The five-star, gold-rated Pembroke Canadian Balanced mandate (previously named Pembroke Growth and Income) topped our recent list of gold-rated Canadian balanced funds. It clocked an impressive 12.51% return, thanks in part to its stock style that’s much more small-cap than its category or index, while picking companies that are only slightly more growth-oriented than the rest of the pack. That’s a conscious decision by the managers. Here’s why.
“We didn’t want to go out and look into a new universe of names for this fund,” says Doug Pospisil, portfolio manager and director of research at Pembroke Management Ltd. in Montreal. “We stayed with the idea of predominantly investing in smaller cap companies, which is our forte. We screen the names to include growth characteristics, really the foundation of Pembroke, and for companies that have an associated dividend yield.”
For some investors, a focus on small caps might set off alarm bells around risk. Here’s how the managers deal with it – risk management is done at two levels among the in-house equity research team of portfolio managers and analysts. One is done at the micro, stock-by-stock level, and the other at the portfolio level. Five years ago, the firm hired a chief risk officer and he has been instrumental in assessing the portfolio from a top-down perspective.
In fact, navigating the mandate through the impact of the coronavirus pandemic was met with the same investment discipline. The first risk measure was assessing businesses that would be negatively impacted, and not having exposure in those areas. The second critical analysis was whether a company had the balance sheet strength and the ability to weather the environment for some sort of reasonable time frame. “And it goes back,” says Pospisil, “to the risk measurement around balance sheets.”
How to Pick a Sector and Stock?
To make it into the fund, the investment managers have a rule of thumb that anything below a 1% dividend yield is too low to go into the portfolio. According to Pospisil, what differentiates this product from other dividend and growth mandates is the hybrid strategy for performance. “We think this approach is really the insurance policy against rising interest,” says Pospisil. “Large businesses that are more mature don’t have as much growth potential and are going to be much more interest-rate sensitive.”
Qualitative factors are essential to the mandate among the approximate 40 holdings that are below $2 billion in market cap when they go into the fund. “We always think,” says Pospisil, “that there is no downside when management of companies are also owners of the stock, more often than not, doing what’s right for the business longer-term.”
With an average portfolio turnover of around 30%, a longer-term approach is favoured by the Pembroke team. Characteristically, the asset mix is approximately a 70%/30% weighting between equities and fixed income. The fixed income component is outsourced to Toronto-based Canso Investment Counsel Ltd. and is represented by one holding, the Canso Corporate Bond fund. That holding is focused on investment grade, Canadian corporate bonds and some government securities.
The sector weighting of approximately 28% industrials, 23% financials, and 19% technology is also characteristic of the mandate. The fund excludes energy and healthcare, where there are few opportunities in the space, and utilities are considered either too large in asset size or there are not enough growth opportunities to be attractive. “By default,” says Pospisil, “it really leads to the big three, industrials, financials and IT.”
Stocks in Focus
One of the largest holdings, Vecima Networks Inc. (VCM), a developer in integrated hardware and software solutions for broadband access, illustrates the investment philosophy. “This is a family-run company,” says Pospisil, “that is effectively in a position of recreating itself; the legacy business was a video-broadband solution.” The product portfolio is evolving into selling to commercial customers and directly to cable companies, offering them a hardware solution to the challenge of network congestion. Pospisil says they are really impressed by the management who have spent over $140 million in R&D and as 60% shareholders, “that’s a big dividend they could have paid to themselves.” The company also uses an M&A strategy, which is potentially getting into new lines of business, such as video content. “It’s a small business, run by highly-aligned individuals,” says Pospisil, “under that radar screen of most Canadian and institutional investors.”
Another favoured holding, Savaria Corp. (SIS), is a business that provides products for personal mobility in a home setting and some institutional settings. The products include wheelchair lifts, stair lifts, small elevators and other mobility aids. “The tailwind associated with growth,” says Pospisil, “is an aging demographics and more desire by individuals to age in their home.” In addition, the company is well positioned as a manufacturer, with distribution channels, and third-party retailers, with opportunities to grow. “It’s a wonderful success story of an entrepreneur who bought the business over 30 years ago.” The company has grown to $1 billion and the owner is still a very big shareholder in the business, similar to Vecima.
Moving forward, “I think the opportunity,” says Pospisil, “will continue to be smaller-cap companies in the Canadian landscape where most institutional investors overlook them. And as a generalization, I think it will be in the more dynamic smaller companies that are, as we say, owner-run or shareholder-oriented types of entities.”
