[00:00:00.040] - Intro

Good morning, ladies and gentlemen, and welcome to this month's conference call with Derek Hebb from CIBC Wood Gundy. Please be advised that this call is being recorded. I would now like to turn the call over to Mr. Derek Hebb, Senior Wealth Advisor. Please go ahead, Mr. Hebb.

 

[00:00:15.750] - Derek Hebb

Thank you, Alena. Today, we're joined by Al Daxner, Senior Vice President of Barrantagh Investment Management in Toronto. Al, who I interviewed in August of last year, has over              25 years of investment experience and is responsible for leading Barrantagh's institutional client service and marketing efforts. Prior to joining Barrantagh, Al was Executive Vice President and Managing Director at McLean Budden for over 13 years. And prior to that, he worked at Ernst & Young Investment Counseling, and he was a financial analyst at SEI. Al is a CFA Charter holder with an MBA and undergraduate degree in Biochemistry from McMaster University. And he serves on the National Audit and Finance Committee of the Canadian Red Cross. Al, thank you for joining us this morning.

 

[00:01:05.930] - Al Daxner

Thanks, Derek. Good morning.

 

[00:01:07.390] - Derek Hebb

Great to have you on the call. Al, as you can attest, small cap markets in Canada this year have been defined by a commodity rally led by the junior gold miners. How does Barrantagh's quality-value philosophy approach the materials and energy sectors?

 

[00:01:28.520] - Al Daxner

Yes, Derek, that very much is the case, and this does happen from time to time, as I think we all recognize commodities, in particular, the materials sector, are highly cyclical and quite unpredictable. Year to date, 2024, we've got nine of the eleven industrial GICS (Global Industry Classification Standard) sectors in small caps all underperforming the broader market in Canada. It really has only been materials. And then communication services as a small sector in the small cap markets are really the only two that have beaten the broader market. So, it's really been the heavyweight industry in terms of materials that has done well. And that's been led by gold, the junior gold miners. A couple of things to think about here. Yes, gold has risen, certainly central banks buying is part of that as a hedge to inflation. We have had elevated inflation for extended period of time, and of course, gold is used as a hedge against that. US dollar volatility, another contributor bringing investors to gold. Of course, geo-politics, no shortage of those issues in the world today, as well as interest rate cuts. So, to various extents, all of these has contributed to the rise in gold. And I know as we've talked in the past, our strategy does not invest in junior gold miners and has no exposure to mining stocks.

 

[00:02:49.360] - Al Daxner

And how we get to that, a couple of things to think about here. We qualify ourselves as quality value investors, value determined by traditional DCF (Discounted Cash Flow) valuation work. We combine that with management interviews, but I really want to focus on the quality part of the investment philosophy. When we think about what is a quality company, we think about companies that have pricing power. Of course, miners have no pricing power whatsoever as commodity prices are set globally. They tend to be low return on capital or low profitability over market cycles. They are high capital intensity, meaning it costs a lot of money to operate mining operations, balance sheets tend to be an issue with a lot of the smaller players here as well. And ESG profiles are generally not that strong as well. So we're looking for quality. We really don't find it in this highly cyclical, highly unpredictable part of the market. So, a little bit more perspective on that. What we've seen this year, gold was up 26% in March of 2024. That's the fifth highest monthly gain in 15 years. So, it was kind of rare to see the move we've seen in gold to the extent we have, in particular in March.

 

[00:04:04.860] - Al Daxner

We would note, historically, when we see gold prices move up more than 20% in a given month, the average of the next 12-month return is negative 2%. So yes, gold tends to move quickly and have big, big positive moves in short periods of time. It doesn't tend to stick around, what we've seen historically. Another way of looking at this is the weight of the energy and material sectors in the small cap market at the end of May was 56%. Well over half of the small cap market is represented by those two commodity-related sectors. Again, at 56%, that's the highest it's been in the last 10 years. So, another way of looking at the sharp move here and the overvaluation in those sectors. And when we've seen that historically, those peaks tend not to last very long, and we tend to see a moderation back or below their long-term average weight in the index, which is about 47%.  And lastly, there's a chart we use quite a bit here. We look at the long-term performance of the junior gold miners in the Canadian market over the last 15 years.

 

[00:05:09.970] - Al Daxner

And we know that the junior gold miners have returned, including this rally, just over 4% per annum. This has underperformed the price of the actual commodity or gold prices itself, which have risen 7 1/2%, and both of which are well below the overall return of our small cap strategy over the same period of just over 13%.

 

[00:05:31.860] - Derek Hebb

That's great, Al.  Interest rates appear to have plateaued and, in fact, have begun to moderate. What impact does this have on the strategy?

 

[00:05:44.530] - Al Daxner

Yeah, that's certainly no question. When we think about economics, we certainly see a moderation in inflation. We saw another CPI reading out of the US today, lower than expectation. So, of course, moderating inflation is going to be combined with moderation in interest rates, and we've certainly seen that already in Canada, and we think we'll start to see that happening in the US as well. So, a couple of things here. If we went back, really looking at the last two years or so, small cap has been out of favour, not just in Canada, but globally in US as well, until more recently here in 2024. And what really did that was the mantra of higher for longer as inflation proved to be quite sticky, and we clearly saw that interest rates were going to stay a bit higher for longer. This did take money out of perceived riskier asset classes like small caps, and that certainly had a negative impact. But when we get back to the fundamentals and looking at valuation of the various 11 industries in the market, and we see significant discounts to their five-year averages. In fact, in the small caps, we see on average about a 20% discount, where these stocks typically trade in some of the key sectors, certainly in our strategy, which would include the consumer sectors, both staples and discretionary.

 

[00:07:04.760] - Al Daxner

Industrials has historically been our largest weight in the portfolio, as well as technology. So, small caps are showing 20% discounts here versus large caps are basically fully valued to their five year average valuation. And of course, what's more timely here with the prospect of lower interest rates is that the higher dividend yielding sectors - more of the interest-sensitive sectors - these are going to do really well as interest rates start to fall and the yield on these sectors starts to look more attractive relative to, say, things like government bonds. And this would include sectors like financials, communications, real estate, and utilities. As a reminder, as a value investor, we do focus on dividend yield and certainly yield well above the index and well above the median manager. So again, this has been a bit of a headwind to us as well. We've had the two headwinds of small cap out of favour. And then, of course, a higher rate environment has weighed on some of our yield sectors, including the ones that I just noted. So no question, falling interest rates is going to be a tailwind, both to small cap as a strategy, pulling investor assets back into it.

 

[00:08:16.510] - Al Daxner

As well, we're going to start to see a relief in some of these higher yielding stocks and sectors in the portfolio. And an ancillary benefit here is increase in merger and activity in the market as well in the portfolio, we would note, since 2018, nine different stocks we've held in the portfolio have been subject to takeouts at pretty significant premiums. We would note here that smaller companies get higher premiums on takeouts. The study we did from 2018 showed deals done less than three billion (dollars) showed premiums on takeout of 37% versus just 18% for deals greater than 3 billion. Lastly here, I would note, most recently here, back in the second quarter, we added a position in consumer discretionary in Sleep Country Canada, of course, pretty well known to Canadians selling mattresses, and they were subject... Sometimes you get lucky, I suppose, but subject to a takeover offer at a 30% premium from Fairfax Financial here recently. So again, another example of a takeout. We expect to see more activity here as lower interest rates will certainly allow financing deals to be done with more frequency.

 

[00:09:30.270] - Derek Hebb

Thanks, Al. Barrantagh's performance this year has lagged the TSX Small Cap Index. And Al, you touched on this. Can you just comment on key detractors and offsetting areas of strength in the portfolio?

 

[00:09:46.510] - Al Daxner

Certainly. So, often when you're talking about performance being ahead or behind a benchmark, typically there's several factors you want to explain, as you've probably just alluded to, here we're at the relatively short list. So, the strategy is up just over 8% for the first eight months of the year, so at August 31st. And this compares to the TSX Small Cap Index at about 13.6%, which is actually the same as the TSX Composite, the Large Cap Index is up 13.6% as well. So, we're running about 5% behind the benchmark. And again, there's really just one thing that accounts for all of that shortfall, and that was underweight in materials and no exposure to the mining, in particular, the junior golds.  That detracted 6.4% in terms of performance. So, it really was materials. Again, this can happen quickly. A lot of this underperformance was sort of back in that March through May period. We would note here that if we look at the quarter ending August, the strategy is up 6% versus the index at 2.5%. So, we're already starting to close the gap on that and the strategy has outperformed by about a percent here so far in September.

 

 

 

[00:11:00.190] - Al Daxner

So, as we've seen, some moderation in the material sector, but in particular, some of the copper stocks that have done quite well this year. We've seen copper prices moderate quite substantially as inventories are rising, and we're even seeing China as an exporter of copper, given the slowness in their industrial complex, which is really historically quite rare that you would see China exporting copper, just dealing with rising inventories. Offsetting this on the positive side, we've had some very good strength in terms of our financial stocks in the portfolio. Financials have added about 4.7% in terms of contribution versus the index. Within that, Propel is a fintech player, benefited from some of the spin off of tightening lending by the big banks. They've been a beneficiary of that. Propel's up 136% so far this year, as well as Definity, an insurance company, is up 34% here as well. And then within technology, one of our key holdings there is Softchoice, is up 66% this year. Mainstreet, as well, in real estate in terms of a REIT has been up 43% and been a good offset here as well. So going forward, we'd like and we would expect to see some broadening of the markets and see instead of just one sector really performing and producing all of the performance, we expect to see more of a broadening here.  And we think, again, that lower interest rates are going to benefit certainly those higher yield sectors and stocks which are prevalent in our portfolio as well. We expect to see more M&A activity, of which with greater frequency, you do see smaller companies as takeover targets.

 

[00:12:47.360] - Derek Hebb

Thanks, Al. Barrantagh gives us exposure to a segment of the market - high quality Canadian dividend-paying small cap stocks - that most investors do not have exposure to. Based on our discussion this morning, I think your portfolio provides an attractive growth opportunity and a timely entry point for investors. In the interest of time, this will conclude today's call. If anyone has questions about the material that Al covered, please contact me. Thanks to everyone for listening in. And Al, thank you again for joining us on this month's call.

 

[00:13:25.960] - Al Daxner

Thanks, Derek.

 

[00:13:27.140] - Derek Hebb

Take care.

 

 

 

 

 

Disclaimers

 

This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2024.

 

Al Daxner is Senior Vice President of Barrantagh Investment Management. The views of Al Daxner do not necessarily reflect those of CIBC World Markets Inc.

 

The contents of this document are for informational purposes only and are not being provided in the context of an offering of a security, sector, or financial instrument, and is not an endorsement, recommendation, or solicitation to buy, hold or sell any security.

 

Clients are advised to seek advice regarding their particular circumstances from their personal tax and legal advisors.

 

“CIBC Private Wealth” consists of services provided by CIBC and certain of its subsidiaries through CIBC Private Banking; CIBC Private Investment Counsel, a division of CIBC Asset Management Inc. (“CAM”); CIBC Trust Corporation; and CIBC Wood Gundy, a division of CIBC World Markets Inc. (“WMI”). CIBC Private Banking provides solutions from CIBC Investor Services Inc. (“ISI”), CAM and credit products. CIBC Private Wealth services are available to qualified individuals. Insurance services are only available through CIBC Wood Gundy Financial Services Inc. In Quebec, insurance services are only available through CIBC Wood Gundy Financial Services (Quebec) Inc. The CIBC logo and “CIBC Private Wealth” are trademarks of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc.

 

™ CIBC Wood Gundy Investment Consulting Service is a trademark of CIBC World Markets Inc. CIBC Wood Gundy will be responsible to CIBC Wood Gundy Investment Consulting Service clients for the advice provided by any Investment Manager. The ICS Program Manager, CIBC Asset Management Inc., is a subsidiary of CIBC.

 

If you are currently a CIBC Wood Gundy client, please contact your Investment Advisor.

 

 

[00:00:00.000] - Intro

Good morning, ladies and gentlemen, and welcome to this month's conference call with Derek Hebb from CIBC Wood Gundy. Please be advised that this call is being recorded. I would now like to turn the call over to Mr. Derek Hebb, Senior Wealth Advisor. Please go ahead, Mr. Hebb.

 

[00:00:18.260] - Derek Hebb

Thank you, Paul. Today, we're joined by David Cooper of KKR in Toronto. David joined KKR in January 2024 as the Head of Canada for Global Wealth Solutions. In his role, David leads capital raising for the open-ended Evergreen funds launching in Canada, working directly with investment advisors and private wealth managers. David has worked in the investment industry for over 14 years, the majority of which has been in the alternative asset space. He graduated from Queens University with an Honours in Economics, and he is a CFA charter holder. David, thank you for joining us this morning.

 

[00:00:57.680] - David Cooper

Yeah, thank you for having me, Derek.

 

[00:00:59.180] - Derek Hebb

It's great to have you on the call.  So, our discussion this morning will focus on private equity investing, which I'm looking forward to, in particular because private equity, while used extensively by pension fund managers for many years, is an untapped investment opportunity for many individual investors. So, to get us started, David, what is the benefit of private equity in an investor's portfolio?

 

[00:01:28.770] - David Cooper

Yeah, thank you, Derek. And I think there are a few key benefits. The first one and the easy one is that private equity has historically outperformed the public markets, especially during times of muted or underwhelming returns for the S&P 500, or the index. And a lot of that can be driven by long term earnings, growth and capital appreciation. But another benefit for private equity is the expanding opportunity set that it offers. If you look at the US and publicly traded companies, there are right now about 4,500 publicly traded names in the United States, and that is down from 7,800 names in 2000. So a very meaningful decline. Whereas there are 256,000 private companies in the United States, if we count just companies with 50 employees or more, which is a relatively large size. So really, just by moving into the private equity space, you're expanding your investment opportunity. And alongside that, there are also just more diversification benefits as well, given that the private sector is not as concentrated as the publicly traded names are in very few holdings or certain sectors. So, you can get a lot more diversification when you enter into the private equity sector.

 

 

[00:02:57.660] - Derek Hebb

Thanks, David. So, within private equity, what are the different investment strategies and the various risk-return profiles of these strategies?

 

[00:03:08.580] - David Cooper

Yeah. And that's a good question because there are definitely different ways to get exposure to private equity. And as you mentioned, there are different return potentials, but also higher returns normally come with higher risk. So starting from maybe on the higher end of the risk spectrum in the earlier stage of investing is venture capital. These are early stage startup companies. They often have unproven business models, likely not even generate any revenue, and most certainly not any profits. And a venture capital investor, like a venture fund, would likely only take a minority stake in a company like this and then rely on the growth of that company and not really exacting any change as a manager. The next stage in the life of a company would be more growth equity, and that is more mature than just a startup. They might be less established, but they could be growing quite fast. They do have revenue, they do have a product, but they are likely maybe not making a profit or still net negative profits. But again, still, there is a proof of concept. But further down the life of company and into the more stable side of private equity is buyout.

 

[00:04:24.680] - David Cooper

And that is where these are mature companies. They have good governance. They have good operations. They have earnings. They've been around for 10, 15, 20 years. And then they can be producing anywhere from 5 to 10 to hundreds of millions of dollars of profit. And a buyout strategy would be to buy that company and bring it in and manage it itself. If you're thinking about from a return perspective, you normally would probably in the buyout category be striving to achieve low 20% type returns. And then if you go to the venture capital, you'd be looking to go much higher than that into the high 20s, 30s, and maybe even in the 40s.

 

[00:05:04.750] - Derek Hebb

That's great. So David, what is the current state of the private equity market, say, versus three years ago, and also just looking back since KKR's founding?

 

[00:05:17.820] - David Cooper

Yeah, the world of private equity has changed over the last 50 years. So, maybe I'll start from the founding of KKR. And private equity was very different than it is today. It used to be referred to as leverage buyout, which still exists today. But the leverage was definitely more of an impactful part of the strategy where you could buy a company and you could leverage it 10 to 1, 20 to 1, 30 to 1. And it was much more of a financial engineering transaction. You'd buy the company, hopefully pay down the debt with the cash flow, and then you'd exit in a few years. And that's just not how private equity has operated for the last two or three decades. Really, a private equity manager in a buyout space is much more focused as an operator. You're not using nearly as much leverage, and you're really going in to buy a good company and to grow the earnings and exit in five years. You're really relying on the earnings growth and the actual growth of the company to achieve that return. And that's really how the industry has changed. Obviously, some people might still be doing it differently, but that's really typically how the big managers have gone from the '80s to today.

 

[00:06:31.530] - David Cooper

To your first question, how is it different from maybe a few years ago? Again, the higher rate environment has definitely changed the market. There is less deal activity. Private equity managers have to be a little more creative on both the entry and the exits. And these higher rates have, if there were managers that were using more leverage, then they likely are not as active. But what that has done is it has brought down the multiples of the valuation of the company. So we are seeing better valuations, better entry points. And then we think in today's market, in a higher rate, those who are really focused on operational improvements will succeed.

 

[00:07:17.620] - Derek Hebb

Great. So, how are institutional investors accessing private equity? And what are some options available to the individual investor today?

 

[00:07:29.560] - David Cooper

Yeah. So, that's also changed over the last 10, 20 years. Institutional investors, this was seen as a satellite, like an alternative to what they're doing, but it's now much more of a core part of their portfolio. If we speak about alternatives, but even private equity, some institutional clients could be anywhere from 30 to 50% in alternative investments, and a big portion of that being private equity. How they typically would invest in this type of asset - they might take a direct holding in the company, which again, you're locked in until you sell it. But more typically, what they will do is they will invest with a private equity manager in what is called a draw-down fund, which is a capital call structure. What that would be is they would commit to 10 years. They would commit a certain amount. The manager would call that capital when they needed it, and then they'd pay it out over a certain life of that vehicle, which can be 7, 10, 12 years. And that's the main way for institutional investors to be accessing private equity. What you are seeing now with a lot of global managers like KKR, to make a product structure a little bit more appealing to an individual client, is we are doing more open-ended or what's called evergreen solutions, where you purchase the fund, you might have a lock-in period or a soft lock, as in if you leave earlier than maybe two years or three years, then you may pay a small penalty.

 

 

 

 

[00:08:59.960] - David Cooper

But you do have access to your capital. You'll have a monthly ability to purchase, a quarterly ability to redeem, and a lot more liquid way, a more semi-liquid way, of accessing the private equity space versus what the institutional strategies have done for the last several decades.

 

[00:09:17.890] - Derek Hebb

Thanks, David. And we can now access your private equity portfolio for CIBC Wood Gundy clients. So, great to be able to access your history of success. And I think this discussion has been certainly informative and helpful. If anyone has questions about the information that David just discussed, please contact me. Thanks to everyone for listening in. And David, thank you again for joining us on this month's call.

 

[00:09:48.620] - David Cooper

Yeah. Thank you for having me.

 

[00:09:50.140] - Derek Hebb

Take care.

 

 

 

 

 

 

 

Disclaimers

 

This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2024.

 

David Cooper is with KKR in the role of Head of Canada for Global Wealth Solutions. The views of David Cooper do not necessarily reflect those of CIBC World Markets Inc.

 

K-PEC, KKR’s Private Equity Strategy, is a private market instrument and differs substantially from public equity.  The K-PEC strategy is only available to accredited investors in Canada through CIBC Wood Gundy on a private placement basis.

 

The contents of this document are for informational purposes only and are not being provided in the context of an offering of a security, sector, or financial instrument, and is not an endorsement, recommendation, or solicitation to buy, hold or sell any security.

 

Clients are advised to seek advice regarding their particular circumstances from their personal tax and legal advisors.

 

“CIBC Private Wealth” consists of services provided by CIBC and certain of its subsidiaries through CIBC Private Banking; CIBC Private Investment Counsel, a division of CIBC Asset Management Inc. (“CAM”); CIBC Trust Corporation; and CIBC Wood Gundy, a division of CIBC World Markets Inc. (“WMI”). CIBC Private Banking provides solutions from CIBC Investor Services Inc. (“ISI”), CAM and credit products. CIBC Private Wealth services are available to qualified individuals. Insurance services are only available through CIBC Wood Gundy Financial Services Inc. In Quebec, insurance services are only available through CIBC Wood Gundy Financial Services (Quebec) Inc. The CIBC logo and “CIBC Private Wealth” are trademarks of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc.

 

If you are currently a CIBC Wood Gundy client, please contact your Investment Advisor.