Fund Launches into Small Cap ‘Sweet Spot’

How this new dividend-focused mandate made a medalist first year with Canadian holdings.

Jade Hemeon 11 November, 2021 | 4:59AM
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Downtown Vancouver

For Pender Small/Mid Cap Dividend Class, performance has been impressive during the short and sweet ride since it was launched in January 2020 - just before the arrival of COVID-19.

Since its inception, the bronze-medalist fund’s F-series mandate garnered an average annual return of 41%, based on Morningstar numbers at Oct. 31, 2021. At the same date, the fund showed a one-year return of 15.3% and a year-to-date gain of 27.9%, handily beating both the Morningstar Small Cap category and Morningstar’s benchmark index. The fund is also available in D-series.

“When we launched, small caps were at attractive valuations,” says David Barr, chief executive officer at PenderFund Capital Management Ltd. of Vancouver and lead manager of Pender Small/Mid Cap Dividend.  “They were already out of favour relative to some of the large cap, growth companies that dominate major market indices, and then we had the onset of the global pandemic.”

Actively Picked Out of Favour Paid Off

While the pandemic initially caused prices to drop sharply across the board, stocks later rallied strongly as governments moved to inject liquidity into global economies. Due to astute stock selection, the fund has recently enjoyed impressive gains.

“Predicting the macro environment is a challenge but we do look at how Covid is impacting the general economy,” Barr says. “There has been a structural shift in how people work and how they shop. People have been forced to do things in new ways, and many will maintain those habits even as restrictions are lifted.”

While Pender Small/Mid Cap Dividend may be new, the fund’s management team at Penderfund has achieved a long record of success with other funds in the company stable, including Pender Small Cap Opportunities and Pender Value Fund by focusing what the team calls “small cap stocks with large ambitions.” The difference with Pender Small/Mid Cap Dividend is that the fund does not invest in any micro-cap companies.

The team buys companies with a market capitalization of no more than US$5 billion at the time of purchase, although companies may be held beyond this size as they evolve and find new legs of growth to extend their runway.

Dividend Preferred, But Strength First

The focus is on companies that pay a dividend, although dividends are not absolutely necessary. About 70% of holdings pay a dividend or some other form of income, enhancing reliability and stability and putting a damper on volatility, Barr says.

“We focus on companies with strong balance sheets and growing cash flow, and some history of returning capital to shareholders through dividends, income or share buybacks,” Barr says. 

With interest rates at low levels and many companies sitting on healthy cash reserves, merger and acquisition activity has been booming, and this has been a benefit to small and medium-sized companies, Barr says.

Smaller-Caps Get the Buyers

This year is on track for a record-setting amount of global M & A activity in terms of both dollar value and number of deals, he says. PenderFund has seen at least 10 companies in its various mutual fund portfolios taken over this year.

“There are more small cap companies than larger companies to start with, and they’re easier for another company to buy than a large corporate giant,” he says. “Who’s going to buy Apple?”

Small caps are generally trading at reasonable valuations that make them attractive to corporate buyers. With small caps, there is less risk of regulators stepping in to block a takeover, as they might with a giant M & A deal.

“Takeovers are good news/bad news,” Barr says. “If a company in our fund is acquired at a 30% premium to the market price, that’s great. But then we have to find something else that’s just as good or better. Sometimes we would like to hold on to a company and watch it grow.”

Barr likes to keep the portfolio to a maximum of 40 companies, and there are currently 38. All holdings are based in Canada.

Inflation-Resistant Assets

While it’s unclear if rising inflation will be a lasting trend, the team takes time to understand the cost structure of companies, and how they are impacted by the price of labour and raw materials. The team seeks companies with pricing power that can pass on cost increases to buyers of their products and services.

“What we’re doing is no different than what we’ve done for the past 11 years,” Barr says. “We look to understand businesses at a deep level and focus on high-quality companies. We then buy a small part of those businesses, hopefully at a discount.” 

Ideally, he likes to hold companies for three to five years, but he says the small cap market can be volatile. If the stock price takes off it often makes sense to take profits due to valuation risk.

Entertainment, Software and Loyalty

A key holding in the fund’s top 10 is media and content company Corus Entertainment Inc. (CJR.B). While it was once a “hodgepodge collection of assets,” Barr says it has been selling off non-core holdings in recent years to focus on broadcasting and direct-to-consumer streaming services.

For example, the company’s StackTV subscription video streaming service on Amazon Prime Video was launched in mid-2019 and this recurring revenue stream has grown rapidly.  It also has strength in children’s television content and has expanded into developing original animated feature films.

Corus Entertainment’s balance sheet has become stronger, cash flow is healthy, and the dividend yield is an attractive 5%.

The Penderfund team has recently added to its stake in Sylogist Ltd. (SYZ), a firm it has followed for more than 10 years.  Sylogist provides software solutions to public and public service organizations across the globe, including school districts and boards, government agencies and non-profit organizations.

Another key fund holding is Diversified Royalty Corp (DIV), which is emerging from headwinds faced during the pandemic and is a “good reopening play as things normalize and business activity accelerates,” Barr says.

Diversified Royalty receives royalties from well-managed multi-location businesses and franchisors across North America, including Mr. Lube, loyalty program AIR MILES, and home care provider Nurse Next Door. 

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Corus Entertainment Inc Shs -B- Non-Voting0.50 CAD0.00
Diversified Royalty Corp2.80 CAD-0.71
Sylogist Ltd9.00 CAD-1.64

About Author

Jade Hemeon

Jade Hemeon  A Toronto-based freelance financial journalist with more than 20 years experience, Jade has previously been a staff reporter for the Financial Post and Toronto Star.

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