October 10, 2013

Manager’s Quarterly Commentary – David Barr – Q3 2013

Written by David Barr

The Pender Small Cap Opportunities Fund turned in another strong quarter. It was up 8.39%1 compared to 6.26% for the benchmark2.

Again, the performance of the Fund was largely driven by the performance of key holdings including QHR Technologies (TSX-V: QHR), CRH Medical (TSX: CRH) and Tio Networks (TSX-V: TNC) with the assistance of one announced takeover in the quarter, Novus Energy (TSX-V: NVS). Since inception3 the Fund has had an annualized return of 19.19%1, compared to 8.02% for the benchmark. 

1 Refers to Class A units in the Fund.
2 S&P/TSX Capped Composite Total Return Index.
3 Inception is June 2009.

Forward thinking, finding catalysts

As value investors, we are in the business of buying low and selling high. Firstly, we are always buying what we believe are undervalued stocks. The second part of the equation is for the price of the business to reach our estimates of intrinsic value which gives us an opportunity to profit from our investment. Sometimes, the market will help “close the discount” as continued strong financial performance increases the share price of a holding.  Many traditional value investors use time as an ally in this regard. However, it often takes longer than expected, leading to the dreaded “value trap”.

In the small cap investing world, companies tend to be acquired more frequently than in the large cap world. Obviously, there are more potential buyers for a $500 million market cap company than for a $100 Billion market cap company.

A key part of our investment process is that we constantly look for potential catalysts that can accelerate the “closing of the discount”. During the quarter, we read the most recent MD&A for Novus Energy.  The company originally came to our attention in December 2012, when it announced a “value optimization process”, investment banker talk for “we are trying to sell the company”. In the recent MD&A, in the penultimate paragraph on page 17, Novus disclosed:

The Company confirms that it is currently in exclusive negotiations with respect to a potential transaction. In that regard, the Company received an order of the Court of Queen’s Bench of Alberta, as well as confirmation from the TSX Venture Exchange, that it may delay its annual general meeting of shareholders until October 24, 2013. This may save the Company the expense of holding an additional meeting, should the Company undertake a transaction which requires shareholder approval”.

To us, this looked like a company that was right at the finish line in closing a sale of the company.  We immediately increased our weighting to 2% of the Fund at $0.85 per share.  Trading in the company was halted three business days later and it announced that it was being acquired for $1.18 per share, a 38.8% premium from the price we paid days earlier.

Portfolio Updates

It is worth noting that the four companies that presented at the Pender Small Cap Opportunities Investment Ideas Lunch in June also had good quarters.

In our search for value, we added four new companies to the portfolio. To make room for these new ideas, we sold five positions – two as a result of being acquired and three based on valuation concerns. 

Within the portfolio, we were quite active in the quarter. As information about companies was made available, we changed our weightings to reflect changing risk/reward metrics.

The cash position in the fund moved back up to 24%, approximately the average cash weighting we’ve had since inception so if the world ends with the potential US government shutdown,  I’m going bargain hunting. 

David Barr, CFA
September 30, 2013

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