CIO also urges investors to focus on secular trends rather than short-term market movements
ESG investing has gained in prominence in recent years, propelled by heightened environmental concerns, social justice movements and, of course, a global pandemic that has exposed poor governance and vulnerable citizens.
It has also supercharged the green energy space, with money piling into electric cars and renewable funds. A side effect of ESG’s popularity has meant there are bargains to be had in the energy and oil sector, according to Felix Narhi, CIO at Penderfund Capital Markets.
Penderfund does not focus on energy per se. Instead, it seeks out, and invests in, top-class management teams, honing in on small caps. It’s noticed that, with ESG becoming a more important factor in capital markets, many small Canadian energy producers are struggling because they are not meeting investors’ criteria.
“From an economics perspective, these assets are depressed,” he said. “If you have a company with a good management team that can buy these assets cheaply, that can be beneficial.
“We own two companies from that perspective – one is ARC Resources and the other one is Spartan Delta. Rather than the direction the commodities are going, we look at management teams that are by nature contrarian, and that have a good balance sheet to take advantage of swings that inevitably will happen. Right now, there have been lots of rich targets in the oil patch.”
With a lack of love from the capital markets meaning undervalued assets, someone who is not constrained by ESG factors can come in and scoop them up on the cheap. Narhi added: “That’s why we like to invest in companies that look for assets to buy because they're undervalued. These companies were able to pick them up and subvert them profitably.”
Penderfund specialises in small caps and takes a medium to long-term view. With equity markets experiencing a degree of sector rotation and what Narhi referred to as moving on to the flavour of the month, he urged investors to focus on secular trends rather than short-term fluctuations.
He highlighted Bitcoin as an example. Penderfund has some investments in beneficiaries of the cryptocurrency and despite getting hit hard in Q2, they have now rallied. Narhi still regards it as a good long-term secular bet.
A big sell-off would only enhance that view in that the winners from last year would represent opportunities. But Narhi said animal spirits are still prominent in the marketplace and there is a record amount of deal activity still going, albeit with a lot of capital chasing relatively few ideas.
“Some of the smaller cap stocks did so well from late last year to late spring. There’s been a bit of a pullback but that makes us bullish, quite frankly.”
He added: “A lot of these companies [that did well in the pandemic] are transformational companies. We own Zillow Group, for example, a company in the U.S. which is reimagining the way that people buy real estate. That's a good place to be. A lot of these companies with tail winds that have been permanently changed, in our mind, by the pandemic should probably see some resilience in the coming months.”
Narhi believes the reopening trade is now largely complete. The Delta variant is stirring up a few nerves in the markets but with greater knowledge and rising vaccination rates, the unknowns are less and confidence higher that the economy can withstand another wave.
But he warned that with so much greed, enthusiasm and capital sloshing up in the market, it's better to err on the side of caution with your portfolio right now.
Narhi added: “We’re generally bullish on small caps because they've underperformed. But it’s all about handicapping odds in the stock market. If something’s going to happen, we just want to have a big discount to it.”
