Manager commentary - Q4 2019

IA Clarington Canadian Small Cap Class Series A returned 4.8% in the quarter versus 6.3% for the BMO Small Cap Blended Total Return Index (weighted). The one-year return was 15.1% for the Fund compared to 19.2% for the benchmark. The Fund invests substantially all of its assets in units of IA Clarington Canadian Small Cap Fund (“the Reference Fund”). Its performance therefore largely reflects the performance of that fund. All reference made to “the Fund” hereinafter reflects a discussion of the portfolio holdings and characteristics of the Reference Fund.

Easing U.S.-China trade concerns buoyed commodity prices in the latter part of the year, benefitting the resource-centric Canadian small-cap market.

Performance in the quarter was broad based as reduced global trade risks supported both sentiment and economic outlook. Materials, including both base metals and gold, were a key source of strength for the benchmark, contributing nearly half of the index return. The Fund’s underweight exposure to the sector was the largest driver of underperformance in the quarter. Within cyclical areas, we believe businesses with strong competitive positions, healthier balance sheets and improving franchises are more likely to deliver resilient operating results and reasonable absolute returns over time.

The Fund’s top contributing investments were iA Financial Corp., Stantec Inc. and Parkland Fuel Corp. The largest detractors were Lassonde Industries Inc., Pason Systems Inc. and Secure Energy Services Inc.

We improved the quality of the portfolio by opportunistically adding to resilient, underappreciated businesses while reducing exposure to companies with deteriorating balance sheets or franchise quality.

In particular, we made significant additions to businesses such as Pason Systems Inc. and Canfor Pulp Products Inc., companies with strong balance sheets and a history of cash generation through difficult environments.

We exited Peyto Exploration & Development Corp. as the constant pressure of lower commodity prices has weakened the balance sheet. We also exited Cervus Equipment Corp. The company has not demonstrated strong capital deployment or cycle-to-cycle improvement in its franchise.

Actions like these over the last year have helped to improve the Fund’s debt-to-equity ratio from 60% to 53%, a sizeable advantage relative to the benchmark. At this late stage in the cycle, our holdings’ healthy balance sheets should provide flexibility if tougher economic conditions materialize, or optionality to grow dividends or reinvest if economic growth continues.

Rising valuation multiples for high-quality businesses have been a persistent challenge, a trend spurred on by low bond yields and easy access to credit. We remain disciplined in our capital deployment, choosing to be opportunistic and seeking to avoid weak businesses seemingly offering value late in the cycle. Although lower quality, momentum-driven businesses can dominate market performance over shorter periods, weak performance by cannabis-related stocks over the last year highlights the risks within these areas of the market.

Despite overall elevated valuations of businesses demonstrating growth or quality, we are pleased to selectively own Canadian and North American franchises with below-market valuation risk at sizable weights. We believe our long-term focus continues to differentiate our positioning in certain segments of the market.

The Fund currently provides a portfolio yield of 3.1%, with over 80% of the companies paying a dividend. A focus on sustainable income generation combined with thoughtful reinvestment provides support for growing these dividends over time.

Fund and benchmark performance as at December 31, 20191 year3 year 5 year10 year
IA Clarington Canadian Small Cap Class - Series A15.1%0.9%3.2%8.3%
BMO Small Cap Index19.2%1.2%3.9%4.7%

 

Learn more about IA Clarington Canadian Small Cap Class

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.