Two distinct trends

Global equity markets started the year by registering their worst month of performance since March 2020. The prospect of US interest rate hikes, rising global inflation, and Russia-Ukraine tensions meant there were few places for equity investors to hide. US consumer inflation climbed to 7%, the highest level since 1982.  The Fund returned -5.4% for the month, the benchmark returned -4.1%.

Top Holdings (alphabetically)

Cogeco Communications

Canada

Communication Services

Orion Engineered Carbons

United States

Materials

Sendas Distribuidora SA

Brazil

Consumer Staples

Serco Group PLC

United Kingdom

Industrials

Softchoice Corp

Canada

Information Technology

The Federal Reserve has accelerated its plans to tighten monetary policy in 2022.  Escalating tensions between the US and Russia over Ukraine added to worries, putting markets in reverse.

In Europe, equity markets were broadly down over the outlook for US interest rates and the uncertainty surrounding Ukraine.  European economic data in January was surprisingly resilient despite rising COVID-19 infections across the continent. The impact of the latest surge in COVID-19 infections due to the Omicron variant on sectors such as the service industry was less than expected since restrictions remained limited.

In Asia, equity markets recorded a modest decline, driven by the same concerns surrounding US interest rates, inflation, and the escalating situation in Ukraine.  South Korea was one of the worst-performing markets in the region.  News of US interest rate hikes and reduced liquidity greatly impacted the market as foreign investors became increasingly risk-averse and exited the region.

The US dollar strengthened against most major currencies except those of some commodity-producing countries. Despite the strengthening US dollar and a very difficult 2021, emerging markets outperformed developed markets during the month.

Looking back at the broad equity market sell-off in January, two distinct trends caught our attention:

1. The significant sell-off in the highly-priced growth end of the equity market. This phenomenon has been discussed widely by the press with the fear of higher rates impacting the speculative valuations of these companies.
2. What has been less publicized was a significant sell-off in the less liquid, small-cap portion of the market. Liquidity dried up quickly in the sell-off driving down the price of small cap equities to quite attractive valuation levels.  While the fundamental risks surrounding inflation aren’t clearly known yet, our belief is a significant portion of the risk has already been discounted in many less expensive small cap equities.

Despite the month-end rally, global large caps significantly outperformed global small caps. At month-end, the MSCI ACWI small cap index was trading at 16.2x estimated P/E on 2022, and the non-US portion of the index was trading at 14x estimated P/E on 2022. This is as discounted as these gauges have been in the last 7 years.

Individual stock selection and currency were the main drivers of underperformance versus the benchmark in January.  The Fund’s overweight position in smaller cap names (companies with market caps of under $2bn) was also a large contributing factor to the negative divergence from the benchmark. Approximately 124 bps separated the top contributor and the largest detractor.  As of 31^st January, the top 10 holdings accounted for approximately 36% of the Fund’s assets, with the largest position approximately 4.3% of the portfolio.  Regional and sector exposure remained relatively unchanged month over month.

Average cash holdings were stable month over month, however, trading activity was heavier during the month driven by increased market volatility.  As a result, the Fund took the opportunity to add to existing positions due to attractive valuations and good downside risk profiles.

The Fund increased positions in Assai (Sendas Distributora), Cogeco Communications, Irish Continental, Orion Engineered, Serco, Softchoice and Tietoevry, as a result making them sizable holdings in the Fund.  All of these businesses have similar characteristics including strong management teams, growth at an attractive price, good free cash flow generation, and attractive valuations. 

he Fund also initiated a position in Majorel which is a Belgian consumer engagement platform that operates call centers and offers a full suite of digital solutions to consumers. Innovative technology is driving growth in the outsourced client segment and larger players continue to win market share due to the technology leadership and scale required to offer a full suite of client solutions.  We expect Majorel to continue to grow in non-English speaking portions of Europe.

As cases of COVID-19 begin to subside, life is returning to a more normal cadence in many places around the world and we continue to be optimistic about what the future holds.  While the portfolio has been affected by the recent sell-off, as highlighted above we are working diligently to capture the opportunities that volatile markets present. We remain committed to making decisions in line with our investment philosophy.  We are actively monitoring company fundamentals and re-evaluating investment theses relative to our original expectations. We continue to take a long-term view and believe patient investors will be rewarded for having the courage to invest in this space.