April 19, 2024
How this small-cap money manager seeks out growth stocks in volatile markets

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David Barr of PenderFund Capital Management.The Globe and Mail

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While many investors are focused on the market-influencing “Magnificent Seven” technology stocks or whether to own banks, utilities and other large-cap names, David Barr has his eye on small-cap companies he believes can outperform their larger peers.

“One of the key reasons we focus on the small-cap space is that the market is less efficient,” says Mr. Barr, chief executive officer and portfolio manager at PenderFund Capital Management Ltd. in Vancouver, who oversees about $500-million of the firm’s $2.7-billion in assets.

“More computers and algorithms drive trading today, which means more capital is chasing mega and large-cap names. As a result, the small-cap market has fewer participants, which means fewer people to figure out these businesses. So, we believe we have an analytical edge and can hopefully generate alpha for our clients.

Given the volatility of small-cap companies, it’s a risker way to invest, but Mr. Barr’s $250-million Pender Small Cap Opportunities Fund has been making money: The fund’s F Class has seen a one-year return of 6.2 per cent, while its five-year annualized return is 11.2 per cent. The performance is based on total returns, net of fees, as of Dec. 31, 2023.

The Globe spoke with Mr. Barr recently about what he’s been buying and selling and a Canadian technology stock he wished he never sold.

Describe your investing style.

We are business analysts. We try to figure out the quality of a business from the bottom up, then figure out what it’s worth and buy it at a discount or a fair price. We focus on asset-light businesses in sectors such as technology, health care, specialty finance and consumer products. Being small-cap investors, we find that companies in our wheelhouse can scale faster when they get their product market fit right and gain customer traction.

How is small-cap investing different in today’s higher interest rate environment?

One of the key areas you need to focus on with small-cap stocks is balance sheet risk. Small-cap companies often don’t have the access to capital that large-cap companies do. So, in this kind of market environment, they can run into difficult situations and need to refinance debt or raise capital. That’s the biggest risk you need to manage for small caps in a rising interest rate environment. The flip side of that, and one of the things we spend a lot of time on, is companies on a growth trajectory that don’t need to raise capital or have strong backers, so their debt will get refinanced at a reasonable rate. When you can identify where the market thinks there will be challenges, but they’re not, you can find attractive opportunities.

What have you been buying lately?

We’ve been adding to our position in Thinkific Labs Inc. THNC-T, which offers a cloud-based software platform that helps online creators monetize their courses online. The company has been increasing its percentage of revenue from small to medium businesses, so it’s moving into a more sticky, predictable revenue base. The company was losing money and the market got concerned, but it turned cash-flow positive in November last year and the stock has rebounded nicely since.

We’ve also been buying more Dye & Durham Inc. DND-T, which makes cloud-based software for law firms dealing mostly with real estate transactions. It’s a sticky, high-margin business with pricing power. We added significantly to the stock in the fourth quarter of last year when the stock dropped after the market became concerned about the company’s debt levels. We had confidence the CEO was going to be able to handle the situation. After that, the company’s debt load has come down quite dramatically. The stock has also rebounded. It’s the largest position in our fund today.

We also purchased Kraken Robotics Inc. PNG-X, which makes sonar systems and underwater batteries for ships and submarines. There’s a lot of demand for this technology today, especially given the growing geopolitical conflicts around the world. We started buying the stock in the fourth quarter of last year and continue to add to it this year.

What have you been selling or trimming?

Last year, we sold television and radio broadcaster Corus Entertainment Inc. CJR-B-T. It’s a stock we owned for several years and sold at a loss. We started to get a bit concerned about its debt level, and given the high-interest rate environment and deterioration of core business fundamentals, we believe there was further downside to come.

We also sold oil and gas exploration and production company Spartan Delta Corp. SDE-T in December last year. We participated in the company’s initial funding in May 2020, when energy was out of favour. The management team did a wonderful job buying distressed assets and then sold part of its business last year. We exited the position for a great rate of return.

Name a stock you wished you bought or didn’t sell.

Descartes System DSG-T, the logistics software company, is a stock we wish we didn’t sell. We bought it in the single digits in 2011 and sold it a couple of years later, thinking it approached fair value. The stock is currently selling at around $120. So, I guess we were wrong.

What advice do you have for new investors?

Focus on the focus on long-term because markets can do some pretty wonky things in the short term.

This interview has been edited and condensed.

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