In 2020, investment performance was driven by two factors: 1) what was your exposure to the structural changes brought on by the pandemic? and 2) how did you react to a fearful/inefficient market that provided opportunities?

Our initial portfolio was negatively exposed to the structural changes brought on by the pandemic. We had a 16% weight in companies reliant on international air travel and hospitality and another 16% weight in banks and insurance companies. These business models were impaired by the pandemic and their share prices rationally declined. Combined, these positions contributed -10.3% to our gross portfolio return. Further, we had no initial weight in the biggest structural winners of the pandemic: large technology companies, clean energy, and gold.

We did take advantage of opportunities provided by the resulting chaotic, but inefficient market. We made meaningful additions to 1) technology companies enabling the digital economy, 2) leading home improvement brands or retailers, 3) strong consumer brands with e-commerce infrastructure, 4) natural gas, and 5) some special situations.  The market initially sold these assets down (severely) despite our view that they structurally benefited from the changes brought on by the pandemic. Ultimately, these positions added 19.3% to our gross portfolio return.

ASSET ALLOCATION

Compan­ies:  90% Weight

Our portfolio remains weighted to publicly traded equities as we believe they remain the most undervalued asset class. However, because of the pandemic, we made meaningful shifts in the type of businesses we own.

• We reduced our exposure to businesses we felt were structurally damaged by permanent changes brought on by the pandemic. This included companies reliant on international air travel or hospitality, as well as banks, who face narrower profit spreads from lower interest rates and higher loan losses.

• Having said that, we did maintain our banking positions in JP Morgan Chase & Co. (-6% in 2020) and Bank of America Corp. (-12% in 2020), as we believe their digital capabilities will allow them to accelerate market share gains. We also maintained our position in hospitality company Gamehost Inc. (-30% in 2020), as we believe their expense control should allow them to weather the storm and see brighter days.

• As mentioned in the Performance section, we made meaningful adds to specific businesses and industries we felt became undervalued in the chaotic market. One example was the home improvement space. With people locked in their homes and with interest rates set to zero, we felt individuals would shift prior vacation spending to improving their home. Despite this view, home improvement retailers and brands sold off dramatically, creating what we felt was an opportunity. We made meaningful adds to Sleep Country Canada Inc. (+184% Mar 21 add, +91% May 21 add), Canadian Tire Corp. (+90% Mar 16 cover), FirstService Corp. (+71% Mar 30 add – Nov 19 trim), Stella-Jones Inc. (+38% May 21 add), and Richelieu Hardware Ltd. (+36% Jun 17 add – Oct 9 trim). This significantly increased our home improvement exposure and rewarded us when the thesis played out.

HARD ASSETS:  4% Real Estate + 3% commodities + 2% Infrastructure

A casualty of the pandemic may be commercial office buildings and malls, we were lucky to have no exposure.

• In commodities, we sold our minor oil investments as we believe oil faces structural headwinds from accelerated adoption of electric vehicles and extreme reductions in air travel. However, we initiated a position in natural gas producer Peyto Exploration and Development Corp. (+140% Mar 18 add) as we believe reduced North American drilling activity could improve natural gas fundamentals.

Currencies/Credit:  1% cash + 0% Bonds

Despite the appearance of stability, we are concerned about the future purchasing power of cash and fixed income.

• Governments responded to the Pandemic by devaluing money at an unprecedented rate, setting interest rates at 0% and initiating universal income-like policies funded by printed money.

INVESTMENT OUTLOOK

Cautiously optimistic in uncertain times      

Despite great uncertainty in the world, we remain cautiously optimistic on the general outlook for public equities. Our positive outlook is based on four factors:

• Most of the economic damage is in the private realm, actually benefiting public companies
• Companies are emerging with much leaner cost structures
• Potential for an economic re-opening
• Interest rates are 0%

Most of the economic damage is in the private realm, actually benefiting public companies. A bearish argument is that the stock market recovery has exceeded the recovery in the actual economy. This is true but we believe rational. We have found the economic damage from the pandemic to be concentrated in smaller family-owned businesses and highly levered businesses typically owned by private equity firms. These companies lacked scale, technology, or a balance sheet and were highly exposed to economic shutdowns. The economic impact was severe with many of these companies going bankrupt or voluntarily closing. This benefits their competitors, which happen to be mostly public companies, who survived because they did have scale, technology, and a clean balance sheet. As a result, many public companies are emerging from the pandemic with much stronger positions in their respective competitive landscape. Said differently, the public stock market is a measure of mostly pandemic winners and does not represent the economic carnage in privately owned businesses.

Companies are emerging with much leaner cost structures. Despite the above, many public companies went through cost cutting exercises and are emerging with much leaner cost structures. This means that their earnings growth should exceed their revenue growth which is already exceeding economic growth.

Potential for an economic re-opening. There is potential for the roll-out of a vaccine and the re-opening of the economy. In fact, there is potential for an economic boom if there is pent-up demand and animal spirits amongst the population. Public companies could be entering an economic boom with a leaner cost structure and much stronger competitive positioning.  

Interest rates are 0%. Zero percent interest rates are supportive of corporate profits (low interest expense) and how investors value corporate profits. They also depress the appeal of alternative investments like fixed income and real estate as those assets offer very little yield in a 0% interest rate environment.

To conclude, there is potential for an economic boom, public company revenues should exceed economic growth (even if booming) due to enhanced competitive positioning, and corporate profit growth should exceed revenue growth due to leaner cost structures. This means corporate earnings growth could far exceed economic growth and we do not believe this is reflected in valuations. We retain caution given the mass uncertainties in the world; however, the above factors keep us cautiously optimistic.

Final Remarks

I will remember 2020 for many things but professionally, it was a reminder that investing in public securities is supposed to be a huge advantage. It allows you to correct mistakes, take advantage of opportunities, and to quickly shift your investment exposure when the world changes because of things like a pandemic. Speaking with a friend in hospitality (restaurant owner), it really struck home. It was virtually impossible for him to quickly sell his restaurant to buy a home improvement store this year. He must live with his once thriving investment that became impaired because of the pandemic.

However, 2020 is also a reminder that what should be an advantage is often a huge disadvantage. The ability to act quickly allows us to act often, to act irrationally, and to act on emotion; these are grave errors. This year is the watermark for the vast importance emotional control plays in investing.  Just look at selling volumes in March. Selling in March was the easiest thing to do emotionally but rationally the worst investment decision you could have made.

Today, the world is more uncertain than ever, which means fundamentals can shift on a dime, just like they did in 2020. The ability to react quickly, rationally, and WITHOUT EMOTION has likely never been more important.

Thank-you for investing!

“If you cannot control your emotions, you cannot control your money.”  – Warren Buffett