Manager’s Quarterly Commentary – David Barr – Q1 2015 – Pender Value Fund

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The Fund started the year with positive performance, returning 7.26%1 over the last three months, and outperforming its benchmark which returned 6.59%2. Performance was driven by three of our key holdings, Nobilis Health (formally Northstar), Espial Group, and Syntel. Two names which deserve an honorable mention are Ebix Inc and Absolute Software.

1 Refers to Class A units of the Fund.
2 Blended benchmark of 50% S&P/TSX and 50% S&P500 CAD

When people look at our portfolios they see our overweight allocations in technology and they quite often ask us if we run technology funds. The quick answer is our funds are not technology funds and we believe industry risk at the portfolio level does not reside primarily in technology.

Why do we look at technology so much?
Most importantly, it’s in our circle of competence. Both Felix and I have both worked in the industry and have been investing in the sector for over 15 years. We experienced the Dot.Com Boom and know first-hand that valuation matters.

Today, we are shifting from a hard asset manufacturing economy to a knowledge-based economy. The number of investment opportunities is increasing. The underlying economics of these knowledge-based businesses can be very good. There is lots of operating leverage and the potential for very high returns on invested capital.

We also find that the stocks of technology companies can be quite volatile. Growth and momentum investors participate in this sector quite actively because of the impressive growth rates. As a result, when companies have short term hiccups, share prices can drop quite dramatically, sometimes to a price we find attractive.

When we look at technology companies, we segment the businesses into two piles.
The first is consumer products. When you think about consumer products you think about companies like Apple. Just look at what the introduction of the iPhone in 2007 did to some “terrific” global companies – Nokia, Blackberry and Motorola. These businesses were almost wiped out because someone came along with a more fashionable mouse trap. The consumer products side of the technology sector is littered with wreckage because of short product cycles, rapidly changing markets, disruptive technologies and finicky, trend-seeking end users. For the most part, we throw consumer tech companies onto the “too hard pile”.

We spend the majority of our time looking at companies that can sell a technology that gets integrated into the day-to-day operation or mission critical aspects of a business or a product. Technologies that help a business run more efficiently and cost-effectively (just think bar codes or global positioning), or that lend increased desirability to a product are hard to replace. These types of businesses can truly have a sustainable competitive advantage. As a result the revenue, margins and cash flows for these businesses become much more predictable.

In the investment industry, a great example is Bloomberg. Almost every Portfolio Manager uses a Bloomberg Terminal and pays $20k per year over their entire career for the privilege. It has had a near monopoly for decades.

The companies we are interested in are usually market leaders, or are competing for the top position, have a tried and tested product, a recurring revenue model and a strong management team with a clear and realistic business plan to add value to the company.

Where is the risk?
When assessing risk at the portfolio level, even though our weighting in technology can be as much as 50%, we look through to the end customers of these companies to see where the true “industry” risk lies. If a company is selling software to the oil and gas industry, it is irrelevant where the Microsoft Windows replacement cycle is. The risk exposure will be to the spending and health of the oil and gas industry, not the technology sector.

What is the opportunity?
Companies that sell technology products and services can have high operating leverage and strong margins addressing big growing markets. We think this is a great place to find businesses that will grow their intrinsic value at impressive rates over the long term. And as we know, one of the two gospel truths about the stock market is that when you invest over the long term, your return will approximate the return of the underlying business that you’re investing in.

The Fund initiated two new positions and did not see any exits. In addition, we actively increased weightings in eight positions and decreased our weightings in two. Three new names entered into the top ten holdings of the Fund, including National-Oilwell Varco. We chose to highlight National-Oilwell, a name that has been “thrown out with the bathwater”, since it offers an insight into our process – buying “best of breed” operators at low valuations. With 34% of the portfolio in cash, we have plenty of ammunition as we hunt for the best deals out there. The Fund’s US exposure stayed relatively constant throughout the quarter (29.13% vs. 29.91% at the end of December 2014).

David Barr
May 26, 2015

Standard Performance Information (April 30, 2015)

Annualized return since fund inception date of June 30, 2013 | * S&P/TSX Capped Composite Total Return Index