How did the International Small-Cap Premier Quality Strategy perform in 1Q21?

Mark Rayner The first quarter offered a stark and frustrating reminder that the operational results of our companies can at times diverge from their stock price movements in the short run. Overall, the operational performance of our holdings remained robust in 1Q21, especially when viewed against the backdrop of COVID-19. This was perhaps most clearly signaled by a metric we use to gauge our companies' operating efficiency—return on operating assets, which is calculated as the latest twelve month’s earnings before interest, taxes and amortization divided by working capital plus property, plant, and equipment. The portfolio’s median of 45.8% on this metric compares very favorably with 13.8% for the index (Source: FactSet). This superior operating efficiency was not evident in share price performance, however, making it a disappointing quarter for us.

Which areas of the portfolio hurt 1Q21 performance most?

MR Seven of the portfolio’s nine equity sectors detracted from first-quarter results. The Information Technology and Health Care sectors made by far the biggest negative impact, followed by Communication Services. At the industry level, each of the three largest detractors came from these three respective sectors: IT services, health care providers & services, and interactive media & services.

Which position detracted most from 1Q21’s results?

MR That would be Australia’s Bravura Solutions Limited, which provides software solutions for the wealth management and funds administration industries. The company’s primary product is Sonata, a front-to-back-office software platform that handled everything from new product creation and distribution to compliance and auditing, administration, valuations, and modeling. While Bravura is still winning new business, its results for the fiscal first half of 2021 reflected lower project work in the United Kingdom for both implementation and subsequent go-live work as a result of the ongoing effects of the pandemic. This led to recent analyst views turning sharply negative in February, though on a short-term basis. We’re still quite confident in its long-term prospects, which is underscored by a conversation we had with the company’s CEO in March, in which he described how Bravura continues to expand its addressable market via new product introductions and innovation while shifting its revenue model to an even more predictable, subscription-based model.

What were the top contributors at the sector and industry level?

Mark Fischer Industrials, which is our largest sector weighting, also made the largest positive contribution to first-quarter performance. Interestingly, we also got a solid contribution from Real Estate, which is one of the Fund’s lowest weightings. You could see the dominance of Industrials at the industry level. Four of the five top-contributing industries all came from this sector, including the top three, which were trading companies & distributors, building products, and professional services.

Which of your holdings contributed most to 1Q21’s performance?

MR It was another company headquartered in Australia, Hansen Technologies. Hansen is a leading global provider of billing software and customer care technologies for utilities and the telecom industry. Its share price gained sharply in March after it announced that it had executed a Master Agreement with Telefonica’s German operations. This news resulted in analyst upgrades of approximately 20% to Hansen’s 2021 EBITDA. This was not the only positive development, however, as this announcement followed one in February in which Hansen reported earnings for the first half of 2021 that were stronger than expected, which saw like-for-like EBITDA increase by 44% year over year, with margins that far exceeded full-year expectations.

How did the Fund perform versus the MSCI ACWI ex-US Small Cap in the first quarter?

MF The Fund lagged its benchmark, with most of the first-quarter underperformance coming from stock selection—sector allocation decisions were only marginally negative. Stock selection detracted most in three sectors—Information Technology, Industrials, and Materials. On the other hand, the combination of a much lower weighting and savvy stock picks gave us an advantage in Real Estate, as did having no exposure to Utilities and Consumer Staples, each of which lagged within the MSCI ACWI ex-US Small Cap for the quarter.

What is your outlook for this Strategy?

MR We employ a bottom-up investment process, which is designed to identify high ROIC (Return on Invested Capital) businesses around the world in order to harness the power of compounding. Of course, over the shorter-term factors other than ROIC can, and normally do, drive stock prices. In our 2020 commentary, we mentioned that many investors were gravitating towards companies offering either ‘thematic growth’ (those benefiting from the COVID-19 pandemic) or latterly to ‘cyclical value’ (those set to benefit from the post pandemic economic re-opening). As these themes often pay little regard to the underlying or long-term profitability of businesses, the preference created a difficult backdrop for our strategy to generate outperformance. These trends extended into 2021’s first quarter, creating something of a paradox. Whilst the Fund lagged in the first quarter (indeed, it had one of its worst quarterly relative performances since inception), we believe that our holdings have arguably never possessed higher quality. We have been taking advantage of the temporary dip in share prices within the small-cap quality universe as the current market environment is offering us opportunities to identify and invest in what we see as high-quality businesses that have escaped the attention of other investors. In the first quarter, for example, we made three new additions to the portfolio.

While we don’t know when the market will shift back to favoring the operating performance of our portfolio companies, we do note that previous periods of underperformance in 2014 and 2016 were followed by marked outperformance in 2015 and 2017, as ‘mathematics’ again trumped ‘thematics’. Meanwhile, we will continue to look for and patiently invest our clients’ money in high-quality businesses, which offer reasonable or better-than-market valuations.

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