The small-cap universe looks attractively valued

The global equity market sell-off continued in February driven primarily by Russia’s invasion of Ukraine. Expectations for the number of interest rate hikes that would be delivered by the US Federal Reserve (Fed), the Bank of England (BoE) and the European Central Bank (ECB) ramped up quickly and pushed equity markets lower.  Equity volatility spiked, with the Volatility Index (VIX) ending the month near 30. Oil prices surged with the potential withdrawal of Russian oil from world markets, and Brent crude closed above $100 per barrel at the end of the month, up from $73 at year end. Against this backdrop, the Fund returned -6.0% in February, underperforming the benchmark return of -3.4%.

Upcoming fee reduction
We are pleased to advised that with effect from 1 April 2022 the management fee for the Pengana Global Small Companies Fund (ARSN 604 292 677, APIR PCL0022AU) (Fund) will reduce from 1.334%pa (including GST net of RITC)1 to 1.1%pa (including GST net of RITC).

Top Holdings (alphabetically)

Cogeco Communications

Canada

Communication Services

Sendas Distribuidora SA

Brazil

Consumer Staples

Serco Group PLC

United Kingdom

Industrials

Softchoice Corp

Canada

Information Technology

TietoEVRY Oyj

Finland

Information Technology

In the US, equity markets were broadly negative on the month, as investors tried to process the implications of Russia’s invasion of Ukraine. Rising inflation continued to be topical and it is expected that the Fed will deliver six rate hikes by the end of the year. Europe was most directly affected by the recent actions of Russia as European equities underperformed other regions. If Russian commodity exports are disrupted, it would have a significant impact on the European Union as Europe is heavily dependent on Russia for crude oil and natural gas resources.

The consumer discretionary and financials sectors were the worst performers, reflecting expectations for pressure on consumer spending and economic activity as energy prices rise.  In Asia, equities recorded a modest decline in February relative to other regions around the world.  Stocks in China and Hong Kong slipped as US and European countries started to impose economic sanctions on Russia, leading to commodity price rises and fresh concerns over higher inflation. In Hong Kong, technology stocks declined due to new concerns over changing regulatory rules in China.  Emerging markets also underperformed global equities driven by large declines in Russian equities.  China and India also posted negative returns.  Global small caps outperformed global large caps on the month as the MSCI ACWI Small Cap index significantly outpaced the MSCI ACWI.

Individual stock selection and the Fund’s regional overweight in western Europe were the main drivers of underperformance versus the benchmark in February.  Smaller cap names in the portfolio underperformed (companies with market caps of under $2bn) contributing to the negative divergence from the benchmark. Approximately 97 bps separated the top contributor and largest detractor.  As of 28^th February, the top 10 holdings accounted for approximately 37% of the Fund’s assets, with the largest position approximately 4.7% of the portfolio.  Regional and sector exposure remained relatively unchanged month over month.

Despite market turbulence, there were relatively few significant changes to the existing names in the portfolio as company fundamentals across the book are still reasonable.  We continue to keep a close eye on global inflation as we believe that will have a more lasting impact on the investment environment than the Russia-Ukraine conflict.  Two new positions were purchased during the month.  The first was Parkland Corporation, a gasoline distribution, and marketing business based in Canada.  They are the largest independent fuel retailing company having a large network of gas stations across Canada and the US and are shifting their business mix towards high margin food and convenience items.  The second addition to the portfolio was Schibsted Media Group, an international media group, headquartered in Oslo, Norway. Schibsted operates a variety of online classified businesses in the Nordic region with very high market share.  After the company backed out of its significant ownership in Adevinta, we purchased shares for 11x EBITDA, a bargain for this quality asset.

The Fund exited three positions in the month including Wizz Air immediately after the Russian-Ukraine conflict started.  Given Wizz’s exposure to air traffic in eastern Europe, we viewed unwinding this position as prudent.  The Fund also exited L&T Technology Services and Future PLC.  Both stocks performed well surpassing our view of fair value.

The market environment continues to be challenging.  Investors are understandably anxious, but we believe the market has already priced in a good portion of downside risk.  With some exceptions, the small-cap universe looks attractively valued and we believe the opportunity set continues to look ripe on a long-term basis.