In a challenging environment for growth stocks, small/mid-cap specialist, Nicolas Chevalier, credits multiple risk management for the track record of the gold-rated Pembroke Canadian Growth mandate.
“In the shorter term,” says Chevalier, “there are headwinds, no doubt about it. A lot of our companies are struggling with rising commodity and oil prices, inflation, labour shortages, and other challenges, but we will not change our stripes. Our approach has always been to invest in high-quality companies and understanding the challenges.”
Chevalier, a partner and portfolio manager at Pembroke Management Ltd. in Montreal, co-manages the portfolio with Stephen Hui, located in Vancouver.
Protective Measures
Embedded in the risk measures is an emphasis on qualitative research supported by quantitative modelling data. “Ultimately,” says Chevalier, “you want to back management teams that have secular tailwinds and the skills to take on the opportunities in a rapidly changing world. That challenging world is where the right people with the right opportunities can make hay and grow, so disruption is a good thing.”
As bottom-up investors, their portfolio is primarily weighted in sectors with the greatest growth potential. The portfolio is currently weighted in approximately 22% industrials, 21% technology, 16% financials, and 14% consumer discretionary. Also currently, the fund has zero exposure in utilities and healthcare, but there is healthcare exposure within the other sectors of the mandate.
Also part of the risk strategy is being pretty strict about never allowing a single sector to represent more than 30% of the Index. From an individual stock perspective, the portfolio of 40 to 50 holdings will not exceed more than a 7% weighting.
With a long-term philosophy, the managers look for companies with a five-year time horizon. Historically, the fund has an annual portfolio turnover of approximately 30%.
When it comes to capitalization in the small and mid-cap growth space, the initial investment strategy targets a potential company with a market cap of around $200 million to $3 billion. “I would say the sweet spot is just under $1 billion,” says Chevalier.
Favoured Growth Stocks
A favoured long-term holding is Tecsys (TCS), a Montreal-based company that provides software for multiple supply chain distribution, including the healthcare and retail sectors. “Essentially they’re installing management software systems for improved inventory management,” says Chevalier. “On the healthcare side, Covid really put the spotlight on some of the inefficiencies in the systems with personal protective equipment, ventilators and masks in a crisis situation.”
Tecsys is the leading player in the space with “a decades-long runway and a very very sticky customer base.” Tailwinds also bode well for the distribution side of the business in an increasingly complex world of selling online and the supply chain operations. In addition, the family are huge owners of the stock, so they are long-term shareholders along with Pembroke.
Another longer-term holding is Richelieu Hardware Ltd. (RCH), an importer, manufacturer and distributor of hardware products to home-furniture manufacturers, woodworkers, and retailers. The company is favoured for the tenure of the CEO who has never sold a share, the successful asset allocation strategy, and the generation of free cash flow over the years. As well, the company has benefited from an increase in demand for hardware kitchen gadgets in Canada and the U.S. market.
A recent addition to the portfolio is Magnet Forensics Inc. (MAGT), a Waterloo-based company that went public last year and is expected to grow successfully for many years. The company provides digital investigative solutions to public security organizations, such as software for police officers across Canada to enhance their research. The company is owned by the founder, an ex-police officer, along with the CEO, and ex-Research in Motion founder. “So it has a very high alignment of interest,” says Chevalier, “with very nice recurring software and service revenue, and low debt. The company was discovered by one of our young analysts.”
Multi-Generational Team
The 15-member investment team is comprised of portfolio managers and analysts with sector-specific expertise in North America. The team includes long-tenured managers, such as Chevalier and Hui with more than two decades of experience, and younger analysts. Chevalier says the team of experienced managers and younger analysts with different insights and perspectives enhances their funds.
In positioning the fund, Chevalier says that one of the pillars of Pembroke is the concept of alignment, such as management teams that are shareholder-friendly, with CEOs with a personal vested interest.
Pembroke takes that philosophy further with the alignment of the firm’s investment managers. “Both Stephen and I,” says Chevalier, “have the majority of our personal money invested in the funds that we manage for our clients. When we’re buying stocks we know there is capital risk. It doesn’t mean that we won’t make mistakes, but we’re hopeful that over time it does reduce mistakes.”
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