Our long-standing clients have come to expect their QV investments to hold in significantly better than the broader market during major downturns. This expected protection comes at a trade-off, which is usually lower relative returns during very strong equity markets. Clients are generally more averse to losses and thus are comfortable with the short-term trade-off, particularly since it has contributed to significant value creation over the long term. As investors in our funds alongside our clients, we too have been disappointed in the year-to-date underperformance of some of our strategies. Why didn’t we hold in through the COVID-19 market crash like we did during the Global Financial Crisis and Tech Wreck? To reflect on our relative year-to-date performance, we must recognize the unique nuances of this downturn and the drivers that have fueled the subsequent rebound.
Leading into the decline, our emphasis on solid businesses with better valuations and durable balance sheets had not changed. But quality and value did not hold in like they did in previous downturns; in some cases, they were even hit harder. The March sell-off was one of the fastest bear markets in history, distinguished by extreme volatility which uncharacteristically extended to more defensive areas of the market. Very few businesses were spared through the broad, indiscriminate selling.
The strength in equity markets since the March lows has been remarkable and a welcome reprieve. Our equity benchmarks, which had declined between 14% and 38% in the first quarter, are now off only 1%-15% year-to-date, and our equity strategies have risen between 30% and 40% since the crux of the crisis. However, despite fleeting periods favouring our style of investing, we generally have not kept up to the rebound led by higher valued, growth and momentum-oriented businesses. This is a continuation of the trends that fueled 2019’s strong rally.
In Canada, gold has also been a key source of strength, with the gold sub-index contributing over 18% of Canadian small cap market returns since the March bottom (10.8% of the total 59.2%). While this has hurt our relative returns in the short run, we believe our emphasis on compounding businesses at attractive valuations will be much more beneficial in the long run.
Source: Bloomberg
*TSX Small Cap Index data approximated by the iShares S&P/TSX Small Cap Index ETF
Our balanced strategy is up over 20% from the lows, helped in part by our decision to increase our equity allocation to a more moderate level. Some may be concerned as to whether we moved too quickly given the uncertainty that still looms in today’s investing environment. The answer to this question depends on one’s time horizon. Over the short run, the only thing that is nearly certain is continued volatility. However, given the extreme interventions by central banks, the comparative risk/reward between equities and fixed income now strongly favours equities. We believe that equities will outperform bonds over the medium to long term.
We firmly believe our strategies are positioned to offer significant growth through the economic recovery and beyond. As an example, on a price-to-book basis, our Canadian equity strategy trades at an 18% discount to the broader Canadian market (TSX Composite) and a 27% discount to itself over the last twenty years. In addition to better value, the strategy’s four-year return on equity is 18% higher than the market, without excessive use of debt. Our other strategies also have similar compelling characteristics. We must continue to be patient for our long-term positioning to be rewarded by the markets. For your continuing support as we persevere through this challenging environment, we thank you.
