The third quarter showed resilience across global markets, with particular attention to U.S. interest rate cuts and inflation impacts, signaling mixed performances and cautious optimism. Small-cap stocks, sensitive to these economic shifts, indicated potential for notable movements in the coming periods, reflecting an evolving investment landscape.
Market Review
Shifts in U.S. Monetary Policy
In the U.S., the third quarter marked a significant shift as the Federal Reserve opted to cut its benchmark interest rate by 50 basis points, signaling the end of the prolonged “higher for longer” interest rate scenario. This adjustment was in response to softening inflation and subtle shifts within the labour market.
Although the rate cut initially fueled a surge of optimism, with markets reacting positively, the sentiment was tempered by subsequent economic indicators—ranging from consumer behaviour to manufacturing output—that presented a mixed economic outlook, reigniting concerns over potential slowdowns or even a recession.
North American Monetary Alignment
During the same period, both the U.S. and Canada implemented parallel interest rate cuts, reflecting a broader movement towards synchronized monetary policies across North America. This strategic alignment was driven by similar economic signs that suggested a necessary easing to support ongoing growth and stability.
The coordinated rate cuts helped reshape investor expectations and investment landscapes across both countries, setting a tone of cautious optimism in financial markets.
Particularly in the U.S., this led to a notable performance differential between small-cap and large-cap stocks, with small-caps benefiting disproportionately from the new lower rate environment. The Russell 2500 and Russell 2000 demonstrated stronger performances, with returns of 8.75% and 9.3%, respectively, driven by the Federal Reserve’s rate cut and its impact on smaller companies.
Canadian Market Adjustments
In Canada, the response to the monetary easing was broadly positive, although the impact was somewhat uneven across different sectors of the market.
Canadian small-cap stocks, typically responsive to rate cuts, did not experience the expected level of outperformance, mainly due to the significant downturn in the energy sector, which is heavily weighted in the TSX Small Cap Index.
The fall in oil prices adversely impacted energy stocks, overshadowing the broader market uplift. However, when excluding the energy sector, Canadian small-caps displayed resilience and outperformed their larger counterparts, driven by attractive valuations and the stimulative effect of lower interest rates.
Asia’s Economic Rally
The economic landscape in Asia was dramatically transformed at the quarter’s end by a series of unexpected stimulus policies from the Chinese government, including rate cuts and support for the stock market.
These measures ignited a major rally in the Chinese markets, with indices like the MSCI China/CSI300 recording substantial gains. The stimulus not only reversed a four-year trend of muted investor enthusiasm but also sparked a broad recovery across the region, particularly as other Asian economies also benefited from reduced monetary pressures following the U.S. Federal Reserve’s rate adjustments.
The MSCI China/CSI300 indices saw dramatic increases of 16.6% and 15.7% in just the last week of the quarter. The broader Asia Pacific region, led by ASEAN markets, posted a collective gain of 9%, although Japan and Korea underperformed due to declines in tech stocks.
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 September 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 third quarter, our portfolio posted a solid return of 9.1%, outperforming the TSX Small Cap Index by 0.7%. Our outperformance was primarily due to superior security selection.
Sector allocation added value to our relative performance despite facing a significant challenge from the materials sector, where we have minimal exposure, our strategic positioning in other sectors compensated for this deficit. Our underexposure to the materials sector, representing over 33% of the TSX Small Cap Index and up by 16.2% in Q3, buoyed by strong commodity prices with notable increases in silver (+10%), gold (+15%) and copper (+5%) was a headwind of 2.6% to our portfolio.
Security selection, which is the cornerstone of our investment strategy, contributed an additional 0.6% in relative outperformance. We experienced solid gains in the consumer discretionary and healthcare sectors, highlighted by significant increases in Sleep Country Canada and Hamilton Thorne, which soared by 35% and 50% respectively in Q3 following takeover offers for both companies. Other portfolio gains underscored our focus on companies with solid growth prospects—both organic and inorganic—and the potential for trading multiple expansion.
Despite the overall strong performance, some of our holdings experienced contraction in their valuation multiples. This compression temporarily hindered potential gains, as robust financial outcomes and stable or improved annual guidance did not translate into proportional share price appreciation. However, these stocks are currently trading well below what we consider their intrinsic value. We anticipate that this multiple compression will reverse in the medium term, paving the way for significant share price appreciation. We remain confident in the attractiveness of our current portfolio valuations and expect these positions to yield substantial returns as market conditions evolve.
Our significant Q3 contributors to performance:
- MDA Space (+27.3%) due to strong Q2 revenue growth in satellite systems and robotics divisions.
- Sleep Country Canada (+35.1%), buoyed by its privatisation by Fairfax Financial.
- Cineplex (+31.5%), benefiting from a strong movie slate and improved theatre attendance.
- Mattr Infrastructure Technologies (-15.2%), due to a delayed order impacting Flexpipe results and fewer completed oil wells.
- Boyd Group Services (-20.2%), affected by lower same-store sales and margin pressures from new location developments.
- Lumine Group (-14.4%), following “messy” Q2 results from one-time costs associated with recent acquisitions, temporarily depressing EBITDA margins and misleading organic growth figures due to its unique business model.
Portfolio Changes
In Q3, we actively managed our model portfolio to enhance its quality and long-term positioning. Amidst significant price movements in the small-cap market, we executed several strategic changes.
Increased Holdings:
- Badger Infrastructure: We increased our investment in Badger based on underappreciation of its long-term growth potential.
- Mattr Infrastructure: We added significantly to Mattr, based on strong growth prospects not reflected in its current valuation.
- AutoCanada: We increased our position due to significant upside potential from its recently announced cost cutting plan.
Reduced Positions
We reduced our holdings in the following names due to valuation and portfolio weight considerations: Cineplex, Aritzia and Colliers International Group.
New Additions
- BioSyent: We initiated a position in this specialty pharmaceutical company, attracted by its profitable growth strategy and the potential of its in-licensed healthcare products.
- 5N Plus: We started a position in this producer of specialty semiconductors and performance materials, recognizing its pivotal role in sectors like renewable energy and medical imaging.
Divestitures
- CWB Financial Group and Sleep Country Canada: We sold these stocks following takeover proposals, opting to reinvest in other more attractive opportunities.
- We divested of Canada Goose Holdings and Tucows to capitalize on more attractive investment alternatives.
These adjustments reflect our commitment to a focused, high-conviction investment strategy, leveraging thorough research to anticipate and react to market dynamics effectively.
Outlook
As we enter a new phase with anticipated interest rate reductions by the Bank of Canada and the Federal Reserve, historical trends suggest a favourable outlook for equities, particularly small-cap stocks. These stocks, historically sensitive to interest rate shifts, are poised for strong performance as upcoming rate cuts aim to bolster the economy, enhance labour market conditions and ease financing for consumers and businesses.
Reflecting on previous cycles of interest rate cuts, such as those in the early 2000s and during 2008-2009, Canadian small-cap stocks significantly outperformed their large-cap counterparts. If this trend repeats in the upcoming year, we expect our Canadian small-cap strategy to yield robust returns relative to large-cap stocks.
However, this optimistic view hinges on avoiding a “hard landing,” a challenging scenario historically linked to prolonged high interest rates. We remain vigilant, closely monitoring Canadian and U.S. economic indicators and corporate commentaries to gauge potential slowdowns or a recession. Current signs, including the latest payroll data, suggest that while economic growth may slow, a severe recession is unlikely. The economy’s foundational elements appear stable without signs of significant deterioration.
Our analysis of portfolio fundamentals indicates a strong position for our small-cap strategy. Our model portfolio shows superior balance sheet health, higher profit margins and better returns on equity (ROE) and investment (ROIC) compared to major Canadian benchmarks. With expected earnings growth outpacing benchmarks in both the short and long term, and valuations remaining competitive, our portfolio is well-situated for outperformance. Given the anticipated higher valuation multiples across our stock universe, stocks with solid fundamentals and strong earnings growth at attractive valuations are likely to excel. We are confident that our portfolio’s strong fundamentals will stand out in this environment. Additionally, the current market undervaluation of 4.5% relative to our conservative assessment of intrinsic value positions us for substantial long-term gains.
Reduced Positions
We reduced our holdings in the following names due to valuation and portfolio weight considerations: Cineplex, Aritzia and Colliers International Group.
New Additions
- BioSyent: We initiated a position in this specialty pharmaceutical company, attracted by its profitable growth strategy and the potential of its in-licensed healthcare products.
- 5N Plus: We started a position in this producer of specialty semiconductors and performance materials, recognizing its pivotal role in sectors like renewable energy and medical imaging.
Divestitures
- CWB Financial Group and Sleep Country Canada: We sold these stocks following takeover proposals, opting to reinvest in other more attractive opportunities.
- We divested of Canada Goose Holdings and Tucows to capitalize on more attractive investment alternatives.
These adjustments reflect our commitment to a focused, high-conviction investment strategy, leveraging thorough research to anticipate and react to market dynamics effectively.
Outlook
As we enter a new phase with anticipated interest rate reductions by the Bank of Canada and the Federal Reserve, historical trends suggest a favourable outlook for equities, particularly small-cap stocks. These stocks, historically sensitive to interest rate shifts, are poised for strong performance as upcoming rate cuts aim to bolster the economy, enhance labour market conditions and ease financing for consumers and businesses.
Reflecting on previous cycles of interest rate cuts, such as those in the early 2000s and during 2008-2009, Canadian small-cap stocks significantly outperformed their large-cap counterparts. If this trend repeats in the upcoming year, we expect our Canadian small-cap strategy to yield robust returns relative to large-cap stocks.
However, this optimistic view hinges on avoiding a “hard landing,” a challenging scenario historically linked to prolonged high interest rates. We remain vigilant, closely monitoring Canadian and U.S. economic indicators and corporate commentaries to gauge potential slowdowns or a recession. Current signs, including the latest payroll data, suggest that while economic growth may slow, a severe recession is unlikely. The economy’s foundational elements appear stable without signs of significant deterioration.
Our analysis of portfolio fundamentals indicates a strong position for our small-cap strategy. Our model portfolio shows superior balance sheet health, higher profit margins and better returns on equity (ROE) and investment (ROIC) compared to major Canadian benchmarks. With expected earnings growth outpacing benchmarks in both the short and long term, and valuations remaining competitive, our portfolio is well-situated for outperformance. Given the anticipated higher valuation multiples across our stock universe, stocks with solid fundamentals and strong earnings growth at attractive valuations are likely to excel. We are confident that our portfolio’s strong fundamentals will stand out in this environment. Additionally, the current market undervaluation of 4.5% relative to our conservative assessment of intrinsic value positions us for substantial long-term gains.
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 September 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
In the third quarter, our U.S. small cap strategy navigated a complex market environment, characterized by speculative trading and rapid shifts in investor sentiment. Despite facing significant headwinds, particularly in July when unprofitable and speculative stocks surged due to a risk-on rally, our disciplined investment approach focused on quality and fundamental analysis remained steadfast.
We continued to prioritize investments in high-quality companies with strong fundamentals. Despite the market’s temporary diversion towards less profitable and speculative entities, our commitment to companies with solid earnings, robust returns on equity and sustainable business models guided our investment decisions.
We maintained a significant but selective exposure to the information technology sector, favouring software and IT services over hardware and semiconductors, which differ from the broader market’s composition, with such portfolio exposure being a headwind to our relative performance in the third quarter. In industrials and financials, we benefited from favourable security selection within Industrials and an overweight position in the outperforming financials sector, aligning with market opportunities and growth prospects.
In terms of responsive adjustments, we reduced our exposure to sectors and stocks where valuations and market dynamics no longer aligned with our long-term growth expectations. We increased our positions in sectors where underlying fundamentals and market conditions suggested undervaluation or potential for significant appreciation.
Our approach to risk management involved a careful balancing of sector exposures and readiness to adjust our positions in response to changing market dynamics. The avoidance of the underperforming energy sector and absence of investments in bond proxies, like real estate, which are highly sensitive to interest rate changes, exemplified our strategic risk mitigation.
Significant contributors to performance in Q3 2024:
- Hamilton Lane (+37.2%), through strong organic growth in private asset management and retail platforms.
- Paylocity (+25.1%), benefitting from favourable earnings and stable growth forecasts in human capital management software.
- Ensign Group (+17.2%), by effectively consolidating the nursing homes industry.
- NMI Holdings (+21.3%) and Victory Capital (+16.9%) due to the positive impact of lower interest rates on investor sentiment and favorable end-market conditions.
Stocks that detracted from performance in Q3 2024:
- Five9 (-33.2%), due to disappointing financial results and reduced revenue forecasts.
- Grocery Outlet (-20.0%), affected by valuation contractions despite resolving IT issues and confirming financial projections.
- Marriott Vacations Worldwide (-14.6%), due to a downward revision in financial guidance.
Portfolio Changes
Our strategic adjustments in the third quarter were driven by a dynamic market environment and our continuous pursuit of high-quality investment opportunities. Below are the key portfolio changes we implemented during the period.
Portfolio Additions:
- We initiated a new position in ESAB Corporation, a global leader in the welding equipment market, attracted by its comprehensive growth strategy, strong market positioning in emerging markets and robust financial performance.
Portfolio Increases:
- CCC Intelligent Solutions: We completed our position in this technology solutions provider, capitalizing on the stock’s stability and our strong conviction in its business model.
- Five9, DoubleVerify, Grocery Outlet, Charles River Laboratories, Installed Building Products, Shake Shack and Euronet Worldwide: We increased stakes in these companies, taking advantage of market weaknesses to realign them to their target weights.
Portfolio Reductions:
- Hamilton Lane, Ensign Group and Federal Signal: We realized profits and rebalanced these holdings to manage risk and adjust for increased valuation.
- Brady Corp, Houlihan Lokey, Grand Canyon Education, Planet Fitness, and NMI Holdings: We trimmed these positions following strong performance, aligning with our valuation discipline.
Divestitures:
We began liquidating our stake in Envestnet following the acquisition announcement by a private equity firm, reallocating capital to other high-potential investments.
These strategic moves reflect our commitment to optimizing portfolio performance while maintaining a disciplined investment approach. Through proactive management and vigilant market analysis, we continue to position our portfolio to capture growth and manage risk effectively.
Outlook
As we enter a new cycle of interest rate reductions by the Federal Reserve, we anticipate a favourable impact on equities, particularly small-cap stocks. These stocks, traditionally sensitive to interest rate changes, are poised for strong performance, supported by the Fed’s likely series of rate cuts aimed at bolstering the economy and labor market, and easing financing conditions for consumers and businesses.
While a bullish outlook for stocks typically follows rate cuts, this perspective hinges on avoiding a severe economic downturn, historically associated with prolonged high interest rates. We remain vigilant, closely monitoring U.S. economic indicators and company commentaries to gauge the potential for a slowdown or recession. Currently, the foundational aspects of the economy appear stable without significant deterioration, suggesting we might avoid a severe recession and experience only moderate economic slowing.
However, one challenge that could temper the U.S. stock market’s rise is the relatively high valuations across various market caps. Given these robust valuations, significant further expansion of valuation multiples seems unlikely. We anticipate that company-specific fundamentals and earnings growth will become the primary drivers of stock performance moving forward.
Despite lagging behind our small-cap benchmark earlier in the year due to unfavorable market conditions from May to July, recent trends indicate a shift towards a more rational market that appreciates fundamental value. This shift has been reflected in our modest outperformance in August and September.
Our portfolio, well-positioned against U.S. benchmarks, boasts superior balance sheet strength, higher profit margins, and greater returns on equity and investment. Anticipating robust earnings growth in the coming years at competitive valuations, we are aligned with the market’s recognition of our solid fundamentals and earnings potential. Confident in our strong performance prospects, the current market valuation of our holdings at a 4% discount to our conservative intrinsic value estimate indicates significant potential for long-term gains.
Portfolio Increases:
- CCC Intelligent Solutions: We completed our position in this technology solutions provider, capitalizing on the stock’s stability and our strong conviction in its business model.
- Five9, DoubleVerify, Grocery Outlet, Charles River Laboratories, Installed Building Products, Shake Shack and Euronet Worldwide: We increased stakes in these companies, taking advantage of market weaknesses to realign them to their target weights.
Portfolio Reductions:
- Hamilton Lane, Ensign Group and Federal Signal: We realized profits and rebalanced these holdings to manage risk and adjust for increased valuation.
- Brady Corp, Houlihan Lokey, Grand Canyon Education, Planet Fitness, and NMI Holdings: We trimmed these positions following strong performance, aligning with our valuation discipline.
Divestitures:
We began liquidating our stake in Envestnet following the acquisition announcement by a private equity firm, reallocating capital to other high-potential investments.
These strategic moves reflect our commitment to optimizing portfolio performance while maintaining a disciplined investment approach. Through proactive management and vigilant market analysis, we continue to position our portfolio to capture growth and manage risk effectively.
Outlook
As we enter a new cycle of interest rate reductions by the Federal Reserve, we anticipate a favourable impact on equities, particularly small-cap stocks. These stocks, traditionally sensitive to interest rate changes, are poised for strong performance, supported by the Fed’s likely series of rate cuts aimed at bolstering the economy and labor market, and easing financing conditions for consumers and businesses.
While a bullish outlook for stocks typically follows rate cuts, this perspective hinges on avoiding a severe economic downturn, historically associated with prolonged high interest rates. We remain vigilant, closely monitoring U.S. economic indicators and company commentaries to gauge the potential for a slowdown or recession. Currently, the foundational aspects of the economy appear stable without significant deterioration, suggesting we might avoid a severe recession and experience only moderate economic slowing.
However, one challenge that could temper the U.S. stock market’s rise is the relatively high valuations across various market caps. Given these robust valuations, significant further expansion of valuation multiples seems unlikely. We anticipate that company-specific fundamentals and earnings growth will become the primary drivers of stock performance moving forward.
Despite lagging behind our small-cap benchmark earlier in the year due to unfavorable market conditions from May to July, recent trends indicate a shift towards a more rational market that appreciates fundamental value. This shift has been reflected in our modest outperformance in August and September.
Our portfolio, well-positioned against U.S. benchmarks, boasts superior balance sheet strength, higher profit margins, and greater returns on equity and investment. Anticipating robust earnings growth in the coming years at competitive valuations, we are aligned with the market’s recognition of our solid fundamentals and earnings potential. Confident in our strong performance prospects, the current market valuation of our holdings at a 4% discount to our conservative intrinsic value estimate indicates significant potential for long-term gains.
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 September 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 current investment landscape, we continued to maintain a strategic focus on the long-term, particularly within the Chinese market where fiscal stimulus details are pending. Our approach aligns with the principle that the stock market anticipates developments six to 12 months in advance. This proactive stance is intended to position our portfolio ahead of potential market upswings, similar to past scenarios where initial central bank actions spurred significant market gains ahead of economic improvements.
This quarter has been pivotal for identifying sector leaders, especially as the Chinese consumer sector shows signs of strain, provides a clear view of which companies hold robust operational strength. We have observed encouraging performance in our portfolio, particularly with companies that have executed well despite the macroeconomic pressures.
Our portfolio strategy is heavily weighted towards consumer and technology sectors, supplemented by a solid stake in property management—a sector offering strong, recurrent cash flows at appealing valuations. Moreover, the companies within our portfolio have articulated clear shareholder return strategies, underpinned by their strong cash flows and robust business operations. Overall, with the top 10 investments comprising 40% of our portfolio, our positioning reflects a deliberate blend of defensive posturing and aggressive growth potential, maximizing returns in an uncertain but opportunistic market environment.
Our portfolio’s top five contributors significantly enhanced returns this quarter:
- Coli Property Management (+35.0%), due to favourable property measures and a raised payout ratio after strong earnings growth.
- Geely (+39.0%), buoyed by robust EV sales growth and expansion into international markets.
- Yum China (+54.0%), excelling in operational efficiency and margin expansion.
- CICC (+64.0%), following government support for the stock market.
- com (+32.0%), by thriving in high-end travel and expanding its international presence.
Our portfolio’s bottom five detractors reduced our overall performance slightly this quarter:
- Li Ning (-17.0%), due to macroeconomic challenges and slow inventory turnover.
- Kulicke (-8.0%), hit by a tech sector downturn and weaker consumer electronics demand.
- CSPC (-22.0%), due to delayed drug commercialization and government price pressures.
- Lotus (-11.0%), facing tough comparisons after a successful drug launch last year.
- Samsonite (-8.0%), affected by market softness in China and India.
Going forward, we remain poised to capitalize on shifts within the market, ensuring our investments are aligned with both current valuations and future growth prospects.
Portfolio Changes
In this quarter, our portfolio saw strategic adjustments and rotations aligned with emerging market dynamics, particularly focusing on AI and high-growth sectors in Asia. Here are the key changes.
Divestitures:
We divested from underperforming stocks or names not well-positioned in the current economic climate, including Luk Fook, Kerry, CSPC, VIPS, Sercomm and Formosa Hotel due to poor market performance or inadequate management responses to the consumption downgrade.
New Additions:
Capitalizing on the lag in AI stock responses in Asia compared to the US, we introduced Alibaba, Tencent, Meituan, Baidu, Mediatek, TSMC and Grab into our portfolio. These companies are leaders in AI development and are positioned to capitalize on regional growth and technological advancements.
Focus on AI Development
Our new investments are in firms with robust AI initiatives and substantial market presence. These include:
- Alibaba and Tencent: Integrated deeply into daily life in China, these platforms offer extensive user data, aiding in efficient AI deployment.
- Mediatek and TSMC: These names are positioned at the forefront of AI hardware, crucial for supporting the infrastructural needs of AI technologies.
- Grab: Expanding in fintech and on-demand services, this company is reinforcing its market dominance in Southeast Asia.
Strengthening AI Ecosystems
Our strategy acknowledges the parallel development of AI ecosystems in China and the US, with investments in companies that support these independent technological advancements.
These portfolio updates reflect our strategic shift towards high-growth AI sectors and our commitment to investing in companies with strong future earning potentials and significant market influence.
Outlook
Amid a backdrop of tentative optimism, China remains an attractive market, trading at 10 times forward earnings. Market sentiment is bolstered by anticipated fiscal stimulus, with a proposed issuance of special sovereign bonds valued at approximately 2 trillion yuan. This initiative aims to stimulate consumption and assist local governments impacted by the property downturn. Noteworthy is the planned allocation for consumer goods trade-ins, business equipment upgrades, and child allowances, awaiting approval from the National People’s Congress later this month.
Market responses are favourable as President Xi’s recent policy directions hint at a robust commitment to bolster the economy, reminiscent of Europe’s financial crisis interventions. China has also committed to additional support if necessary, signaling a readiness to stabilize its stock market akin to recovery strategies post-2008.
Looking forward, the U.S. Federal Reserve’s recent rate cuts may prompt further Chinese economic stimulus, enhancing liquidity flows back to Asia and emerging markets. However, global uncertainties persist with the U.S. elections and potential escalations in Ukraine and the Middle East, though Asia appears relatively shielded from these conflicts.
Our investment strategy remains firm: investing in well-managed companies at compelling valuations and benefiting from shareholder returns through dividends and buybacks. The anticipation of aligning AI valuation premiums between China and the U.S. presents a promising outlook for substantial future gains. This strategic approach underpins our confidence in navigating through market fluctuations and capitalizing on emerging opportunities.
New Additions:
Capitalizing on the lag in AI stock responses in Asia compared to the US, we introduced Alibaba, Tencent, Meituan, Baidu, Mediatek, TSMC and Grab into our portfolio. These companies are leaders in AI development and are positioned to capitalize on regional growth and technological advancements.
Focus on AI Development
Our new investments are in firms with robust AI initiatives and substantial market presence. These include:
- Alibaba and Tencent: Integrated deeply into daily life in China, these platforms offer extensive user data, aiding in efficient AI deployment.
- Mediatek and TSMC: These names are positioned at the forefront of AI hardware, crucial for supporting the infrastructural needs of AI technologies.
- Grab: Expanding in fintech and on-demand services, this company is reinforcing its market dominance in Southeast Asia.
Strengthening AI Ecosystems
Our strategy acknowledges the parallel development of AI ecosystems in China and the US, with investments in companies that support these independent technological advancements.
These portfolio updates reflect our strategic shift towards high-growth AI sectors and our commitment to investing in companies with strong future earning potentials and significant market influence.
Outlook
Amid a backdrop of tentative optimism, China remains an attractive market, trading at 10 times forward earnings. Market sentiment is bolstered by anticipated fiscal stimulus, with a proposed issuance of special sovereign bonds valued at approximately 2 trillion yuan. This initiative aims to stimulate consumption and assist local governments impacted by the property downturn. Noteworthy is the planned allocation for consumer goods trade-ins, business equipment upgrades, and child allowances, awaiting approval from the National People’s Congress later this month.
Market responses are favourable as President Xi’s recent policy directions hint at a robust commitment to bolster the economy, reminiscent of Europe’s financial crisis interventions. China has also committed to additional support if necessary, signaling a readiness to stabilize its stock market akin to recovery strategies post-2008.
Looking forward, the U.S. Federal Reserve’s recent rate cuts may prompt further Chinese economic stimulus, enhancing liquidity flows back to Asia and emerging markets. However, global uncertainties persist with the U.S. elections and potential escalations in Ukraine and the Middle East, though Asia appears relatively shielded from these conflicts.
Our investment strategy remains firm: investing in well-managed companies at compelling valuations and benefiting from shareholder returns through dividends and buybacks. The anticipation of aligning AI valuation premiums between China and the U.S. presents a promising outlook for substantial future gains. This strategic approach underpins our confidence in navigating through market fluctuations and capitalizing on emerging opportunities.
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 September 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
Our portfolio yielded a robust return this quarter, significantly outperforming the Russell 2500 Index’s gain, due mainly to a strategic focus on sectors that benefit from the current economic environment.
The U.S. Federal Reserve’s pivot towards rate cuts amid controlled inflation and strong job data has shaped our investment strategy, particularly favouring sectors that thrive in a declining interest rate environment such as real estate, communication services, financials, and utilities.
Despite broader market challenges, our focus on small-cap and small- to mid-cap stocks, which are deeply integrated into the U.S. economy and sensitive to labour market trends, has positioned this portfolio well, as these sectors tend to excel in the current macroeconomic climate.
This approach helped mitigate the impact of less favourable conditions in other areas of the market.
Here is how we positioned the portfolio this quarter:
- Increased exposure in interest rate-sensitive sectors: Anticipating a decrease in rates, we strategically increased holdings in sectors like real estate and utilities, which tend to offer attractive yields and benefit from lower interest rates.
- Selective investments in small caps: We capitalized on the underperformance of small caps relative to mega caps by increasing our exposure to small and mid-size companies that are poised for recovery.
- Maintained underweights in low growth sectors: Consistent with our strategy, we remained underweight in sectors that traditionally exhibit low growth, despite their performance this quarter, to maintain a balance between risk and potential returns.
- Robust sector performance monitoring: The portfolio also benefitted from a solid earnings season across our holdings, with most companies managing the declining inflation scenario effectively, thereby supporting our portfolio’s overall performance.
Substantial contributors to our Q3 performance include these names:
- Pennant Group (+54.0%), driven by strong revenue growth across its segments and strategic acquisitions.
- HLNE (+36.7%), due to robust financial performance and growth in its Specialised Funds channel.
- MarketAxess (+28.0%), supported by favourable market conditions for fixed income volumes following Federal Reserve rate cuts.
- First Advantage (+23.0%), benefiting from efficient cost management and strategic acquisition moves despite overall industry challenges.
Substantial detractors to our Q3 performance include these stocks:
- Five9 (-38.3%), due to significant challenges with revenue growth and market sentiment
- Grocery Outlet (-21.7%), due to competitive pressures and weak consumer spending.
- DoubleVerify (-17.9%) and Fox Factory (-14.8%), faced with continued market pressure and negative investor sentiment.
Portfolio Changes
In the third quarter, our portfolio demonstrated strong performance with strategic adjustments to maximize returns. Below are the key portfolio changes and their rationale:
Exited Position
We sold Envestnet ahead of its upcoming acquisition, reallocating capital to maintain strategic flexibility and capture growth from new opportunities.
New Purchase
We acquired Entegris in Q4, a direct replacement for Envestnet, enhancing our exposure to promising sectors with potential for significant returns.
Portfolio Concentration
We increased our portfolio concentration slightly, with the top 10 names comprising 31.2% of the portfolio, up from 30.2% at the end of Q2. This adjustment reflects our strategy to capitalize on momentum from our strongest performers.
Sector Weight Adjustments
- Consumer discretionary remains our largest overweight sector, slightly adjusted from 9.4% to 8.5% overweight, reflecting a strategic positioning based on our bottom-up selection process.
- In terms of underweight sectors, we maintained no positions in real estate, materials, and energy due to their typical low growth or commodity-dependent nature.
- We increased cash holdings slightly by 25 basis points to 2%, a strategic move following profit-taking activities through the quarter.
Overall Portfolio Health
Our portfolio continues to hold 42 stocks, maintaining diversification and balance across various sectors, aligning with our fundamental investment approach without making macroeconomic bets.
These adjustments underscore our commitment to rigorous valuation discipline, reducing exposure to overvalued stocks and enhancing positions where market valuation aligns with growth potential.
Outlook
As the Federal Reserve initiates an easing cycle amidst sustained economic growth, the outlook for equities, particularly small-cap stocks, appears robust over the next 12 months.
Small caps, primarily driven by domestic revenue, are particularly responsive to decreasing interest rates and show a promising trajectory excluding the possibility of a severe economic downturn. Historically, election years have bolstered market returns, and this pattern seems to persist.
The primary risk to this positive outlook involves potential exogenous shocks, such as geopolitical conflicts or commodity crises. Currently, global conflicts appear regionally contained, posing minimal risk to domestic U.S. markets. Additionally, as interest rates decline, we anticipate a beneficial impact on valuation multiples for small caps, which typically exhibit higher growth rates than large caps.
This environment favours well-managed, profitable businesses, likely attracting increased investor interest.
Our investment approach, which thrives in stable cycles less influenced by fluctuating rates, is well-positioned to capitalize on these conditions.
We anticipate strong potential for double-digit returns both this year and in 2025. The significant underperformance of the Russell 2500 and 2000 indices compared to the S&P 500 over the past five years is expected to begin correcting.
The appealing valuations of small and medium-sized enterprises (SMEs), crucial to the U.S. economy, are likely to draw renewed interest from investors, making this an opportune moment for strategic equity investment.
New Purchase
We acquired Entegris in Q4, a direct replacement for Envestnet, enhancing our exposure to promising sectors with potential for significant returns.
Portfolio Concentration
We increased our portfolio concentration slightly, with the top 10 names comprising 31.2% of the portfolio, up from 30.2% at the end of Q2. This adjustment reflects our strategy to capitalize on momentum from our strongest performers.
Sector Weight Adjustments
- Consumer discretionary remains our largest overweight sector, slightly adjusted from 9.4% to 8.5% overweight, reflecting a strategic positioning based on our bottom-up selection process.
- In terms of underweight sectors, we maintained no positions in real estate, materials, and energy due to their typical low growth or commodity-dependent nature.
- We increased cash holdings slightly by 25 basis points to 2%, a strategic move following profit-taking activities through the quarter.
Overall Portfolio Health
Our portfolio continues to hold 42 stocks, maintaining diversification and balance across various sectors, aligning with our fundamental investment approach without making macroeconomic bets.
These adjustments underscore our commitment to rigorous valuation discipline, reducing exposure to overvalued stocks and enhancing positions where market valuation aligns with growth potential.
Outlook
As the Federal Reserve initiates an easing cycle amidst sustained economic growth, the outlook for equities, particularly small-cap stocks, appears robust over the next 12 months.
Small caps, primarily driven by domestic revenue, are particularly responsive to decreasing interest rates and show a promising trajectory excluding the possibility of a severe economic downturn. Historically, election years have bolstered market returns, and this pattern seems to persist.
The primary risk to this positive outlook involves potential exogenous shocks, such as geopolitical conflicts or commodity crises. Currently, global conflicts appear regionally contained, posing minimal risk to domestic U.S. markets. Additionally, as interest rates decline, we anticipate a beneficial impact on valuation multiples for small caps, which typically exhibit higher growth rates than large caps.
This environment favours well-managed, profitable businesses, likely attracting increased investor interest.
Our investment approach, which thrives in stable cycles less influenced by fluctuating rates, is well-positioned to capitalize on these conditions.
We anticipate strong potential for double-digit returns both this year and in 2025. The significant underperformance of the Russell 2500 and 2000 indices compared to the S&P 500 over the past five years is expected to begin correcting.
The appealing valuations of small and medium-sized enterprises (SMEs), crucial to the U.S. economy, are likely to draw renewed interest from investors, making this an opportune moment for strategic equity investment.
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 September 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
As we highlighted last quarter, the disconnect between the valuations of our portfolio companies and their strong fundamentals was notable. Now, with the market’s rapid pivot following the Fed’s rate cut, we are hopeful that this signals renewed interest in small caps, which is a welcome shift for our strategy.
We are pleased with our current portfolio positioning and believe the current environment is favourable for our approach as the rate cut cycle takes hold. During the quarter, our portfolio delivered a steady return compared to the benchmark return. Although performance was relatively in line with the broader market, we believe our portfolio’s focus on companies with strong fundamentals and high-quality management will start to differentiate them over time.
Over the past quarter, the primary contributor to performance was our stock selection in Canadian holdings, while U.S. tech stocks were a drag on returns. In Europe, the quarter was relatively quiet due to the typical summer slowdown, with little corporate activity during the region’s extended vacation period. In Asia, a surprise rate hike in Japan and the rotation into Chinese markets had a slight net negative impact.
In Q3 2024, key portfolio performers included these names:
- MDA Space (+27.2%)
- Hamilton Lane (+35.0%)
- Smartcraft (+21.9%)
In Q3 2024, key detractors included these stocks:
- Five9 (-35.7%)
- ATS Automation (-18.0%)
- Marriott Vacations (-16.0%)
We believe that we are in the early stages of a rotation, as capital begins to flow passively into the small-cap category.
As the earnings power of higher-quality companies becomes evident, we expect a more discerning approach to emerge.
With positive factors such as historically low valuations, easing inflation, tighter credit spreads, reduced volatility and the market-clearing effects of the U.S. elections, we remain highly bullish on our portfolio holdings.
Portfolio Changes
In the recent quarter, we strategically adjusted our portfolio, focusing on value and growth potential. Here are the significant changes:
- We initiated a position in Badger Infrastructure, a leader in non-destructive excavating, due to its strong market presence and attractive valuation of 6.5x forward EV/EBITDA. The company’s vertical integration and expansion into large national accounts in North America enhance its growth prospects.
- We invested in Grocery Outlet, a value retailer with a robust expansion potential, at 7.0x forward EV/EBITDA. The company’s proven resilience and consistent store-level economics support its potential to increase store count significantly.
- We opened a position in Internet Initiative Japan, a leader in enterprise internet solutions in Japan, at 7.5x forward EV/EBITDA. IIJ is poised to benefit from Japan’s digital transformation, with strong projected revenue growth and high ROE.
- We initiated a stake in Mitie Group, a leading U.K. facilities management firm, valued at 10x earnings. Mitie’s comprehensive services and potential for 10%+ annual earnings growth through various channels make it a compelling addition.
- We sold our positions in ATS, CMG and HQY based on relative opportunities.
- We exited ENV and KWS because both companies are being acquired.
These changes align with our goal to capitalize on robust growth opportunities while managing risks effectively.
Outlook
Our team recently travelled to Stockholm, Paris, Mila, Munich and Delhi. We were able to gather insights into various markets.
In India, there’s a burgeoning optimism driven by substantial infrastructure investments under Prime Minister Modi. The country has seen transformative developments such as the establishment of over 500 million bank accounts and significant expansions in gas connections and clean water access.
E-commerce, though only 7% penetrated, has grown at a 30% compounded rate over the past five years. India’s political stability stands out in an otherwise volatile emerging market landscape. Despite the allure of India’s growth, the current valuations of Indian companies, significantly higher than global counterparts, prompt a cautious approach. We remain vigilant, waiting for appropriately priced opportunities.
China presents a contrasting scenario with subdued consumer sentiment and corporate investment hesitancy, prompted by economic challenges. The government’s recent stimulus measures underline the severity of the situation but also refine our focus towards exceptional companies now available at attractive valuations.
In Europe and the U.K., the investment landscape is mixed. Germany faces economic pressures, particularly from its automotive sector’s reliance on China. Conversely, the Nordics are showing signs of recovery, spurred by recent rate cuts. The new pro-housing policies of the U.K. promise long-term growth, though immediate impacts are unlikely.
The U.S. market outlook hinges on the forthcoming election in 2024. While domestic corporations anticipate little change from the election’s outcome, international companies view it as a source of potential uncertainty affecting their U.S. operations. Nonetheless, the fundamental aspects of the U.S. economy remain robust, though consumer pressures are evident.
Overall, we remain focused on finding quality assets at favorable valuations. Our global perspective reinforces our readiness to act when the right opportunities emerge, underpinned by a commitment to rigorous analysis and prudent investment.
- We opened a position in Internet Initiative Japan, a leader in enterprise internet solutions in Japan, at 7.5x forward EV/EBITDA. IIJ is poised to benefit from Japan’s digital transformation, with strong projected revenue growth and high ROE.
- We initiated a stake in Mitie Group, a leading U.K. facilities management firm, valued at 10x earnings. Mitie’s comprehensive services and potential for 10%+ annual earnings growth through various channels make it a compelling addition.
- We sold our positions in ATS, CMG and HQY based on relative opportunities.
- We exited ENV and KWS because both companies are being acquired.
These changes align with our goal to capitalize on robust growth opportunities while managing risks effectively.
Outlook
Our team recently travelled to Stockholm, Paris, Mila, Munich and Delhi. We were able to gather insights into various markets.
In India, there’s a burgeoning optimism driven by substantial infrastructure investments under Prime Minister Modi. The country has seen transformative developments such as the establishment of over 500 million bank accounts and significant expansions in gas connections and clean water access.
E-commerce, though only 7% penetrated, has grown at a 30% compounded rate over the past five years. India’s political stability stands out in an otherwise volatile emerging market landscape. Despite the allure of India’s growth, the current valuations of Indian companies, significantly higher than global counterparts, prompt a cautious approach. We remain vigilant, waiting for appropriately priced opportunities.
China presents a contrasting scenario with subdued consumer sentiment and corporate investment hesitancy, prompted by economic challenges. The government’s recent stimulus measures underline the severity of the situation but also refine our focus towards exceptional companies now available at attractive valuations.
In Europe and the U.K., the investment landscape is mixed. Germany faces economic pressures, particularly from its automotive sector’s reliance on China. Conversely, the Nordics are showing signs of recovery, spurred by recent rate cuts. The new pro-housing policies of the U.K. promise long-term growth, though immediate impacts are unlikely.
The U.S. market outlook hinges on the forthcoming election in 2024. While domestic corporations anticipate little change from the election’s outcome, international companies view it as a source of potential uncertainty affecting their U.S. operations. Nonetheless, the fundamental aspects of the U.S. economy remain robust, though consumer pressures are evident.
Overall, we remain focused on finding quality assets at favorable valuations. Our global perspective reinforces our readiness to act when the right opportunities emerge, underpinned by a commitment to rigorous analysis and prudent investment.