Microcap Bulletin – Q1 2020
As you all know, we are living through unprecedented and challenging times due to the COVID-19 pandemic. First and foremost, we wish that you and your families are safe and healthy, which is the most important thing right now.
The first quarter was also very challenging for portfolio managers across the globe, as there were very few places where one could hide to avoid negative returns. During February, concerns about the spread of the coronavirus pushed stocks sharply lower in a matter of days. The S&P 500, the main US equity index, fell more than 20 % in just 15 trading days, which was the quickest decline in its history and twice as fast as during the Great Depression of 1929.
Despite the challenges that a period like this brings, we remain positive and see great opportunities, which we will detail later in this letter. But first, let’s take a look at some metrics about the fund, as at March 31st, 2020:
- $5.39 million in net assets under management.
- 89.5 % was invested and 10.5 % remained in net cash.
- 25 positions. The largest represented 13.1 % of the portfolio.
- The top 5 positions represented 36.4 % of the portfolio.
- Fund unit value of $4.93*, for an overall return of – 20.9 %** during the third quarter.
** Net return after all fees. Please note that individual performance varies based on the price paid per unit.
To compare our performance during the first quarter (January 1st to March 31st, 2020), we use the S&P/TSX Small Cap Index as our benchmark. This index reflects the small cap market performance in Canada. To get an overview of the US market performance, we refer to the LD Micro Index. Here is the performance of the two indices during the quarter:
The sectors that are likely to suffer the most are the ones affected by shelter-at-home measures, such as hospitality, cruises, airlines, brick and mortar retail, restaurants, live events, and so on. On the other hand, some sectors will do much better and, in some cases, will thrive in this environment. Think about technology, healthcare, food delivery or food packaging, for example. Just these four sectors represent 76 % of the Rivemont MicroCap Fund portfolio. Sure, the share price of our companies will go down like everything else in a sharp market selloff, but will these companies really be affected in the long run? We don’t think so. And don’t worry about the other 24 % of the portfolio either. There is a little over 10 % in cash, and the remaining 14 % is split between industrials and building products, which should do well coming out of the crisis, plus a couple of stocks in the gold sector. Overall, we feel very good about how the portfolio is currently positioned to get through the crisis and come out stronger on the other side.
To conclude this section, we will briefly discuss the performance of large-capitalization stocks in Canada and the US. Although these stocks don’t compare directly with our strategy, we know that many investors hold them as part of a diversified portfolio. Comparing with large-capitalization stocks can help you see the difference in volatility between them and our microcap strategy. For the first quarter, the TSX Composite index in Canada generated a total return (including dividends) of -20,9 %, which is exactly equal to the Rivemont MicroCap Fund. In the US, the S&P 500 generated a total return of -19,6 %, which was slightly better than the fund.
The biggest takeaway for us at this point, and one that is very positive, is that the Rivemont MicroCap Fund doesn’t underperform and doesn’t seem to be riskier (more volatile) than typically safer assets such as large-capitalization stocks during a market crisis. If the fund can outperform in good times, like in 2019, and not underperform in bad times like we are living now, we are confident that patient investors will be well rewarded over the long term.
We’ve been asked a lot lately about the number of withdrawal requests we have received since the start of the crisis. We are pleased to report that we have not experienced any panic from unitholders and have only received minor withdrawal requests. It is now apparent to us that you all understand the long-term nature of our strategy, and we are grateful for this. Patient capital will be one of our strongest allies in successfully navigating through this crisis.
We know it can be scary and stressful to see the value of your investments go down. What is important to realize is that markets have been and will always be cyclical. The smart way to invest is to stay the course for the long term without letting fear and emotions interfere with your judgment. The markets will recover eventually, there is no question about that. We believe that now is a time to be patient and trust the strategy. You will be rewarded over the long term.
For those who have savings to invest, now is a much better time to invest than a few months ago. Yes, there is more uncertainty and the pandemic could decimate some industries, but stock values are much lower across the board to reflect that. We believe that a portfolio of solid companies, positioned in the right sectors, will significantly outperform the broader market when we come out of this crisis.
There is also a second aspect regarding liquidity that we want to briefly touch on: liquidity at the portfolio level, which means our ability to buy or sell stocks in the market.
As you probably know, the Rivemont MicroCap Fund holds positions in companies that are sometimes very illiquid and hard to buy. We patiently built this portfolio over the last two years, and some positions were very challenging to establish. You would be hard-pressed to go out in the market and replicate a similar portfolio because there is simply not enough liquidity to do so quickly.
On the one hand, this could represent a risk if we were forced to liquidate stocks quickly, because it would be hard to do so without making prices plunge. On the other hand, we think this same liquidity issue creates a great opportunity for investors.
Most of the stocks in the portfolio went down anywhere from 10 % to 50 % during the first quarter, but this happened with low trading volumes. Again, we think it would be challenging to replicate our portfolio by buying in the market today. By purchasing units of the fund, however, you are essentially able to buy a liquid position in a basket of illiquid and high-quality stocks.
We should also mention that there is tremendous hidden value in this portfolio. Since an important part of our strategy is to participate in private placements, we often get warrants as a bonus in these financings. A warrant is essentially an option to buy more shares of a company at a predetermined price for a predetermined time.
Let’s say we are given a warrant with an exercise price of $1 per share. If the stock goes up and trades at $1.50, we have the option to exercise the warrants and to buy the shares at $1, netting us a profit of $0.50 per share. On the other hand, if the stock is under $1, our option is worthless (but we didn’t pay anything for it).
The fund currently owns warrants of 12 different companies, but only 1 of them has a value that is reflected in the Net Asset Value of the fund (meaning that the stock price is over the exercise price of the warrant). The other eleven are not worth anything today, but since they expire anywhere from 4 months to 4 and a half years, they could well be worth a lot in the future.
This part of the portfolio is absolutely impossible to replicate, and we believe that the warrants will contribute significantly to the fund’s return in the future. Investors today are benefiting from this optionality for free.
Changes at Espace MicroCaps
We were recently advised that there have been some internal changes at Espace MicroCaps and that one of the consultants, Philippe Bergeron-Bélanger, has left the company to dedicate his time to building a technology start-up.
Philippe wrote a short letter to explain his decision, which you can read in Appendix A at the end of this letter. We wish to thank Philippe for his contribution, and we wish him the best with his future projects!
Mathieu Martin will be stepping in as the president and sole owner of Espace MicroCaps and will be the lead consultant for the Rivemont MicroCap Fund. We have been working closely with Mathieu for over two years, and we expect this transition to be seamless. The Espace MicroCaps philosophy and investment strategy remain the same, and we don’t expect any changes to the fund’s investment strategy as a result of this transition.
However, what we do know for sure is that the Rivemont MicroCap Fund is very well positioned in high-quality companies. We have put more emphasis on specific sector allocations. Using this kind of approach is not something we typically like to do, but we believe it is now critical to avoid the riskier sectors to make sure our companies get through even some of the worst-case scenarios out there.
As Warren Buffett has famously said: ” Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.” We are taking this advice to heart in a period like this and are only investing in companies that have very high probabilities of making it through the crisis and coming out stronger on the other side.
Also, our cash position, which stands at over 10 % currently, will be exceedingly useful to profit from further market declines if they happen. So far in April, we have seen a rather strong rebound from March lows, so it looks like investors are generally optimistic about the prospects of an economic recovery in the coming months. With that being said, we don’t take anything for granted, and we continue to manage the portfolio cautiously.
To conclude, let us say again that we hope you and your loved ones are all safe and healthy. If you have any questions or concerns, please don’t hesitate to reach out. The same goes if you would like to increase your participation in the fund at a considerable discount compared to just two months ago.
Thank you again for your trust, and we look forward to our next communication.
Stay hopeful. We will get through this!
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.
Appendix A – Philippe Bergeron-Bélanger’s Letter to Clients
I would like to take a few minutes of your time to announce that I have made an important personal decision and to explain the reasons behind this choice. On March 31, 2020, I stepped down and I divested of my shares in MicroCaps Research Canada Inc. (“MRC”), the company that owns the Espace MicroCaps blog and that acts as a Consultant for the Rivemont MicroCap Fund since its inception on January 18, 2018.
This decision, announced in mid-February to Mathieu, Jean and Martin, had been well-though-out for several months. I will be candid with you, although the success of your investments at Rivemont is very close to my heart, after more than five years as a full-time investor and more than two years as a Consultant at Rivemont, I felt the need to take up new challenges.
Over the years, I have experienced and tasted what entrepreneurial success feels like by investing alongside inspiring entrepreneurs. I would now like to live this wonderful experience myself by contributing to the growth of a technological company both as an employee and shareholder. Unfortunately, in the context of my involvement with the Rivemont MicroCap Fund, it would have been difficult to take up this challenge without partially diverting my focus away from the Fund or placing myself in a position of conflict of interest with the Fund’s investors.
Now that my departure is official… To all of you, I say: THANK YOU!
Thank you for believing in us and making our dream of contributing to the launch of a microcap investment fund come true. Without any hesitation, this experience was highly rewarding for me. As you have had the chance to read in this quarterly letter, the Fund has beaten its benchmarks since inception and, more particularly, in the context of the COVID-19 crisis.
Admittedly, times will be difficult in the coming months. Still, I’m speaking from experience when I tell you that it is more relevant than ever not to panic and to keep a long-term investment horizon to profit from the exceptional opportunities that will arise.
Besides, I have been able to witness the composure and discipline of Mathieu, Jean and Martin over the past few weeks, and I am sure they will continue to do an excellent job. I remain very confident that my money is in good hands. For those who would not dare ask me the question, I prefer to be transparent and give you the answer: the majority of my liquid assets will remain invested in the Rivemont MicroCap Fund. It would be impossible for me to recreate a portfolio of such high quality without influencing stock prices in the market.
This is the end for me as a Consultant for the Rivemont MicroCap Fund, but the adventure has only just begun and I intend to remain alongside you as an investor in the Fund.
With that, I wish you all, as well as your family and loved ones, health and financial security in these exceptional times.
Feel free to email me at my new email address email@example.com if you have any questions or just to chat. It will be my pleasure to keep in touch with each of you.
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