Manager’s Quarterly Commentary – David Barr – Q1 2016

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Roller Coasters and Small Cap Stocks

That was an exciting first quarter. Markets started the year in a steep downturn that was far less thrilling and much more stressful than a roller coaster. The TSX decreased 8.4%, bottoming out on January 20 at 11,843. The ride up the other side from mid-February has been almost as fast as the descent, with the TSX bouncing back and being up 13.9% from the lows at quarter end. The Russell 2000 was down 14.0% from the beginning of the year to February 11, then rebounded 16.8% to end the quarter relatively flat.

When prices go down, we get excited and we have taken advantage of the downturn, utilizing our cash positions to deploy capital into what we believe are very attractive opportunities. We believe the funds are positioned very well and are similar to where we were in 2011 after the market sell off in August of that year.

Our traditional opportunity set

A few years ago, we read “100:1 in the stock market” by Thomas Phelps. It tracked the types of companies which, if you had invested, would have returned over 100 times your original investment over an extended period of time.

While such companies are rare, our key takeaway was that the same principles apply whether your time horizon is 25 years or, in our case, three to five years. That is, to generate the best long term returns in the stock market is to focus on smaller companies, with proven businesses, that addressed new, large and growing markets. Effectively finding the IBM’s and J&J’s of tomorrow, today.

This has become our traditional opportunity set and is where we continue to find opportunities: non-resource, small cap, North American companies with long-runways. As a result of the downturn we have taken the opportunity to increase weightings in existing holdings where the price has decreased. This serves to decrease our potential risk and increase our potential return. We have also found new ideas for the portfolios.

One example is NeuLion, a provider of “over the top” streaming services that allow live events to be streamed directly over the internet. The stock became attractive during the market downturn as it coincided with an announcement that they had lost the NHL as a customer…clearly a red flag to any hockey-mad Canadian portfolio manager. However, we viewed the loss of that customer as inevitable and the decrease in price provided a very attractive entry point to build a position in a strong business with a great product in a market that is increasing dramatically.

Our opportunistic opportunity set

A second area where we are starting to identify opportunities is resource companies at the bottom of the cycle. What is really interesting are the potential gains that can be had by investing across the capital structure.

  • Either buying the equity of a company that the herd didn’t believe would survive and did;
  • or buying the debt of a company that was subsequently turned into equity.

We have witnessed recent strength in Canadian markets as brave investors believe resource stocks have bottomed. Capital has been flowing into resource issuers and the markets have responded accordingly. Our perspective is that the underlying fundamentals remain the same with high inventory levels, high supply relative to demand and over-levered, expensive companies. While we have found some idiosyncratic opportunities in the resource sector, we believe patience will be the provider of positive long term returns.

A roller coaster ride is incredibly entertaining but you always end up where you started. Small cap investing can have the same thrilling ride, but if you are invested in companies at a discount to intrinsic value and that intrinsic value is increasing over time, then the end result can be much more satisfying than just getting off the roller coaster and having an adrenaline crash.

David Barr
April 26, 2016

*Source:, 2012

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