Small Cap Equity – Manager’s Commentary – January 2021
Fellow unit holders,
The strong performance of the Pender Small Cap Opportunities Fund during the fall of 2020 continued in December and into the New Year. For December, the Pender Small Cap Opportunities Fund was up 15.3%, taking the quarterly performance to 43.6% and performance for the year to 47.8%. This trend continued into January with the Fund being up 7.3%. The Pender Value Fund finished the year delivering a return of 11.0% in December, taking the quarterly performance to 28.4% and the 2020 return to 20.1%. The results continued in January with the Fund being up 9.0% at month end. Our performance of late has been largely driven by our focus on small cap stocks and the technology sector.
The rapid appreciation in the value of companies held by the funds has changed the intent of a question we receive. Last summer and into the fall the question we received was “why should we continue to hold small cap stocks”. Long-time readers of this commentary have heard us talk about the valuation and performance disconnect between large and small cap stocks on more than one occasion. That extended underperformance had people questioning whether small cap stocks would ever be popular again. Well, as countless teenage dramas have shown us, popularity can change quickly overnight. Just ask Dan. Q4 looks to be that moment in the small cap market.
So now when we are asked the question, “why should we continue to hold small cap stocks” our answer is that even with the recent strong performance in the funds, we continue to see very attractive opportunities. We believe that small cap stocks are still in the early innings of playing catchup to the large cap stocks. On top of that we are seeing a very attractive M&A setup. There is a lot of pent-up M&A demand right now and, with capital flooding into IPOs and SPACs, our view is that the number of potential buyers increases by the day.
The key takeaway from the past year is that it is not about timing the market it is about time in the market. Returns from investing in stocks can be very lumpy and you need to be invested when they come. The only way to ensure that is to stay invested. We know this can be incredibly challenging when people all around you are losing their heads and their money, but we are very thankful to the investors who followed this credo and trusted to The Pender Way. Managing other people’s money is a highly emotional endeavor. We are happy for our fellow investors who stuck to the plan and came through 2020 with us.
With a robust opportunity set, we continue to be near to fully invested. This does take me back to the blog post I wrote last summer about balancing offence and defence. Our defence is focussed on shorter duration special situations, either SPACS, merger arbitrage or credit opportunities. This weighting is still under 10% in both funds but does serve as a potential volatility buffer and source of cash if markets change. From a portfolio perspective we continue to vigilantly monitor both valuation and business quality.
To summarize our sell discipline. If a business is low quality and expensive, we will usually exit the position and reinvest in better opportunities. If a business is high quality with a high valuation, we usually do not exit the position immediately. We find most of the time high quality businesses tend to be undervalued by markets and our intrinsic estimates can be too conservative therefore we choose to trim the position and maintain a more modest exposure. On the other hand, if a business is low
quality and inexpensive, we will usually hold the position and wait for catalysts to happen to close the discount. On the buy side, we believe that the best opportunities exist where businesses are high quality and undervalued or misunderstood by the markets. This is where we want to fish and strike for the full weight.
Our fund performance was driven by a wide range of the underlying portfolio holdings. The majority of our holdings had positive returns over the last couple of months (December and January). Notably, ProntoForms (TSXV-PFM) and MAV Beauty Brands (TSX-MAV) were among the key contributors for both the Pender Small Cap Opportunities Fund and Pender Value Fund. PFM and MAV are two core holdings for which we have high conviction, and we shared our thesis for both at the recent MOI Best Ideas 2021 Conference. PFM provides software solutions to transform paper forms into mobile forms to collect and analyze field data. We like its robust organic growth profile with high margin, predictable recurring revenue, numerous revenue expansion opportunities, large untapped market and experienced management team and board. With its market cap at $175M, we believe that PFM is an emerging compounder and has a long runway ahead of it. MAV, on the other hand, is a compelling special situation name with a dislocated valuation. We have talked about MAV a few times in our commentaries: a busted IPO that has shown incredible progress in improving operations and making itself known as a growing acquisition platform for hair products. We like its capital light operating model, strong cash conversion and free cashflow yield. We believe there is a high probability that the multiple will materially re-rate or that the company will be acquired. MAV just announced a strategic review process “to identify, review and evaluate potential strategic alternatives that may be available to the Company, including without limitation, the sale of all or substantially all of the Company’s securities and/or its assets”. This announcement has further reinforced our thesis.
WeCommerce (TSXV-WE) was a new position we added to the Pender Small Cap Opportunities Fund in December last year. We participated in the go public transaction and were quite impressed with the management team and the potential of the company. WE is a highly scalable growth platform fueled by steady organic growth and acquisitions opportunities with attractive profit margins. We believe the management team are experienced serial technology company acquirers and are capable of leveraging the large market opportunity created by Shopify’s evolving partner ecosystem to create shareholder value. WE went public at $7 and has been trading around $25. We had the opportunity to speak to Andrew Wilkinson, WE’s co-founder, for Episode 62 of the Pender Podcast to be released next week.
Stitch Fix (Nasdaq:SFIX) was a top contributor to the Pender Value Fund. We introduced a group of holdings called the “ZIPSS” (Zillow, IAC, PAR Tech, Square, and Stitch Fix) in our last commentary. This is a group of technology companies that have some similarities to the business models of the popular high flying big five tech names like Amazon and Facebook, but which we believe still have long growth runways and which have not been fully appreciated by many investors. We believe profit pools have moved away from many traditional industries to alternative business models that are more efficient and which provide far more value to consumers than the old way of doing the same thing. SFIX is an online apparel company focused on hyper personalizing the proper fit and style of clothing in order to delight consumers. This is better than the traditional way of sourcing clothes at department stores by going through racks of clothes that don’t fit and are not your style. With the digital transformation that we are witnessing, further accelerated by the global pandemic, we believe SFIX is poised to create a lot of value for patient shareholders in the years ahead.
On the flip side, LEAF Group (NYSE:LEAF) was a key detractor for the Pender Small Cap Opportunities Fund and Burford Capital (NYSE:BUR) was a key detractor for the Pender Value Fund. That said, we are not concerned with the month-to-month price volatility of these two businesses. While LEAF was going through an activist shareholder campaign, its ecommerce business took off, fueled by the pandemic, and has been growing at triple digits. Burford recently announced a business update with strong 2020 performance and a re-initiation of dividend payments. We also believe Burford could be a potential beneficiary as insurers face increasing litigation for pandemic payouts.
The recent market experience has been incredibly positive and, while we don’t know what the future will bring, you can be sure that we will stick to the Pender Way.
The Pender investment process went through its most stringent stress test yet in the early stages of the pandemic but proved not only resilient but rewarding, with almost all of Pender’s funds being in the top quartile in their respective Morningstar rankings. However, while we are pleased, we are by no means euphoric. Last year was a lesson in humility.
David Barr, CFA
February 19, 2021
 All performance data points are for Class F of the Fund; PenderFund
 At Feb 12, 2021