Manager commentary - December 31, 2018

Falling commodity prices and severe discounts for Canadian energy products have heavily impacted investor sentiment in Canada. In difficult markets, small-cap stocks tend to underperform. This year was no exception, as it was one of the worst years for small-cap stocks since the financial crisis. Weak performance during the quarter was broad-based, but particularly acute in the oil and gas sector, with oil and Alberta-based natural gas production falling precipitously. The Fund’s energy investments outperformed the benchmark sector, falling 17% versus the benchmark’s decline of 33%. The Fund’s focus on cash-generating businesses within cyclical areas and less valuation risk than the market contributed to relative outperformance. The Fund’s top-contributing investments were Badger Daylighting Ltd., AltaGas Canada Inc. and Element Fleet Management Corp. The largest detractors from performance were AltaGas Ltd., Canadian Western Bank and Superior Plus Corp.

We initiated an investment in Lucara Diamond Corp. Since its mine entered full production in 2013, the company has realized attractive margins and produced a return on equity exceeding 20% with no debt on the balance sheet. The company improves sector diversification and balance sheet metrics of the Fund, and the shares are trading at a steep discount to our net asset value calculations. The Fund also initiated an investment in AltaGas Canada Inc. (ACI), a recent IPO and spin-out from AltaGas Inc. With most of the company’s earnings stemming from regulated assets, we expect cash flows and earnings power to be predictable and stable over the long term. ACI trades at an attractive valuation relative to its North American utility peers and the current portfolio, while offering an attractive dividend yield. The partial sale of ACI and a dividend reduction should position AltaGas Inc. on more sound footing to internally fund its growth plans while improving its balance sheet. We exited our investment in Maxar Technologies Ltd. Although Maxar has a strong legacy as a leader in the Canadian technology space, the company has failed to address heightened debt levels since it made a major acquisition last year. A failure to address balance sheet leverage put the company’s long-term competitive positioning at risk. During the quarter, Brookfield Infrastructure Partners completed the acquisition of fund holding Enercare Inc. This increased cash levels from the prior quarter.

Over the past two decades, the strategy has weathered numerous market and economic cycles by owning a diversified portfolio of businesses that exhibit above-average profitability and below-average valuations relative to the benchmark. This discipline persists. Valuations of growth-oriented and expensive high-quality businesses have pulled back with recent market weakness and less-than-perfect company execution. We remain focused on businesses that can execute their strategies in challenging periods, with the ability to improve their franchises without relying on exogenous factors. Cash is at above-average levels, providing ample dry powder to deploy capital as opportunities develop. The Fund provides higher income generation, a lower payout ratio and stronger balance sheet metrics than the benchmark, which should all contribute to downside support in a more challenging market environment.

Fund and benchmark performance as at December 31, 20181 year3 year 5 year10 year
IA Clarington Canadian Small Cap Fund - Series A-12.3%3.0%1.5%9.8%
BMO Nesbitt Burns Small Cap Index-18.2%5.6%0.3%8.8%

Learn more about IA Clarington Canadian Small Cap Fund

The performance data comparison presented is intended to illustrate the Fund’s historical performance as compared with historical performance of widely quoted market indices. There are various important differences that may exist between the Fund and the stated indices that may affect the performance of each. The BMO Nesbitt Burns Small Cap Index includes common shares of all Canadian companies trading on the Toronto and Montreal Stock Exchanges with a total capitalization at the beginning of each month which does not exceed 0.1% of the total capitalization of the S&P/TSX Index. The Fund’s sector and geographic exposure may differ from that of the benchmark. The Fund’s currency risk exposure may be different than that of the benchmark. The Fund may hold cash while the benchmark does not. It is not possible to invest directly in market indices. The performance comparison is for illustrative purposes only and does not imply future performance. Effective June 5, 2009, IA Clarington Canadian Opportunities Fund merged into this Fund.