WASIX Commentary (Q1 2022)
March 2022
Correction
Stocks have been under pressure through the first leg of 2022. Our benchmark fell 6.25% and our fund declined 18%. This direction is certainly not our aim.
The chart below displays our track record over short- and long-term periods:
| Periods ended 3/31/22 | WASIX | MSCI ACWI Index | Bloomberg Barclays US Aggregate Bond Index | MSCI World Small Cap Index |
|---|---|---|---|---|
| Quarter | -17.88% | -5.36% | -5.93% | -6.25% | Year | -1.12% | 7.28% | -4.15% | -0.35% | 3 Years | 8.74% | 13.75% | 1.69% | 11.75% | 5 Years | 7.49% | 11.64% | 2.14% | 9.55% | 10 Years | 8.21% | 10.00% | 2.24% | 9.64% |
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 0.95%. This agreement is in effect through January 31, 2023 and, may only be terminated before then by the Board of Trustees, and is reevaluated on an annual basis
The market drawdown, although painful, appears rational to us considering the many crosscurrents that are influencing the global economy right now. Our inflationary environment is being exacerbated by geopolitics (primarily the war in Ukraine) and persistent supply chain problems caused by ever-roving waves of COVID. Each dilemma alone is a powerful force, while at the same time none is individually significant or targeted enough to account for our own performance shortfall. The fund’s aim is to own profitable, defensive, and fairly-valued quality growth companies; companies that should fare well in any environment. What gives?
As we pondered the data, an explanation became clearer, and our confusion was eased with a single word: Correction. Through the first quarter of 2022, our top ten detractors hit us by 12%. Interestingly, many of our top weights appeared on this detractor list. The companies we are most comfortable with hurt us the most in the first quarter. This feels odd as our logic and analysis behind owning these best in class companies which trade at reasonable valuations has been vetted repeatedly. In order to make sense of performance, we looked back at 2021 and found what we view to be the best explanation. Our top three detractors well-illustrate what happened. The combination of Future Group (FUTR LN), GTPL Hathway (GTPL IN), and Radico (RDCK IN) hit us by 6%. In 2021 Future Group returned 119%, GTPL returned 106%, and Radico returned 166%. In total, seven of our top 10 detractors in the first quarter 2022 were top 10 contributors in 2021, five of which produced returns in excess of 135% last year. Although a tough quarter is always hard to stomach, the details of our underperformance give us confidence. The aforementioned crosscurrents undoubtedly created fear, and that fear led investors to take profits. This profit-taking appears to be the primary cause of the portfolio correction. The first quarter seems to be a digestion period in which big 2021 winners are showing short-term corrections.
The theme of Q1 was a continuation of late last year: value stocks are en vogue as interest rates are set to rise, while expensive growth stocks continue to be punished. This sentiment shift did not significantly impact the fund. Only two of our top ten detractors, Momo.com (3030 TT) and M3 Technology (6799 TT), would be considered higher-valuation growth stocks. While we are growth investors, our focus is on smaller and less-discovered companies. This niche allows us to own quality companies for cheaper valuations. Our top five positions all currently trade below a 15x year-end 2022 PE multiple. And for all five we target earnings growth in excess of 15% this year. Because of this focus, our portfolio should be more resilient even if “sticker shock” continues to drive higher-multiple stocks out of favor.
While at the company level the businesses and valuations appear in good health, we faced real headwinds from an allocation perspective. Smaller companies have sold off to a greater degree than larger companies, and our largest sector exposures, Communication Services, Technology, and Consumer Discretionary, all underperformed the broader benchmark. Our weighted average market cap is 35% below the bench and our three largest sector exposures made up 54% of the portfolio–nearly double the benchmark weight of 29%. This sector overweight accounted for 11.5 points, or 65% of our underperformance, versus 3.7 points, or 58%, of the benchmark’s drawdown.
Geographic allocation was also a headwind. We remain underweight the US, which made up 51% of the benchmark and performed slightly better than the benchmark overall. For many years we have found better opportunities in the international markets, but with the latest small-cap drawdown, we chose to add five positions to our US exposure: Helios (HLIO US), Richardson Electric (RELL US), Semler (SMLR US), Rush (RUSHA US), and OOMA (OOMA US). On the international side, we carried a large overweight in the UK, Poland, and India, all of which underperformed the collective benchmark overall.
We did not sit still in response to the macro winds, and were quite active in the quarter. While four of our top five positions remain the same as year-end 2021, we sold nine positions and added fourteen. The turnover through the period is higher than we’d like and anticipate going forward, but we always hope to take advantage of volatility. This activity was driven by reducing our Eastern EU exposure, adding to our US exposure, and cutting a few token positions that we no longer felt were a fit for the fund. As for the additions, all but three are companies we’ve owned at SCA in the past, and we believe they currently present great entry opportunities.
The three new positions to the fund are: Richardson Electric (RELL US), a US supercapacitor integrator; Schoeller-Bleckmann (SBO AV), a global leader with dominant market share in precision drilling components; and Parex Resources (PXT CN), a low-cost oil producer in Latin America. We believe Richardson will benefit from tailwinds in next-generation power generation and storage, Schoeller will profit off catch-up capital investment after nearly seven years of industry underinvestment, and Parex will enjoy the more immediate impact of current oil prices.
Outlook:
A recent top headline in Bloomberg was Markets Reel in Information Overload, Jamming Real-Time Models. We do not use real-time macroeconomic models, but we can easily discern the lack of macro clarity given the changes afoot. We are keyed into impacts from rapid interest rate increases, while we are also mindful of the Fed’s highly accommodative–sometimes reactive–behavior in relation to the stock market. Though this is our current playing field, we don’t feel compelled to rewrite our playbook. We have always been cautious investors, in good times and bad, searching all angles even when making any incremental investment. With this strategy in mind, our focus remains on finding companies that will grow and therefore increase their value to shareholders in any environment–including the opaque one that’s upon us.
Sincerely,
The WASIX Fund Management Team
For a list of current top ten holding and performance charts, please click here.
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