WAGTX Commentary (Q4 2022)
January 2023
OVERVIEW
Fourth quarter 2022 bucked the trend of an otherwise difficult year. Our Q4 numbers were especially encouraging given that Q4 remained a challenging environment for our style of growth investing, with the value component of the benchmark ahead of the growth component by nearly 3%. Our conclusion: the fund’s 7.41% outperformance of the benchmark during Q4 came from stock picking. As bottom-up growth investors we strive to outperform based on savvy stock picking, which these returns validate.
The operating metrics and long-term trajectories of our portfolio companies continue to point in the right direction. As of the last available reporting period, weighted average revenue growth of companies in our fund was 25%, and EBITDA growth was 18%; both indicate reacceleration from slower growth rates of the last four quarters. This gives us confidence that, despite the volatility in stock prices, our portfolio is positioned well for the future.
In 2022 we trailed the benchmark by 17.4%, with the growth component of the benchmark underperforming the value component by 12.7%. It was a tough year for growth investors. The chart below shows that, despite the fund’s strong Q4 results, our stock picking for the year was regretfully subpar.
The chart below displays our track record over short- and long-term periods:
| Periods ended 12/31/22 | WAGTX | MSCI ACWI Ex-USA Small Cap Index |
|---|---|---|
| Quarter | 20.73% | 13.32% | Year | -37.05% | -19.65% | 3 Years Annualized | -2.65% | 1.46% | 5 Years Annualized | -0.08% | 1.05% | 10 Years Annualized | 6.55% | 5.62% |
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 1.76% and 1.56% for the Investor Class Shares and the Institutional Class Shares respectively until at least January 31, 2023. This agreement is in effect through January 31, 2023, may only be terminated before then by the Board of Trustees, and is reevaluated on an annual basis.
DETAILS FROM THE QUARTER
The unifying theme for the quarter was markets finding solid ground after indiscriminate selloffs during the first nine months of 2022. The benchmark hit bottom in October but rallied in Q4. While we’re not macro experts and don’t know if this respite is temporary or permanent, there are indications that the market is beginning an ascent. One such indication is the perceived peaking of inflation in the US. Though there is lingering concern of a US recession following interest rate hikes at near-unprecedented speed, the rate hikes themselves seem to be in the market’s rear view mirror. This is important for two reasons. First, it impacts international markets, as both the European Union and Japan Central Banks lagged behind the US in hiking rates, leading to USD outperformance against foreign currencies. With US rate hikes ending, the dollar will likely weaken against EUR and JPY, creating a sizable tailwind for international stocks. Second, as rates stabilize across the global economy, investors are becoming more confident in global stock valuations. A more concrete indication of market recovery is that a significant number of listed companies we follow have been recently acquired by private equity. One of our largest holdings (featured repeatedly in these commentaries) is Va-Q-Tec (VQT GY), which was taken private during the quarter at an approximately 109% premium to the pre-announcement price. A number of other small- and micro-cap European companies that we follow have also been taken private: Home24, Biffa PLC, EMIS Group, Basware, Ted Baker, RPS Group, and Aveva. We think this activity indicates that the market bottomed out, attracting private money to acquire oversold quality companies, and should be positioned to climb. Most of the fund’s outperformance for the quarter came from a select few software and industrial names. The biggest contributor was Va-Q-Tec (VQT GY), one of top weights in this fund for a number of years due to our strong conviction in long-term demand trends for affordable cold chain solutions. VQT’s privatization prevents us from participating in its ongoing growth, but we are gratified that we stayed a step ahead of the market in identifying a company with great potential. We intend to keep this edge.
In Q4 the fund also saw reversals of underperformance of software names that were overly punished in the selloff of early 2022. GK Software (GKS GY), Appier (4180 JT), and Smaregi (4431 JT) were major contributors in the quarter. GKS offers software that helps large supermarket chains digitize the check-out process, and has been a reliable and profitable grower. Despite a record of revenue and earnings growth consistency, the stock sold off by 34% in the first nine months of the year, but rallied almost 30% in Q4, recovering much of what was lost. We are encouraged by the fact that the market realized the stock was excessively punished and has adjusted up accordingly. Appier is a fairly recent addition to the fund. It provides software that allows customers to automate and optimize their marketing spend. The stock corrected nearly 65% after its IPO in the boom times of early 2021, giving us a good opportunity to initiate a position. Over 2022, Appier repeatedly raised its earnings guidance due to underlying demand strength, and returned 24% in Q4. Smaregi is a leading digital point-of-sale software in Japan. Like Appier, the stock suffered a severe correction in the first half of 2021, as its valuation corrected from ecommerce boom levels during Covid. Smaregi executed well this year, continuing to grow customer count and subscription revenues, and even increased prices for its software. In Q4, when the market noticed Smaregi’s strong demand trends, it returned 99%.
Changes to the portfolio continued to be incremental and centered around our convictions about future earnings trajectories and valuation dislocations. We initiated positions in a number of software as a service (SaaS) names that were unduly punished in the selloff. According to traditional metrics they appear expensive, but all have solid business models with clear competitive advantages. These SaaS companies include Truecaller (TRUEB SS), Trustpilot (TRST LN), and Hypoport (HYQ GR). We also bought Victorian Plumbing (VIC LN) and Treatt (TET LN), companies with strong long-term fundamentals that were disregarded by the market after disappointing short-term earnings performance. We have conviction in the long-term growth of these businesses, and the market is giving us an opportunity to initiate a position at a great valuation. The most notable sell during the quarter was Va-Q-Tec, bought out by a private equity group, as mentioned earlier. We also sold a few names whose long-term growth opportunities seemed less appealing than before. The change in CEO at Future PLC (FUTR LN), coupled with the difficult ad spend environment in the post-Covid world, made us question its long-term earnings trajectory. We began to question sustainability of demand for Avian Paints (AVIA IJ). And we sold Oisix (3182 JP) when concerns emerged about the company’s acquisition strategy. There were no major changes to the fund’s sector or country positioning in the quarter.
OUTLOOK
If the defining market debate of 2022 was the direction of inflation and interest rates, the defining debate of 2023 will be the severity of the impending recession in the US. For internationally-oriented investors, that’s a coin of two sides. On one side, any further selloffs in the US market due to evidence of earnings declines may cause global markets to sell off in sympathy. On the other side, since Europe has already experienced a severe economic contraction, it is more likely to come out of this contraction ahead of the US. The other important factor in 2023 is the shift in Chinese policy from waves of Covid-induced lockdowns to what seems like a permanent reopening. This will hopefully provide a much needed shot in the arm for global demand as the Western world grapples with recessionary tendencies. We feel that the market is slowly digesting the negative news of geopolitics, inflation, rising interest rates, and recessionary impulses. While 2022 was a year of indiscriminate selling, we feel that in 2023 the market will be more reflective of underlying fundamentals. Our companies continue to grow sales and earnings, as evidenced by the latest metrics showing average sales growth of 25% and average EBITDA growth of 18%. While we think some of this growth is bounce-back from depressed Covid earnings, we expect our portfolio companies to continue to grow and take market share irrespective of the macro environment.
The fund’s strategy is to invest in innovative small- and micro-cap companies able to grow over the long-term by taking market share due to sustainable competitive advantages of their services or products. This philosophy leads us to structural overweight in sectors such as technology and healthcare, where the majority of long-term growth opportunities reside. This positioning also leads to higher levels of volatility, as we observed in 2022 when higher growth stocks temporarily fell out of favor. We believe that the market will reward companies that deliver revenue and earnings growth in difficult economic environments. We also believe that there are many quality growth names yet to achieve positive earnings after being overly punished in 2022’s indiscriminate selloff. Such companies present opportunities for future outperformance. We think paying reasonable valuations for sustainable earnings growth in any macroeconomic environment will reward strategically patient investors, and we are grateful to our investors who share that outlook.
Sincerely,
The World Innovators Fund Management Team
DEFINITIONS
EBITDA (Earnings before interest, tax, depreciation and amortization) is a measure of a company's operating performance.
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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