WAGTX Commentary (Q4 2019)

The Fund ended the year with a win, up 9.86% during the December quarter. This is a healthy return for three months and a better return than the 9.05% rise in its primary benchmark, the MSCI All Country World Investable Markets Index (MSCI ACWI IMI). The results for the year were good too, up over 20%. Investment excellence over the long term is built on consistently having more wins and draws than losses. A perfect result every day, quarter, and year is not a realistic expectation. The chart below shows our track record compared to the benchmark for relevant periods over the long run:

Periods ended 12/31/19	WAGTX	MSCI ACWI IMI Index	MSCI ACWI Ex-USA Small Cap Index*
Quarter	9.87%	9.05%	11.03%
Year	20.60%	26.35%	22.86%
3 Years	13.05%	12.09%	10.02%
5 Years	9.50%	8.34%	7.39%
10 Years	12.03%	8.91%	7.28%

*the MSCI All Country World Index Ex-USA Small Cap is a commonly used international small cap benchmark

Data shows past performance. Past performance is not indicative of future performance and current performance may be lower or higher than the data quoted. For the most recent month-end performance data, visit www.sevencanyonsadvisors.com. Investment returns and principal value will fluctuate and shares, when redeemed, may be worth more or less than their original cost. The Advisor may absorb certain Fund expenses, leading to higher total shareholder returns. The Advisor has contractually agreed to reimburse Total Annual Operating Expenses in excess of 1.75% and 1.55% for the Investor Class Shares and the Institutional Class Shares  respectively until at least September 10, 2020. This agreement is in effect through September 10, 2020, and may only be terminated before then by the Board of Trustees, and is reevaluated on an annual basis.

We are pleased with the benchmark-beating 12% annual return the Fund has generated for our shareholders over the past decade. Active fund managers take a lot of heat over fees these days, but our hard work and investment strategy have paid off, and in the 2010s we believe that we earned our keep.

Careful readers may notice that we added a second benchmark to the chart, which merits explanation. The Fund’s current geographic and market cap allocations are significantly different from the original benchmark. In the following screenshot the column labeled “Port” represents weightings in the Fund, the column labeled “Bmrk” represents weightings in the MSCI ACWI IMI:

This next screenshot shows the Fund compared to the newly added small cap international benchmark:

Clearly the latter is the better fit and is relevant when prospective and current customers are evaluating our ability to pick stocks and outperform our opportunity set. The Fund’s prospectus allows us to buy companies in all investable global markets. But we think there are several reasons that international small cap stocks are structurally set up to be prime hunting grounds for nimble, active managers like SCA for many years to come. For one, regulatory pressures in European markets have led banks to reduce the number of brokerage analysts covering European small caps. This leaves an information vacuum in Europe that SCA can exploit. Furthermore, new Securities and Exchange (SEC) rules implemented last year compelled US mutual funds to reduce their investments in lower liquidity securities. Anticipation of the change prompted some forced-selling over the past three years, which improved valuations for new buyers. And going forward, large US institutional investors are likely to pass up smaller companies. These factors mean there will be less information available regarding small international companies, and they will be less efficiently priced than US stocks and larger caps. We intend to buy the best growth companies around the globe early, before other large institutional money is willing or able to seek them out and invest in them. As they grow, we believe they will capture the attention of our peers, and eventually get valuation premiums as they migrate from small to mid caps.

PERFORMANCE DRIVERS FOR THE YEAR AND DECADE

When digging into the details of our 20% return this year and 12% annual return for the decade, a few things really jumped out at us. 

The main contributor to our success, by far, is our stock selection. Our process is to screen for companies growing their sales and earnings faster than the rest of the economy. We then do background research, including calls and meetings with management, in order to determine if we think a company will continue to report exceptional growth for years to come. And finally, we build models to decide if a company is selling for a price that is cheap relative to its future value. This style is called bottom up investing, and the goal is to produce positive benchmark-beating returns through stock selection. Over the last decade we delivered on our goal – mission accomplished! We believe our strategy can deliver again in the 2020s.

Our best stocks this year included several UK companies with defensive products that thrived despite Brexit-related headwinds.

Despite beating the benchmark, our success was tempered by holding too much cash, which hurt performance over the past decade when equity markets’ main direction of travel was up; and our underweight in US equities, which were the place to be during the 2010s. Last year provides a good illustration of how this structure of the portfolio came to be. 

In 2019 our stock picks beat the MSCI ACWI IMI by 120 basis points. However, the Fund’s high-teens cash position during the year caused a 387 basis point drag relative to the benchmark. The primary reason we held cash was because many of the companies we liked had parabolic increases in their stock prices, leaving valuations unattractive. ROKU, for example, was one of our largest holdings at the end of 2018, a 2%+ position. After ROKU’s stock tripled early in the year, we were compelled to sell our shares even though we like the business. We are continually screening for new ideas, however, and by the end of the year we found worthy replacements for ROKU and other valuation-driven sales, and exited 2019 with a reasonable 6.65% cash balance. We saw this same pattern emerge over and over again during the latter half of the decade. Our research efforts often led to successful investments in great secular growth companies but the rapid discovery of these companies by other market participants and re-rating in their share prices, especially in the US, compelled us to sell and hold more cash than we would have liked.

At the top of the list of best geographies to be invested in during the post-GFC (Global Financial Crisis) economic cycle, the US stands alone. The chart below shows the substantial divergence in US versus international stock market returns that began in 2011 and continued to gain steam in 2019: 

US stocks returned over 250% for the decade, versus a return of slightly more than 60% (in USD) for non-US stocks. As US valuations surpassed historical averages and approached historical records, we harvested gains in the US and re-invested in high quality growth companies overseas at cheaper prices. We believe that over the next decade valuations may revert to the mean and give a boost to international equities with good earnings growth. 

OUTLOOK

We are excited about our bottom up investment opportunities today. We are looking for high-quality well managed firms that are growing for secular reasons (i.e. disrupters gaining market share). Such companies can take advantage of the changing world rather than struggle because of it. We expect global economic growth to remain sluggish. And we do not think that the signing of the US-China trade agreement will alleviate the structural pressures of over-indebted consumers, looming pension liabilities, or geopolitical pressures. While we can’t control macro factors, we can choose to invest in companies with innovative products and services that take share and grow in both good and bad economies. 

 DEFINITIONS

Basis Points (bps) are a one hundredth of one percent

Global Financial Crisis (GFC) refers to the period of extreme stress in global financial markets and banking systems between mid 2007 and early 2009

The World Innovators Fund seeks to provide long-term capital growth by investing primarily in domestic and foreign growth companies that we believe are innovators in their respective sectors or industries.”

All investing involves risk. Investments in securities of foreign companies involve additional risks, including less liquidity, currency-rate fluctuations, political and economic instability and differences in financial reporting standards and securities market regulation. Investing in small and micro-cap funds will be more volatile and loss of principal could be greater than investing in large cap or more diversified funds.

Past performance is not indicative of future performance and current performance may be lower or higher than the data quoted. The gross fee for the fund is 1.95% for both retail and institutional. For the most recent month-end performance data, visit www.sevencanyonsadvisors.com. Investment returns and principal value will fluctuate and shares, when redeemed, may be worth more or less than their original cost.

For a current list of top ten holdings and performance charts, please click here.

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