Small Cap Equity – Manager’s Commentary – July 2020

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Fellow Unitholders,

We hope you and your families continue to be safe and healthy.

July continued where the last couple of months left off. Pender Small Cap Opportunities Fund was up 7.9%, while Pender Value Fund was up 4.3%[1]. The S&P 500 (CAD) was up 4.2% and the S&P/TSX Composite was up 4.5%. We are happy to see that our funds have rebounded nicely from the troughs in March, but we are fully aware that the global economy is not out of the woods yet and there are many uncertainties still ahead of us.  

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In our portfolios we remain highly attuned to the need to play both offense and defense. In these uncertain times portfolios are confronted with both left and right tail risk. Both can leave a hole in your long-term returns.  In more normal times, the tail risk of the market moving more than 20% either up or down has a low probability. With the precarious nature of today’s economy, the probability of a 20% drop or gain is much higher. You need to participate on the upside but protect capital on the downside. Within our portfolios we continue to manage this risk, partially with position sizing. With close the discount (CTD) names we are trimming more aggressively than normal as they approach our estimate of fair value; we are being even more stingy on the price we pay for new CTD names and we are focused on the catalysts that could potentially close the discount. On the other side, with compounders, while we have taken down our maximum position sizes, we are more hesitant to trim and are not selling completely if valuation is the only driver to sell.

Portfolio Updates
In the month of July, key contributors for the Pender Small Cap Opportunities Fund and the Pender Value Fund include Dye & Durham Limited (DND) and Leaf Group (LEAF). DND provides software solutions to automate due diligence search processes for law firms. The company IPO’d on the TSX on July 17 and had a great run, ending at $14.50 on July 31, almost doubling the IPO price of $7.50. We talked about Leaf Group in our last commentary as there is a group of activist shareholders are pushing the Company to unlock shareholder value. While that process is still ongoing, the Company’s marketplace segment reported triple digit growth benefiting from the COVID ecommerce tailwinds. We have encouraged the Company to seriously consider the proposals put forward by the activist group and take action to maximize value. Alcanna (CLIQ) was another contributor for both funds while KKR and Zillow (ZG) contributed positively for the Pender Value Fund.

On the flip side, some of the names we liked in the technology space came in as key detractors in July, for example, eGain (EGAN) in the Pender Value Fund and Cloudera (CLDR) in the Pender Small Cap Opportunities Fund. We believe the price fluctuations were only temporary and that the business of these two companies remains solid.

Picking up on the DND IPO, according to Bloomberg[2] “the timing couldn’t have been better” and, it was “the biggest technology IPO in Canada since…March 2019”. We think this could be a sign of things to come. Private companies, in particular tech companies, have held off going public in recent years. They didn’t need to with access to ample reserves of capital, a disdain for being public and private market valuations that “appeared” to be higher than public market valuations. It seems as though those three factors have flipped now in favour of going public. Private company funding has come off YTD. According to the latest US data[3] late-stage investments outpaced early-stage rounds in Q2 for the first time in at least five years and first-time funding rounds are tracking to their lowest annual total in 10 years. SPACs and successful IPOs have helped erase the stigma of being public. With public SaaS companies trading at 50X revenue, venture capitalists must be licking their chops at the carry that will generate. There is a large cohort of tech companies that have held off going public and we could see that reverse itself. We worked with DND pre-IPO and we believe we are well positioned to capitalize on this emerging trend, given our experience investing in private technology companies.

David Barr, CFA
August 12, 2020

[1] F Class; source: PenderFund

[2] Well-timed IPO leads to 76% surge in debut for Dye & Durham

[3] Source: PitchBook-NVCA Venture Monitor, as of June 30, 2020