WAGTX Commentary (Q2 2024)

July 2024

OVERVIEW

In the second quarter of this year international small-cap stocks generally showed very little movement, with the fund leading the benchmark by approximately 1%. We remain optimistic about the current opportunities represented in the portfolio, an optimism stemming from our take on the current concentration of the market. By one measure, 2024 is shaping up to be the most concentrated market in the last 37 years – certainly worth pondering. We are not here to make a bearish call on the companies and stocks that are driving all the coverage and flows, but it takes no stretch of the imagination to believe that one byproduct of a highly concentrated market is that large parts of the investable world are being ignored. We do not believe that there are only a handful of companies growing and generating steady profits. To that end, we have spoken directly with hundreds of small-cap companies in our due diligence process of uncovering opportunities beyond the market’s current fixation. These companies primarily are owned and run by their founders, are growing at a meaningful pace, are generating profitable growth, and, largely due to the lack of investor attention, are selling at much more reasonable valuations than where the public attention is focused. Timing can be a humbling thing in the market, and we do not profess precognition, but there is no doubt that the time will come for the market to broaden its lens. We are working diligently to build an attractive portfolio of opportunities to exploit that inevitable event.

While we are bottom-up investors focused on company fundamentals, certain events cause us to make broader observations. The elections in India, for example, were noteworthy. India has been on a steady path of economic reforms since Narendra Modi (the current prime minister) rose to power in 2014. After 10 years under his leadership, this year’s election was a referendum on the country’s path. Despite lingering concern that politics may revert further to the opposition, the election was interpreted as an extension of the reformist mandate. India has set its course for the next five years on a trajectory of promoting economic growth. India has long been one of the fund’s largest weights as well as a largest overweight position, and, as quality-oriented growth investors, we continue to see tremendous opportunity in India. While the election did cause some short term volatility in the Indian market, the market endorsed the election results, generating the highest return of all major benchmark constituents, and an outstanding 22% contribution to the fund.

Our bottom-up approach occasionally enables us to infer bigger trends based on the performance of our companies and from what shows up on our screens. One such trend that’s becoming apparent is explosive growth in drone usage. On the back of rising world conflicts and increased importance of drones in said conflicts, we are seeing accelerated interest in and development of drone technology across the globe. As such, we have invested in two drone companies: NextVision Stabilized Systems (NXSN IT) in Israel, and Droneshield (DRO AU) in Australia. These are not speculative concept stocks – given the growth they are seeing, these companies are demonstrating strong earnings growth and trade at a reasonable multiple of earnings. Our experience with these two stocks is a great example of application of our process and of the edge that small-cap investing provides: we found these names through screening while they were largely undiscovered by the broader investment community, and we were able to enjoy significant returns in Q2 when they were finally discovered, with Next Vision up 19%, and Droneshield up a staggering 138%. We think drone technology will continue to sustain aggressive development. Investments like these remind us of why we choose to stick with small-cap investing – nothing is quite as satisfying as gaining exposure to exciting long-term growth opportunities right before they grab the attention of larger-cap investors.

DETAILS FROM THE QUARTER

Underneath the calm of the index in Q2, individual countries showed quite a bit of dispersion. This was a quarter of elections, including India, Mexico, South Africa, and the European Parliament. The Indian market was up 19%, South Africa up 19%, and Mexico down 17% as the market opined on the results. France and Germany were respectively down 9% and 8% – perhaps the European election did not cause as much excitement as elections in emerging market countries. While the fund has no exposure to Mexico or South Africa, India is the fund’s largest country, and we benefited from our considerable weight.

Fund performance during the quarter was strong in most countries, offset, unfortunately, by continuing underperformance in Japan. As noted, India was the star contributor, followed by Australia and Germany. Quality growth at reasonable valuations tended to be rewarded this quarter. Japan was an exception, with our software as a service (SaaS) names being punished by the numbers, even as they demonstrate strong fundamentals consistent with what their managements have been guiding. The Japanese names we own are on the growth trajectory we expected, but their discount relative to US and European peers continues to widen, with Japanese SaaS names we own now trading at more than a 50% discount off western counterparts despite growing at a faster rate. We find it hard to believe that such a valuation gap will persist long.

The largest contributor to the fund’s performance in Q2 was the mammoth 138% return by Droneshield, which attracted us with its strong earnings growth in a large untapped market, and its reasonable valuation of 10x current year’s earnings. Ongoing newsflow has been supportive, with Droneshield receiving record new orders. The company has also raised equity capital on the back of strong orders, exposing the stock to a much broader investment universe. Such a strong run drove a re-rating of the stock to the point where valuation is now more reflective of the opportunities ahead, thus we have been trimming our position.

The second largest contributor was FlatexDegiro (FTK GR), a stock we have written frequently about. A long-term holding and one of the fund’s biggest weights, it returned 27% in Q2 on the back of a number of developments. Due to its very strong position in a massive market, we believe this $1.4B market cap company has the ability to become a large-cap in the long term, despite some turbulence post-Covid. In Q2, positive developments included a drastic reduction in marketing costs, accelerated growth in new customers, and, on the back of higher interest income and improved monetization of trading activities, accelerated revenue growth. These led to significant earnings growth and an upgrade from management for this year’s earnings expectations. Furthermore, with cash in its coffers, the company recently announced a dividend and stock buyback, leading to a long-awaited return of capital to investors.

A bittersweet contribution to performance came from Epsilon Net (EPSIL GA), a leading small business software company in Greece that was bought out in Q2. Epsilon was a meaningful position in the fund, at 1.5% weight, and while we received reasonable compensation for our shares in the company, we always regret when a core holding is taken private when there is still much growth opportunity ahead. Nevertheless, this M&A reinforces our belief that European growth stocks are deeply undervalued.

The two largest detractors in Q2 were Japanese SaaS holdings FREEE (4478 JP) and SpiderPlus (4192 JP). As noted above, our Japanese SaaS positions present a bit of a conundrum. They are high-quality growth companies that consistently deliver on their goals, yet the market continues to punish them. Q2 was no different, with FREEE declining by 36% and SpiderPlus by 33%. Meanwhile, the fundamentals are developing as expected, and the companies are trading at a 40% discount to western counterparts. Despite the recent declines, we remain excited about these companies for several reasons. First, SaaS is a highly sustainable business model, as evidenced in other countries. Second, FREEE and SpiderPlus have obtained leading market share in their fields. And third, these companies both have executed consistent with what management has communicated. We are further encouraged by the fact that these companies have passed the peak cash burn period, giving a short line of sight to operating profitability.

OUTLOOK

Metrics for Q2 continue to align with our portfolio-weighted average EBITDA growth of 26.4%. This demonstrates that, regardless of macroeconomic uncertainties, our portfolio companies are continuing to grow profitably. We expect combined earnings for our investments to follow a mid- to high-teens trajectory over the long term. As bottom-up stock pickers, these are the metrics on which we most rely. At Seven Canyons, we search for businesses with real long-term growth driven by sustainable competitive advantages, and the attractive opportunity set presented by international small caps allows us to invest in such companies early in their growth cycle. As in the past, we intend to devote time to speaking with the management teams of companies we own, and of companies on our get-to-know list – companies that often have little to no coverage by the street or our competitors. Doing so will enable us to assemble a mosaic of indicators about the true nature of these businesses, their opportunity sets, and the likelihood that they will achieve their goals. Purchasing businesses that demonstrate an ability to thrive through the majority of macro environments, will ultimately reward our investment. We are grateful for your trust, and welcome your feedback and questions.

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 fund operating expenses in excess of 1.70% and 1.60% for the Investor Class Shares and the Institutional Class Shares respectively until at least January 31, 2025. This agreement is in effect through January 31, 2025, may only be terminated before then by the Board of Trustees, and is reevaluated on an annual basis.

DEFINITIONS

EBITDA (Earnings before interest, tax, depreciation, and amortization) is a measure of a company's operating performance.

M&A (Mergers and Acquisitions) is a term for an acquisition of a company

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.

An investor should consider investment objectives, risks, charges, and expenses carefully before investing. To obtain a prospectus, which contains this and other information, visit www.sevencanyonsadvisors.com or call +1 (833) 722-6966. Read the prospectus carefully before investing.

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Seven Canyons Funds are distributed by ALPS Distributors, Inc. (ADI)

WAGTX CommentarySeven CanyonsJuly 1, 2024