market fluctuations.
There has been a cautious return of capital to Chinese markets, which remain underweighted by global investors awaiting clearer macroeconomic signals. In addition, India’s market sentiment is tempered by high valuations and political uncertainties following recent elections.
Looking ahead, the next two years are expected to see robust tech spending as economies aim to boost productivity in response to an aging global population. This trend underscores a potentially vibrant period for technological investment and growth.
In China, optimism is cautiously returning, supported by improving corporate fundamentals among large internet companies, which are reporting higher-than-expected profits and engaging in significant buybacks. The stabilization seen in the real estate sector has also helped mitigate systematic risks, enhancing the focus on corporate performance rather than external geopolitical or economic uncertainties.
Currently, the MSCI China index trades at a compelling valuation, marked at 10x forward P/E, and stands at a 20% discount compared to the MSCI Emerging Markets index. This valuation gap, coupled with a gradual resolution of policy directions post the mid-July Plenum, provides a strategic entry point for informed investors.
Our portfolio remains well-positioned to capitalize on these trends, maintaining a focus on robust corporate fundamentals and clear growth trajectories. Notably, our exposure includes sectors that are less influenced by immediate macroeconomic shifts, providing a buffer against short-term market volatility.
Furthermore, our strategy continues to avoid the recent trend towards high-yield, low-growth dividend stocks, which have dominated investor preferences in recent quarters. Instead, we are enhancing our portfolio with new additions that promise higher growth potentials, aligning with our long-term growth target of 25% at an attractive valuation of 13.8x forward earnings.
U.S. Small-Mid Cap Equity Strategy
Investment Performance
The following table shows the investment performance of the Van Berkom U.S. Small-Mid Cap Composite (in U.S. dollars), compared to the Russell 2500 Small Cap Index (as at June 30, 2024).
Returns are calculated using the time-weighted method and presented gross of management and trustee fees and withholding taxes. Returns are annualized for periods longer than 12 months.
* Note : September 30, 2017
Portfolio Positioning
The second quarter highlighted the significant impact of Artificial Intelligence (AI) on the technology sector, notably within small and mid-cap software stocks. The AI frenzy significantly influenced market dynamics, echoing the thematic investment trends seen in recent years but with a renewed focus on AI capabilities, which led to extreme market reactions particularly in the hardware segment, where companies like Nvidia saw unprecedented valuation increases.
AI’s prominence bolstered hardware companies while many software companies, not directly linked to AI, saw their valuations diminish. Our portfolio felt this shift acutely, as investments like Five9 underperformed due to market’s narrow focus on immediate AI beneficiaries.
The broader economic environment remains challenged by high inflation and strong employment, preventing significant rate cuts. The Federal Reserve’s decision to maintain rates led to increased market caution, impacting liquidity flows away from equities towards safer money market accounts.
Despite strong fundamentals and positive guidance from many of our holdings, the portfolio did not perform as expected due to the overwhelming influence of thematic investing, particularly in AI. The momentum seen in April dissipated in the subsequent months, with adverse reactions to stocks not aligned with the dominant AI theme.
In response to these challenges, our portfolio strategy remains vigilant in balancing exposure to high-growth AI opportunities with maintaining investments in high-quality companies with solid fundamentals but currently out of market favour.
In the second quarter, the portfolio remained relatively stable across key metrics. We maintained our holdings at 42 stocks, with minor adjustments in concentration: the top 10 stocks now constitute 30% of the portfolio, a slight increase of 1% from the first quarter. Similarly, the top 20 stocks represent 56% of the portfolio, reflecting a modest rise of 1.25% from Q1. Challenges were predominantly noted in the mid to lower tiers of the portfolio, whereas the top 10 holdings continued to perform robustly.
Despite some challenges in the broader portfolio, several holdings exhibited notable performance improvements this quarter, highlighting our strategic positioning and management adaptability. Here are a few key performers:
- Pennant Group (+18.51%), due to its demonstration of resilience and growth potential, post-COVID.
- Planet Fitness (+17.83%), benefiting from strategic price adjustments and strong leadership under the new CEO.
- Victory Capital (+15.79%), after expanding its AUM and reinforcing its market position with the recent Amundi asset integration.
The top detractors from our performance in Q2 2024 are as follows:
- Cerence (-64.89%), after a disappointing quarter with revised downward management guidance and the withdrawal of its long-term profit plan.
- Double Verify (-44.44%), due to lowered revenue growth forecasts.
- Five9 (-29.93%), suffering from market reactions to perceived threats from AI advancements and new competitive entries.
- Grocery Outlet (-21.30%), due to a drag on gross margins from complex ERP implementation issues.
Portfolio Changes
In the second quarter, we made several strategic adjustments to optimize our portfolio amidst evolving market conditions.
Added Two New Stocks:
- CCC Intelligent Solutions: leading provider in the P&C insurance tech sector with a robust AI-driven cloud platform. The company’s strong market presence and financial health are indicated by a high Net Promoter Score and dominant market share.
- Dynatrace (DT): Added DT, a key player in the Observability market. DT offers essential performance monitoring tools, positioned for significant growth with a market share under 5% in a rapidly expanding market.
Exited Positions:
- GoDaddy: Exited in May to capitalize on significant returns, following a strategic reduction in April. This decision was driven by substantial growth in earnings multiple and achieving our 100% return target three years early.
Increased Holdings:
- Planet Fitness (PLNT): Increased our stake after a strong Q2 performance, taking profits above $73, reflecting confidence in the new CEO’s leadership.
Reduced Holdings:
- Pennant Group (PNTG): Realized profits following a substantial market rebound in 2024, acknowledging successful management transition and market revaluation.
- Victory Capital (VCTR): Secured gains from a doubling of our investment, propelled by strategic acquisitions and significant AUM growth from $18bn in 2013 to an expected $275bn.
These strategic adjustments are designed to enhance our portfolio’s performance potential, supported by a thorough analysis and a focus on long-term value and a strategic alignment with market trends.
Outlook
Investors embark on the second half of the year with uncertainty surrounding interest rates, inflation, and overall economic trajectories. Various macroeconomic scenarios could unfold in the coming months, presenting both risks and opportunities. Notably, if the Federal Reserve initiates a series of interest rate cuts, it could be aimed at mitigating a deeper economic downturn—a scenario not widely anticipated by market pundits.
Stability in the economy is currently the baseline expectation among economists, but it remains uncertain whether corporate earnings can significantly accelerate from current levels to drive stock market gains, especially given some end-market weaknesses observed recently.
AI’s resurgence has significantly impacted market dynamics, influencing stock performances across the board, particularly in small caps. This influence, combined with corporate interest in integrating AI strategies, suggests a potential shift in spending towards AI-related hardware and consulting, possibly at the expense of broader software investments. This could lead to a consolidation trend within the software sector as funds are reallocated to support emerging AI initiatives.
Moreover, the ongoing robustness of inflation and strong employment levels has led to adjusted expectations for interest rate reductions. While a softening of rate cut forecasts might suggest an economy in relatively good health, it also keeps capital in safer, non-equity assets longer than some investors might prefer. This dynamic could delay significant gains in stock markets until money market rates become less attractive compared to equities.
Despite these challenges, the outlook for AI and its integration into various business operations is a notable growth area. As AI becomes more pervasive, it is expected to catalyze shifts in technology investments and corporate strategies. However, this could result in a market environment where the ‘haves’ and ‘have-nots’ of AI capabilities could see a narrowing of valuation disparities.
Ultimately, the second half of the year is poised to be a period of strategic adjustments for investors. The potential recalibration of interest rate expectations and the deeper integration of AI into corporate strategies are likely to be key drivers of market behavior. Investors should remain vigilant and adaptable to navigate these evolving dynamics effectively.
Exited Positions:
- GoDaddy: Exited in May to capitalize on significant returns, following a strategic reduction in April. This decision was driven by substantial growth in earnings multiple and achieving our 100% return target three years early.
Increased Holdings:
- Planet Fitness (PLNT): Increased our stake after a strong Q2 performance, taking profits above $73, reflecting confidence in the new CEO’s leadership.
Reduced Holdings:
- Pennant Group (PNTG): Realized profits following a substantial market rebound in 2024, acknowledging successful management transition and market revaluation.
- Victory Capital (VCTR): Secured gains from a doubling of our investment, propelled by strategic acquisitions and significant AUM growth from $18bn in 2013 to an expected $275bn.
These strategic adjustments are designed to enhance our portfolio’s performance potential, supported by a thorough analysis and a focus on long-term value and a strategic alignment with market trends.
Outlook
Investors embark on the second half of the year with uncertainty surrounding interest rates, inflation, and overall economic trajectories. Various macroeconomic scenarios could unfold in the coming months, presenting both risks and opportunities. Notably, if the Federal Reserve initiates a series of interest rate cuts, it could be aimed at mitigating a deeper economic downturn—a scenario not widely anticipated by market pundits.
Stability in the economy is currently the baseline expectation among economists, but it remains uncertain whether corporate earnings can significantly accelerate from current levels to drive stock market gains, especially given some end-market weaknesses observed recently.
AI’s resurgence has significantly impacted market dynamics, influencing stock performances across the board, particularly in small caps. This influence, combined with corporate interest in integrating AI strategies, suggests a potential shift in spending towards AI-related hardware and consulting, possibly at the expense of broader software investments. This could lead to a consolidation trend within the software sector as funds are reallocated to support emerging AI initiatives.
Moreover, the ongoing robustness of inflation and strong employment levels has led to adjusted expectations for interest rate reductions. While a softening of rate cut forecasts might suggest an economy in relatively good health, it also keeps capital in safer, non-equity assets longer than some investors might prefer. This dynamic could delay significant gains in stock markets until money market rates become less attractive compared to equities.
Despite these challenges, the outlook for AI and its integration into various business operations is a notable growth area. As AI becomes more pervasive, it is expected to catalyze shifts in technology investments and corporate strategies. However, this could result in a market environment where the ‘haves’ and ‘have-nots’ of AI capabilities could see a narrowing of valuation disparities.
Ultimately, the second half of the year is poised to be a period of strategic adjustments for investors. The potential recalibration of interest rate expectations and the deeper integration of AI into corporate strategies are likely to be key drivers of market behavior. Investors should remain vigilant and adaptable to navigate these evolving dynamics effectively.
Global Small Cap Equity Strategy
Investment Performance
The following table shows the investment performance of the Van Berkom Global Small Cap Fund, compared to the MSCI ACWI Small Cap Index in CAD (as at June 30, 2024).
Returns are calculated using the time-weighted method and presented gross of management and trustee fees and withholding taxes. Returns are annualized for periods longer than 12 months.
* Note : July 31, 2022
Portfolio Positioning
In the second quarter, our portfolio experienced underperformance, a situation we anticipated given the current market dynamics, where meme rallies are prevalent, and a single stock can overshadow the entire U.S. small-cap index. Such conditions signal a deviation from fundamental investment principles, which aligns with our disciplined approach. The primary factors influencing global performance include the changing narrative around U.S. Federal Reserve rate cuts and the market’s intense focus on artificial intelligence (AI). Uncertainties about interest rates have led to erratic investment behaviors, sidelining long-term strategies in favor of reactive decisions. This shift has caused rate-sensitive companies to perform well under the “higher for longer” interest rate scenario, while consumer discretionary sectors falter amidst sustained inflation pressures. These market reactions are opposite to those observed in the second half of 2023, indicating that such volatility may persist until rate adjustments materialize.
Moreover, the overwhelming focus on AI technology has concentrated market gains unusually narrowly. For instance, the top five S&P 500 contributors represented half of its returns this year. This trend affects our portfolio primarily through its impact on software companies, which are experiencing significant valuation adjustments as capital shifts towards AI-supportive hardware. Despite this, we maintain a strong position in software due to its intrinsic value characterized by recurring revenue, high margins, and robust growth potential.
Our U.S. software holdings faced a relative performance downturn, shedding 283 basis points this quarter due to rapid market shifts from software to AI-focused hardware investments. However, historical patterns and ongoing corporate growth suggest that these software entities are poised to benefit substantially from broader AI integration over time.
Despite current market indifference to fundamentals, our portfolio’s underlying strengths—reflected in consistent earnings surpassing expectations and robust return on equity (ROE)—support our investment thesis. The solid performance of European and U.K. stocks within our portfolio, which rebounded strongly from early selloffs, underscores our strategy’s efficacy. Additionally, the active interest from private markets in undervalued public entities hints at potential lucrative exits, as seen in recent significant takeovers and private equity engagements.
Significant contributors to performance in Q2 2024:
- Keywords Studios (+77.8%)
- Globus Medical (+27.7%)
- Smartcraft (+21.9%)
Stocks that detracted from performance in Q2 2024:
- M&A Research (-45.9%)
- DoubleVerify (-44.6%%)
- Autostore (-35.9%)
Looking forward, we anticipate that the alignment of company performance with fundamental valuations will correct the current market mispricings, especially as firms continue to deliver growth. Our strategy remains focused on leveraging market volatility to enhance positions in high-quality businesses at favourable valuations, guided by a clear focus on long-term financial results and solid corporate fundamentals.
Portfolio Changes
The past quarter saw strategic adjustments to our portfolio, reflecting our proactive approach to seizing emerging market opportunities and addressing shifts in investment theses:
New Addition – Visional:
- We added Visional, a leader in Japan’s mid-career recruiting, supporting over 26,000 employers and 2 million job seekers.
- Visional is positioned to benefit from demographic shifts in Japan, with an increasing need for experienced employees over traditional university hires.
- Visional boasts robust financial metrics with expectations of 15%-20% growth, high teen net margins, 29% ROE and 25% ROIC, trading at 11x forward EV/EBITDA and 20x forward earnings.
Exited Positions
- Qualys: Exited to reallocate capital towards more promising opportunities, including the addition of Visional.
- Fluidra: Sold following the achievement of our target exit price, capitalizing on favourable market conditions.
- Cerence: Divested due to significant deviations from the original investment thesis, ensuring portfolio alignment with long-term strategic goals.
These changes underscore our commitment to adapting to market dynamics and enhancing portfolio performance through tactical entries and timely exits.
Outlook
As we look ahead to the second half of 2024, several key factors shape our market outlook.
The impending U.S. elections add a layer of uncertainty, potentially causing hesitancy in corporate growth spending. The narrative surrounding AI continues to dominate market attention, with significant investments and interest concentrated in this sector. However, the resilience of U.S. consumers could be tested, given the prolonged high interest rates and inflation, suggesting a more conservative spending outlook as we move into the latter part of the year.
Post-election stability in both the U.K. and France has provided a conducive environment for continued economic recovery. The initial positive momentum observed in Q1 appears set to continue, with no immediate disruptive political outcomes anticipated. Our portfolio companies in these regions are showing encouraging signs, supported by clearer fiscal policies and less political unpredictability.
Consumer behaviour in China is evolving, with a noticeable shift towards locally branded goods and services. This trend is driven by an increasing preference for quality and suitability to local tastes, particularly in sectors like automotive, electronics, and consumer services. This shift is expected to sustain consumption growth, albeit in a transformed landscape where local brands gain prominence over multinational ones.
The completion of major elections in the U.K., France, and the impending U.S. elections will redefine the political environment significantly. The outcomes will influence fiscal and monetary policies, which in turn will impact corporate investment strategies and consumer spending patterns. Better visibility on these policies will likely provide businesses and consumers alike with the confidence to make more informed spending and investment decisions.
Our approach remains focused on identifying companies well-positioned to benefit from these macroeconomic and geopolitical trends. We will continue to leverage opportunities in AI and technology, sectors poised for growth irrespective of broader economic challenges. Simultaneously, we are mindful of the market dynamics and will maintain flexibility in our investment strategy to adapt to changing conditions effectively.
Overall, while the landscape presents challenges, it also offers opportunities for strategic growth and positioning. Our commitment to closely monitoring market developments and adjusting our strategies accordingly will ensure that we remain aligned with our long-term investment objectives.
- Visional is positioned to benefit from demographic shifts in Japan, with an increasing need for experienced employees over traditional university hires.
- Visional boasts robust financial metrics with expectations of 15%-20% growth, high teen net margins, 29% ROE and 25% ROIC, trading at 11x forward EV/EBITDA and 20x forward earnings.
Exited Positions
- Qualys: Exited to reallocate capital towards more promising opportunities, including the addition of Visional.
- Fluidra: Sold following the achievement of our target exit price, capitalizing on favourable market conditions.
- Cerence: Divested due to significant deviations from the original investment thesis, ensuring portfolio alignment with long-term strategic goals.
These changes underscore our commitment to adapting to market dynamics and enhancing portfolio performance through tactical entries and timely exits.
Outlook
As we look ahead to the second half of 2024, several key factors shape our market outlook.
The impending U.S. elections add a layer of uncertainty, potentially causing hesitancy in corporate growth spending. The narrative surrounding AI continues to dominate market attention, with significant investments and interest concentrated in this sector. However, the resilience of U.S. consumers could be tested, given the prolonged high interest rates and inflation, suggesting a more conservative spending outlook as we move into the latter part of the year.
Post-election stability in both the U.K. and France has provided a conducive environment for continued economic recovery. The initial positive momentum observed in Q1 appears set to continue, with no immediate disruptive political outcomes anticipated. Our portfolio companies in these regions are showing encouraging signs, supported by clearer fiscal policies and less political unpredictability.
Consumer behaviour in China is evolving, with a noticeable shift towards locally branded goods and services. This trend is driven by an increasing preference for quality and suitability to local tastes, particularly in sectors like automotive, electronics, and consumer services. This shift is expected to sustain consumption growth, albeit in a transformed landscape where local brands gain prominence over multinational ones.
The completion of major elections in the U.K., France, and the impending U.S. elections will redefine the political environment significantly. The outcomes will influence fiscal and monetary policies, which in turn will impact corporate investment strategies and consumer spending patterns. Better visibility on these policies will likely provide businesses and consumers alike with the confidence to make more informed spending and investment decisions.
Our approach remains focused on identifying companies well-positioned to benefit from these macroeconomic and geopolitical trends. We will continue to leverage opportunities in AI and technology, sectors poised for growth irrespective of broader economic challenges. Simultaneously, we are mindful of the market dynamics and will maintain flexibility in our investment strategy to adapt to changing conditions effectively.
Overall, while the landscape presents challenges, it also offers opportunities for strategic growth and positioning. Our commitment to closely monitoring market developments and adjusting our strategies accordingly will ensure that we remain aligned with our long-term investment objectives.
