Microcap Bulletin – Q3 2022

Dear investors,

The stock market continued its downtrend in the third quarter as central banks kept raising interest rates and withdrawing liquidity from the market. Inflation remains high, but according to some experts, key indicators point to an imminent slowdown, which could curb the rise in interest rates and appease investors.

The moves in interest rates and inflation are challenging to predict. Although we remain informed of what is happening in the economy, we try to avoid basing our investment decisions on things we cannot accurately predict.

Therefore, it is difficult to determine when we will see a trend reversal. That said, the longer this bear market continues, the more attractive it becomes to invest in the stock market since company valuations are getting less expensive. Our job is to ensure that the fund invests in the best opportunities and to be patient to reap the rewards of these efforts over the long term.

Let’s now take a look at some metrics about the fund as at September 30, 2022:

• $12 million in net assets under management.
• 93 % was invested and 7 % remained in net cash.
• 25 positions. The largest represented 16.7 % of the portfolio.
• The top 5 positions represented 52 % of the portfolio.
• Fund unit value of $6.73*, for an overall return of – 4.1 %** during the quarter.

* Series A units (MAJ720)
** Net return after all fees.

To compare our performance during the third quarter (July 1 to September 30, 2022), we use the S&P/TSX Small Cap Index as our benchmark. This index reflects the small cap market performance in Canada. We refer to the LD Micro Index to get an overview of the US market performance. Here is the performance of the two indices during the quarter:

Overall, the fund’s performance was quite similar to the rest of the market during the quarter. We feel illiquidity (low trading volumes) is the main culprit for the substantial price fluctuations in most of our stocks rather than a direct correlation with the market.

We concentrated the portfolio further during the quarter, increasing to 52% of assets invested in the top 5 holdings (from 48% as of June 30, 2022) and reducing the number of positions to 25 (from 26 as of June 30, 2022). We believe that concentrating the portfolio into our best investment ideas is the optimal way to position ourselves favorably for an eventual stock market rally.

Monthly Video Updates

At the beginning of this year, we started publishing monthly video updates about the microcap strategy. These updates aim to elaborate on our investment strategy and research process and share some general insights on the market.

You can find the three videos produced during the quarter via the following links:
Monthly Update – July 2022 (5:54)
Monthly Update – August 2022 (9:58)
Monthly Update – September 2022 (10:25)

If you have questions about the strategy, we would be pleased to answer them in future video updates. Don’t hesitate to send your questions to mathieu.martin@rivemont.ca.

Some Comments on Xebec Adsorption (TSX: XBC)

Those following us for a while probably know that Xebec Adsorption has long had an important place in the Rivemont MicroCap Fund portfolio. It was also one of our most profitable investments since the launch of the strategy.

Towards the end of September, Xebec announced that it was seeking creditor protection to pursue a restructuring or sale of its business. It was the culmination of a challenging year fraught with operational and financial issues. Trading in the stock is currently halted, and there is a good chance that the Toronto Stock Exchange will delist the stock in the coming days.

Following several questions from our investors, we would like to let you know that the Rivemont MicroCap Fund is no longer a shareholder of the company. After initially buying shares in May 2018 at around $0.70 per share, we gradually sold parts of our position profitably during the stock’s subsequent rise, including a significant portion of the position near $9 per share in March 2021. Our decision to sell was mainly motivated by the very expensive valuation we could no longer justify, even with our most optimistic scenarios.

Subsequently, numerous operational problems surfaced, and the management team was entirely replaced. In light of these adverse fundamental developments, we concluded that our investment thesis was no longer valid and ultimately decided to sell the small position we had left in March 2022 at $1.87 per share on average.

There is no need to worry about Xebec’s recent issues since the Rivemont MicroCap Fund will not suffer any impact.

This unfortunate situation can teach us two critical lessons about investing in microcaps:

1. Microcaps are companies that have not yet reached maturity. Therefore, we must always remain vigilant and monitor them closely to detect operational and financial problems. If necessary, we need to act quickly and decisively.
2. Having the discipline to sell when the valuation gets ridiculously expensive is crucial. We took significant profits on Xebec, not necessarily knowing that problems would arise but because the high valuation left no room for error. The company had to execute flawlessly, removing any margin of safety on our investment.

We believe this is an excellent example of how actively managing a microcap strategy can add value to your portfolio.

Outlook

One interesting data point we see right now is that investor sentiment is extremely pessimistic. Bearish sentiment peaked in September, with more than 60% of investors expecting the stock market to decline over the next six months, according to a weekly poll conducted by the American Association of Individual Investors.

Why do we find this interesting? Because sentiment surveys can be good contrarian indicators. Historically, periods of higher-than-average returns have often followed a very high level of pessimism and vice versa. Investors have a nasty habit of extrapolating trends as if they will never reverse, becoming more pessimistic after a significant market decline or more optimistic after a major market rise. But it should be the opposite. The lower the market declines, the more bargains there are, and therefore the better the prospects for future returns become.

While it can be depressing to look at the value of your portfolio right now (ours, too!), remember that the prospects of above-average returns are improving by the day as our high-quality businesses continue to make fundamental progress. The underlying value that is being created will be recognized by the market sooner or later.

We are very optimistic about the prospective long-term returns based on current valuation levels.

We thank you very much for your trust and patience during these challenging times. Although the Rivemont MicroCap Fund allows withdrawals at the end of each month, the vast majority of investors have elected to stay invested during this past year. Your collective long-term vision creates a strong competitive advantage for the fund. While other fund managers must sell their microcaps at bargain basement prices to pay their investors’ redemptions, our long-term capital base allows us to take advantage of these bargains and position ourselves exceptionally well for the future. Don’t underestimate your role in this winning formula.

Finally, it’s impossible not to invite you once again to the next Cocktail 5 à 7 of the Rivemont MicroCap team. It will take place at the Bonaventure Hotel, on Thursday November 3rd. Click here to reserve your ticket!

We look forward to our next communication!

Rivemont Investments

Portfolio Manager of the Rivemont MicroCap Fund

Units of the Rivemont MicroCap Fund are available under exemptions from the prospectus requirements, pursuant to National Instrument 45-106 Prospectus and Registration Exemptions, and are available only to qualified investors, including portfolio manager clients. This document is not a recommendation nor an investment advice and is presented for informational purposes only.