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Following a strong Q1, the TSX has been in a downward trend since the second quarter began. The market has given up most of its gains from Q1. Specifically, the TSX was down 1.6% in the second quarter leaving the index up 0.74% for the year. The Jemekk Long/Short Fund however continued its momentum from Q1 posting positive returns for each month in Q2. We are pleased with how the Fund performed for the quarter and year to date handily beating its benchmarks. Outperformance for the Fund was primarily driven by our Technology, Consumer Cyclical, and Basic Material weightings which we will discuss further.

Below is an analysis of the Fund and some comparative indices in Q2:

Q2 2017 YTD 2017 Since Inception
Jemekk Long/Short Fund 3.83% 9.56% 195.35%
S&P/TSX Composite -1.64% 0.74% 153.92%
S&P/TSX Small Cap Ind. -5.51% -4.12% 56.86%

*Benchmarks quoted in Total Returns

Performance in the second quarter for Canadian markets reversed as we saw both the TSX and TSX Small Cap indices give up most or all of its Q1 gains. Focusing on the broad based TSX index, the gains in the quarter were mainly from the Industrial and Consumer Discretionary sectors however these gains weren’t enough to offset the moves in the Energy sector. The 8% drawdown in WTI led to the Energy sub-index being down over 9% for the quarter which is material given the Energy weighting for the TSX is 20%. The small cap area of the market also posted a very weak quarter driven by the heavier resource weighting in those Canadian indexes.

 

South of the border geopolitical events such as the heightened terrorist acts in Europe and continued missile testing from North Korea have done nothing to slow down the US markets. In fact, all major US indices are pushing all time highs. So, as it stands now the US markets continue their bull run (now in year 8), valuations are on the upper range, interest rates are increasing, and earnings growth is tepid at best. These factors do not bode well for equities. However, we believe the earnings backdrop remains quite healthy in certain sectors although the outlook for energy remains uncertain. June was a particularly interesting month as we witnessed a violent sector rotation out of technology names into more value oriented stocks. Tech stocks in the US have since rebounded but in Canada it’s a different picture. Canadian tech names are still 10-15% off their highs and we see this as an opportunity as valuations are justified given growth expectations. Consensus for portfolio positioning for the back half of the year is overweight cyclicals and underweight telecom and utilities (interest rate sensitive stocks) which we would agree with, for the most part, but also see technology continuing its leadership.

 

We have taken the exposure of the Fund down over the quarter. Specifically, the Fund was 95% net long coming into Q2 and exited at 80% net long. We acknowledge there is much to be worried about but overall we see underlying trends still being favorable to equity markets. However, there is definitely a divergence occurring between Canadian markets and US markets. Year to date performance for the TSX is being noticeably dragged down by energy and financials (two largest sectors in TSX) and this is readily apparent when compared to US markets that continue its upward trajectory with strong gains in technology and consumer based names. As such we would like to highlight the Fund’s outperformance versus its Canadian benchmarks and note stock picking along with large sector calls are the only way to outperform. For the quarter, the Fund’s performance was led by technology (Shopify), consumer cyclicals (Air Canada), and basic material (a basket of junior gold stocks) weightings while our energy book was a detractor.

We typically enjoy highlighting new stocks we own but would like to take this opportunity to discuss three core names in the Fund. We attended a conference in Montreal in April and had the opportunity to meet the management teams from Boyd Group, Kinaxis, and CCL Industries, which also included a site tour of their health care labeling facility. We understand stock picking is incredibly difficult but equally difficult is knowing when to sell a stock. This is where we believe we differ from other managers. Meaning, we are not quick to sell stocks with gains rather we continue to support management and if anything, buy more. Below we provide a brief summary on each of the three names and reason why we continue to be long.

 

  • Boyd Group Income Fund – Boyd, a leading collision repair company with 85% of its business from the US, continues to impress on executing its growth initiatives. We were first attracted to the story in August of 2011 because of its large growth opportunities in terms of consolidating the highly fragmented collision repair industry. Since we first purchased the stock, the company has, and continues to, exceed expectations. We have met with the CEO, Brock Bulbuck, on a number of occasions and can confidently say Brock is one of the best allocators of capital we have come across. He has publicly announced he plans on doubling the size of the business in five years, and although we are less than half way in this process, he has delivered to date on his stated objectives. We remain long and look forward to seeing Brock continue to allocate capital for maximum ROE.

 

  • Kinaxis – Kinaxis, a developer and marketer of supply chain management software, is an example of a stock where we added to the name as we got more comfortable with the story as the company executed. What made us interested in the stock was how competitive its offering was compared to global giants like SAP. We believe Kinaxis’ product is superior to its competitors and this is confirmed by continuing to add Fortune 500 companies. After meeting with management, we come away as confident as ever and excited to see this Canadian tech gem win business and one day become the de facto product solution for supply chain management.

 

  • CCL IndustriesCCL, a global leader in packaging and labeling, reminded us of a Boyd-like situation when we first started to work on it. Meaning, the company was also acquisition based and looking to consolidate the fragmented industry. However, CCL has proven to be much more than a roll-up story. We have witnessed CCL bring in both large and small companies onto their platform and remove inefficiencies resulting in margin expansion and top line growth. We view the CEO, Geoff Martin, similar to the CEO of Boyd as being an impressive allocator of capital. When on the site tour of its facility producing packaging for drug companies we were surprised by how much technology goes into the labeling process. CCL has made some very interesting acquisitions in the RFID and banknote space and we believe this is what sets the company apart from its competitors. Meaning, CCL positions itself in high growth areas of business. The company was just added the TSX 60 which should fuel more buying as we believe CCL is still an under owned stock.

 

The above stocks share common characteristics we look for when investing in companies. Specifically, they are market leaders that have high barriers to entry and have demonstrated solid growth with a clear path of continuing to capture more share in their respective industries. Also, and perhaps most important, each of these companies is led by a committed and focused CEO surrounded by a tier one management team. When investing we have found promising companies with a great business model but without the execution of a great CEO these companies have missed their mark.

 

The third quarter has started with what most would’ve seen as an unlikely event coming into the year with the Bank of Canada increasing interest rates for the first time in seven years. Much like the US, Canada is now in a rising rate environment which suggests our economy is doing well despite energy headwinds and real estate bubble talk and as such we have to position the portfolio accordingly. As we head into earnings season we remain constructive on select pockets of the equity markets but acknowledge the macroeconomic setup for stocks reads negative. We do however continue to find great ideas albeit at a more muted pace for the time being. One last thing, we would like to note the 13 year anniversary for the Jemekk Long/Short Fund. We are quite proud to have such a long history in Canadian capital markets and determined to continue to source the best ideas on behalf of our partners. Thank you as always for the continued support.