Hillsdale Investment Management
Why Canadian Small Cap Is Beautiful
June 2016
Harry Marmer, MBA, CFA – Executive Vice President, Institutional Investment Services 416.913.3907/[email protected]
Discussion Points
Size Is A Major Differentiator In Canada
Large Breadth In Canadian Small Caps
Active Management Potential In Canadian Small Caps Is Significant
Current Market Environment
Hillsdale’s Competitive Attributes
Why Small Cap Is Beautiful
Appendix
2
Size Is a Major Differentiator of Manager Returns in Canada
3
Equity Factor Risk Model: Factors’ Frequency of Statistical Significance2006-2012
Source: Axioma AXCA Canada.
There Is Large Breadth in Canadian Small Caps
Source: See Footnote 1. Data as of March 31, 2016Note: Values rounded where indicated
*Small Cap Universe includes all small cap stocks with market capitalization less than or equal to $2 Billion.
4
TSX 60 S&P/TSX CompositeCanadian Small Cap
Universe*
Number of Stocks 60 235 2781
Average Market Cap ($Billions)
$23.9 $8.2 $0.5
Total Market Cap ($Billions)
$1,431 $1,937 $381
Top 10 Stocks (%) 49% 38% 9%
Top 20 Stocks (%) 70% 53% 16%
Asset Class Odds of Adding ValueLow Average High
Canadian Small Cap
U.S. Small Cap
Global Small Cap
Global Equity
Emerging Markets
Canadian Equity
U.S. Equity
Canadian Fixed Income
High Active Management Potential In Canadian Small Cap
5 Source: Perspectives On Institutional Investment Management, By Harry S. Marmer, Rogers Publishing, 2002
Canadian Small Cap Potential Is Evident From Active Manager Results
Asset Class Median Manager Annual Excess Return
Canadian Small Cap 7.9%
U.S. Small Cap 2.0%
Global Small Cap 1.1%
Emerging Markets 1.7%
Canadian Equity 0.9%
U.S. Equity 0.4%
Canadian Fixed Income 0.0%
Global Equity 1.9%
*Based on Back Test of Hillsdale’s Global Small Cap Equity Strategy.Source: Hillsdale Investment Management, eVestment Alliance. Returns are based on local currency. Median manager annual excess return is based on the median of the calendar year median manager excess returns vs. respective benchmarks. Hillsdale annualized excess returns are based on strategy inception date and are ending December 31, 2015. Inception date of Hillsdale’s Canadian Small Cap is Jan 1996. Inception date of Hillsdale’s US Small Cap is Mar 1996. Inception date of Hillsdale’s Back Test of Global Small Cap Strategy is Jan 2003. Inception date of Hillsdale’s Canadian Core Strategy is May 2009. Inception date of Hillsdale’s US 130/30 All Cap Strategy is Jul 2007. Cdn Fixed Income is represented by the Canadian Fixed Income universe.
6
Inefficiencies Are Created By The “Neglect Effect”:Canadian Investors Neglect Investing Canadian Small Caps
Valued Added Potential Valued Added Potential
Large Cap Cdn Equity
Exp
ecte
d R
etur
n of
Ass
et C
lass
(%)
Large Cap US Equity
Fixed Income
Valued Added Potential
Alternatives
0
2
4
6
8
10
12
14
16
Allocation to Asset Class (%)10 20 30 40 50 60 70 80 90 100
Smal
l Cap
Equ
ity
Source: John Ilkiw, CPPIB, presented by Christopher Guthrie, in “US Small Cap: A Breadth of Opportunity” May 20107
Highest Value Add Potential
“Small” Small Cap Allocation
Canadian Small Caps Have Different Fundamental Drivers Than Canadian Large Cap Stocks
Sector WeightsS&P/TSX Composite – S&P/TSX Small Cap, March 31, 2016
Source: See Footnote 18
Difference
-24% -16% -8% 0% 8% 16% 24%
Gold
Consumer Discretionary
Technology
Industrials
Materials x-Gold
Utilities
Energy
Consumer Staples
Health Care
Telecommunications
Financials
TSX Composite - TSX Small Cap
S&P/TSX Composite
S&P/TSX Small Cap
Financials 37.9% 14.3%
Telecommunications 19.3% 0.0%
Health Care 5.7% 4.2%
Consumer Staples 0.9% 3.9%
Energy 4.7% 15.9%
Utilities 2.5% 4.6%
Materials x-Gold 3.1% 7.4%
Industrials6.8% 10.9%
Technology 8.2% 5.5%
Consumer Discretionary 4.4% 8.8%
Gold 6.6% 24.5%
Diversity Between Large & Small Cap Is Reflected In Index
Source: See Footnote 19
Sector S&P/TSX Composite S&P/TSX SCI Sector S&P/TSX Composite S&P/TSX SCI
Royal Bank of Canada Dundee Transalta Superior Plus Corp Toronto Dominion Laurentian Bank of Canada Brookfield Power Innergex Renewable Energy
Bank of Nova Scotia First National Financial Northland Power Valener BCE Potash Saskatchewan Labrador Iron OreTelus Barrick Gold Silver Standard Resources
Rogers Communications GoldCorp First Majestic SilverValeant Pharmaceuticals Knight Therapeutics Canadian National Railway Russel MetalsChartwell Retirement Res Extendicare Canadian Pacific Railway Stantec
Prometic Life Iences Theratech Bombardier Chorus Aviation Inc Alimentation Couche Tard North West Co Blackberry Wi-LAN
Loblaw Clearwater Seafoods CGI Mitel NetworksMetro AGT Food & Ingredients Open Text Computer Modelling Group
Suncor Energy Birchcliff Energy Thomson Reuters Yellow Pages Canadian Natural Resources Baytex Energy Manga International Boston Pizza Royalties
TransCanada Corp Enerflex Shaw Communications Corus Entertainment
ConsumerDisc.
Financials
Health Care
Energy
Materials
Industrials
Telecom
Utilities
ITConsumer Staples
Top Holdings Per Sector
These Factors Contribute To the Potential For Active Small Cap Management
10Source: See Footnote 1
Hillsdale Canadian Small Cap Equity Strategy vs. S&P/TSX Small CapSince Inception, Jan 1996 – Mar 2016
1 – Annualized, based on daily returns.2 –Active Share represents the percent of portfolio holdings that differ from the benchmark index holdings. An index fund would have an active share of 0%. 3 - Sortino Ratio is a measure of downside risk and is calculated as the excess return (or risk premium) per unit of downside deviation. The excess return is measured over the return of a risk free asset (T-Bills) divided by the variability or standard deviation of negative returns. Calculated using an assumed risk free rate of 2.0%.4 – Capture ratios are calculated based on monthly return data. In a bear market, a capture ratio under 100% indicates outperformance vs. market; in a bull market, a capture ratio capture over 100% indicates outperformance vs. market.
Hillsdale Cdn Small Cap
S&P/TSX Small Cap TRI
Return 16.6% 5.6%Value-Added 11.0% -% Positive Quarterly Value Added 75.3% -Tracking Error vs. TSX SCI1 9.3% -Information Ratio vs. TSX SCI1 1.19 -Current Active Share2 76.9% -
Risk1 18.4% 18.2%Return to Risk 0.9 0.3Beta vs. TSX SCI1 0.88 1.00Sortino Ratio3 1.42 0.31Bull Market Capture4 132% -Bear Market Capture4 78% -
Active Management
Metrics
Return and Risk Metrics
11
Russell 2000 Index vs. S&P/TSX Small Cap Index, March 31 2016 - Sector Weights
US & Canadian Small Cap Stocks Are Complements
Data as of March 31, 2016
Source: See Footnote 1.
12.1%
10.7%
9.8%
3.7%
0.8%
0.6%
-0.4%
-2.0%
-8.2%
-8.4%
-20.0% -10.0% 0.0% 10.0% 20.0%S&P/TSX Small Cap
Russell 2000
5.3% 17.4%
5.4% 16.1%
14.5% 24.3%
10.7% 14.5%
0.0% 0.8%
12.2% 12.8%
3.6% 3.3%
5.0% 3.1%
12.2% 4.0%
12.2% 3.9%
Technology
Health Care
Financials
Discretionary
Telecom
Industrials
Utilities
Staples
Materials
Energy
Source: See Footnote 1
Managing Liquidity and Capacity Is Critical
Average Monthly Valued Traded Past Year1 Year Ending April 30, 2016, $Millions
12
S&P/TSX Composite S&P/TSX SCI
Average $1,082 $159
Median $1,023 $177
Maximum $1,435 $188
Minimum $869 $52
13
Canadian Small Cap Market Outlook
Price to Book of TSX Small Cap Index vs. TSX Composite IndexMonthly, Sep 2004 – Mar 2016
14
Canadian Small Cap Valuations vs. Large Cap Have Improved But Remain Well Below Their Long-Term Average
Source: See Footnote 1. As of March 31, 2016
0.4
0.5
0.6
0.7
0.8
0.9
1
3/31/2003 3/31/2005 3/31/2007 3/31/2009 3/31/2011 3/31/2013 3/31/2015
Average
0.5
0.6
0.7
0.8
0.9
1.0
1.1
0.5
0.6
0.7
0.8
0.9
1.0
1.1
Dec
-71
Dec
-73
Dec
-75
Dec
-77
Dec
-79
Dec
-81
Dec
-83
Dec
-85
Dec
-87
Dec
-89
Dec
-91
Dec
-93
Dec
-95
Dec
-97
Dec
-99
Dec
-01
Dec
-03
Dec
-05
Dec
-07
Dec
-09
Dec
-11
Dec
-13
Dec
-15
CAD/USD Exchange RateMonthly, Jan 31, 1971 – Mar 31, 2016
Canadian Dollar Weakness Provides Support for Canadian Small Cap Earnings Cushioning the Effect of Lower Commodity Prices
15
CAD$ Appreciating
CAD$ Depreciating
Source: See Footnote 1.
The Price of Gold in Canadian Dollars is Near a Multi-Year High
16 Source: See Footnote 1. As of Apr 4, 2016.
Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q22012 2013 2014 2015 2016
1000
1100
1200
1300
1400
1500
1600
1700
1800
1900
1000
1100
1200
1300
1400
1500
1600
1700
1800
1900
Gold Futures - Price (USD)Gold Futures - Price (CAD)
Gold Price Used in Analyst Estimates is Significantly Lower Than Spot Price
17 Source: See Footnote 1. As of Apr 4, 2016.
2012 2013 2014 2015102010401060108011001120114011601180120012201240126012801300
1330
1360
1390
1420
1450
1480151015401570160016301660169017201750178018101840
1890
102010401060108011001120114011601180120012201240126012801300
1330
1360
1390
1420
1450
1480151015401570160016301660169017201750178018101840
1890
Gold - Spot Price (Log)Gold - 12M-Forward Consensus Estimate (Log)
Price of Oil Remains Weak in Both USD and CAD
18 Source: See Footnote 1. As of Apr 4, 2016.
Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q22012 2013 2014 2015 2016
20
30
40
50
60
70
80
90
100
110
120
20
30
40
50
60
70
80
90
100
110
120
Crude Oil Futures - Price (USD)Crude Oil Futures - Price (CAD)
Oil Price Used in Analyst Estimates is Higher Than Spot Price
19 Source: See Footnote 1. As of Apr 4, 2016.
2012 2013 2014 2015252627
29
31
33
35
37
39
41434547495153
56
59
6265687174778084889296
100104108113
252627
29
31
33
35
37
39
41434547495153
56
59
6265687174778084889296100104108113
Crude Oil - Spot Price (Log)Crude Oil - 12M-Forward Consensus Estimate (Log)
20
Canadian Small Cap Outperformed Canadian Large Cap
Source: See Footnote 1. As of May 20, 2016
21
Hillsdale’s Competitive Advantages
Hillsdale’s Skills in Canadian, US and Global Small Cap
Asset Class Median Manager Annual Excess Return
Hillsdale Annualized Excess Return
Canadian Small Cap 7.9% 11.3%
U.S. Small Cap 2.0% 7.9%
Global Small Cap 1.1% 8.6%*
Emerging Markets 1.7% N/A
Canadian Equity 0.9% 2.9%
U.S. Equity 0.4% 5.5%
Canadian Fixed Income 0.0% N/A
Global Equity 1.9% N/A*Based on Back Test of Hillsdale’s Global Small Cap Equity Strategy.Source: Hillsdale Investment Management, eVestment Alliance. Returns are based on local currency. Median manager annual excess return is based on the median of the calendar year median manager excess returns vs. respective benchmarks. Hillsdale annualized excess returns are based on strategy inception date and are ending December 31, 2015. Inception date of Hillsdale’s Canadian Small Cap is Jan 1996. Inception date of Hillsdale’s US Small Cap is Mar 1996. Inception date of Hillsdale’s Back Test of Global Small Cap Strategy is Jan 2003. Inception date of Hillsdale’s Canadian Core Strategy is May 2009. Inception date of Hillsdale’s US 130/30 All Cap Strategy is Jul 2007. Cdn Fixed Income is represented by the Canadian Fixed Income universe.
22
Hillsdale Covers The Entire Canadian Small Cap Universe
“Total Small Cap Coverage” includes all small cap stocks with market capitalization less than or equal to $2 Billion. “Total Investable Universe” includes stocks within Total Small Cap Coverage with market cap greater than $25 million.
23 Source: See Footnote 1. As of December 31, 2013.
500
550
1050
2750
0 500 1000 1500 2000 2500 3000
Investable Small CapUniverse
Investable Micro CapUniverse
Total InvestableUniverse
Total Small CapCoverage
Number of Stocks
24
A Diversified & Prudent Approach
Hillsdale Canadian Equity Small Cap AllocationMarch 31, 2016
Source: See Footnote 1. Excludes cash allocation.
Canadian Core
Small Cap70%
CanadianMicro Cap
22%
9%US Small Cap
4
6
8
10
12
14
16
18
4
6
8
10
12
14
16
18
20
25
Performance Ranking
Source: eVestment Alliance, Dec 2015. Returns are gross of fees. Past performance is not indicative of future return.S&P/TSX Small Cap Index performance is represented by the TSE200 before Feb 2000.Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes.Russell® is a trademark of Russell Investment Group
20 Years Of Experience In Small Cap Stock Investing
Hillsdale US Small Cap
(Mar 1996 – Mar 2016)
Hillsdale
Russell 2000
US Small Cap Universe
Cdn Small Cap Universe
Hillsdale Cdn Small Cap
(Jan 1996 – Mar 2016)
Hillsdale
S&P/TSX Small Cap
26
In Pursuit of Best Execution
In 2015, Average Commission Costs Were 2.0 Cents/Share, Average Firm-Wide Slippage was 40bps.
Trading Costs
OpportunityCosts
ExecutionCosts
• Delay Costs• Bid/Ask Spreads • Market Volatility/Trend• Market Impact
• Costs of Non-Execution• Consideration of Alpha Forecast
• Broker/Dealer Commission• Transaction Fees
In Pursuit of Best Execution Hillsdale Trade Analysis Includes
2727
An Institutional Investment Boutique, Capacity Aware
Other is US Large Cap and Equity Minimum Risk
$1.2 Billion Assets Under Management as of May 2016
Source: See Footnote 1
Small Cap (CPE, UPE, GPE)
50%
Return Premium (VMQ, QEI)
31%
Canadian Equities (Core, Cdn LC, CLS)
7%
[CATEGORY NAME]
[VALUE] Other (CMV, UMV)5%
0%
10%
20%
30%
40%
50%
60%
Small Cap (CPE,UPE, GPE)
Return Premium(VMQ, QEI)
Canadian Equities(Core, Cdn LC, CLS)
Absolute Return(HARS)
Other (CMV, UMV)
0%
10%
20%
30%
40%
50%
60%
0 to 1 1 to 2 2 to 4 4 to 6 6 to 8 8 to 10 10 +
28
Firm-Wide Canadian Stock Allocation by Average Days TradingAs of December 31, 2015
Source: See Footnote 1
Purposely Aware of Liquidity and Market Impact in a Capacity Constrained Environment
29
Why Canadian Small Cap Is Beautiful
1”Size Matters, If You Control Your Junk” by Cliff Asness, Andrea Frazzini and Ronen Israel, AQR Management, Jan 2015.
Why Canadian Small Cap Is Beautiful
• Size Is A Major Differentiator in Canada
• Small Cap Breadth Creates Opportunities for Skillful Managers
• Neglect Effect Also Provides for Market Inefficiencies
• Provides Diversity In Fundamental Drivers
• U.S. and Canadian Small Cap Stocks Are Complements
• Capacity Aware and Liquidity Management Are Critical
• Market Outlook Favors Canadian Small Caps
30
Appendix
Hillsdale Canadian Micro Cap Equity Pg 34
The Small Cap Effect Pg 38
Why Small Cap Is Beautiful Pg 45
Footnotes and References Pg 48
31
Breadth Is Important For The Success of Active Management
Source: Active Portfolio Management, by R. Grinold & R. Kahn, McGraw Hill, New York, NY, 2000
Information Ratio = (Excess Return)/(Tracking Error) Tracking Error = Standard Deviation of Excess Return
The Magic Formula of Active Investment Management
The Fundamental Law of Active Management
Number of Independent Forecasts of E (R)
Information Ratio = Manager’s Skill × √ Breath
Relationship Between Forecasts and Actual Outcomes
Breadth
32
Skillful Managers Desire Breadth
Skill Breadth
33
34
Hillsdale Canadian Micro Cap Equity
35
Micro Cap “Private Equity” Attributes Are Very Attractive
Source: See Footnote 1.
Exposure vs. TSX Small CapCdn Micro Cap
S&P/TSX Small Cap
Fundamental Attributes
Enterprise Value to EBITDA 6.5 11.0
Enterprise Value to EBIT 9.5 33.8
Price to EBITDA 5.9 6.2
Price to EBIT 8.6 19.0
Enterprise Value to Cash Flow 7.9 14.4
Enterprise Value to Sales 0.9 2.0
Debt to Enterprise Value 16.5 28.1
Interest Coverage (EBIT/INT) 6.0 1.7
-1.00 -0.50 0.00 0.50 1.00
Ending March 31, 2016
36
Canadian Micro Cap Portfolio AttributesEnding March 31, 2016
Source: See Footnote 1*Exposure based on one-tailed distribution
Exposure vs. TSX SCI
Higher Earnings and Cash Flow Growth
Strong Reinvestment Rate and Lower Debt
Attractive Valuations
Better Accounting and Governance
Revisions and Price Momentum are Superior to the Benchmark.
Lower Market Cap
QualityAccounting & Governance Score (4=Best)Earnings Variability (%)\
Capital EfficiencyCash Flow to DebtReinvestment Rate Est. (%)Debt/Equity
ValuationPrice/SalesPrice/Earnings Est.Price/Cash Flow Est.Price/BookEV/EBITDA (trl.)Dividend Yield (%)
GrowthQuarterly Sales Growth (%)Quarterly Earnings Growth (%)Quarterly Cash Flow Growth (%)
Consensus/MomentumQuarterly Earnings Surprise (%)Quarterly Estimate Revision (%)12 Month Price Change (%)
Size/Liquidity/RiskWeighted Average Market Cap ($ millions)Daily Trading Volume ($ millions)120 Standard Deviation
-1.50 -1.00 -0.50 0.00 0.50 1.00 1.50
Cdn Micro Cap
S&P/TSX Small Cap
3.1 2.817.0 30.2
0.8 0.211.6 -0.80.3 0.6
0.8 1.110.4 53.56.4 6.91.5 1.26.5 11.02.1 2.6
2.7 -2.529.8 -49.216.3 -12.0
5.2 -0.313.3 -24.036.9 -13.1
205.9 1,011.40.6 4.946.5 49.5
37
Since Inception Return and Risk Metrics vs. TSX SCI
Source: See Footnote 1
Hillsdale Canadian Micro Cap Equity FundSince Fund Inception, Dec 2013 – Mar 2016
1 – Annualized, based on monthly returns. Returns are based on Hillsdale Canadian Micro Cap Equity Fund. 2 –Active Share represents the percent of portfolio holdings that differ from the benchmark index holdings. An index fund would have an active share of 0%. 3 - Sortino Ratio is a measure of downside risk and is calculated as the excess return (or risk premium) per unit of downside deviation. The excess return is measured over the return of a risk free asset (T-Bills) divided by the variability or standard deviation of negative returns. Calculated using an assumed risk free rate of 2%.4 – Capture ratios are calculated based on quarterly return data. In a bear market, a capture ratio under 100% indicates outperformance vs. market; in a bull market, a capture ratio capture over 100% indicates outperformance vs. market.
Hillsdale Cdn Micro Cap
S&P/TSX Small Cap TRI
Return1 12.6% -2.5%Value-Added 15.0% -% Positive Quarterly Value Added 71.4% -Tracking Error vs. TSX SCI1 7.9% -Information Ratio vs. TSX SCI1 1.90 -Current Active Share2 98.2% -
Risk1 11.7% 15.6%Return to Risk 1.1 -0.2Beta vs. TSX SCI1 0.65 1.00Sortino Ratio3 0.30 -0.95Bull Market Capture4 114% -Bear Market Capture4 45% -
Active Management
Metrics
Return and Risk Metrics
The Small Cap Effect
38
“A Significant Size Premium Emerges, Which is Stable through Time, Robust to the Specification, More Consistent Across Seasons and Markets…”1
1”Size Matters, If You Control Your Junk” by Cliff Asness, Andrea Frazzini and Ronen Israel, AQR Management, Jan 2015.
US Small Caps Are An Excellent Complement to Canadian Small Caps
Hillsdale CdnSmall Cap
Hillsdale US Small Cap
Gold 20.1% 0.0%
Industrials 24.8% 14.1%
Consumer Staples 12.1% 7.3%
Materials X‐Gold 8.8% 6.0%
Consumer Discretionary 8.6% 6.9%
Energy 1.8% 0.6%
Utilities 3.0% 2.0%
Telecommunications 0.4% 4.0%
Financials 8.1% 20.7%
Health Care 1.2% 13.9%
Technology 7.5% 21.6%
Sector WeightsHillsdale Canadian Small Cap vs. Hillsdale US Small Cap, March 31, 2016
Source: See Footnote 139
Difference
-30% -20% -10% 0% 10% 20% 30%
Technology
Health Care
Financials
Telecommunications
Utilities
Energy
Consumer Discretionary
Materials x-Gold
Consumer Staples
Industrials
Gold
Hillsdale Cdn Small Cap - Hillsdale US Small Cap
Small Cap Has Superior Attributes To Private Equity
Criteria Micro Cap Small Cap Private Equity
Liquidity Higher High Lower
Time and Resource Commitment Lower Low Higher
Valuation Market Market Estimated
Manager Universe Narrow Wide Narrow
Breadth Broad Broad Limited
Transparency High High Low
Fees Average Average High
40
Why There Is A Small Cap EffectSIZE, JANUARY, & DAY OF THE WEEK • Keim, D. 1987. "Daily returns & size-related premiums: One more time." Journal of Portfolio Management 13 (2): 41-47. • Keim, D.B. 1983. 'Size-Related Anomalies & Stock Return Seasonality: Further Empirical Evidence,' Journal of Financial Economics, March, 13-32. • Rogalski, R. 1984. "New findings regarding day-of-the-week returns over trading & non-trading periods: A note." Journal of Finance 39 (5): 1603-1614. SIZE & RETURN REVERSAL • Fama, E. & K. French. 1987. "Permanent & temporary components of stock prices." CRSP Working Paper #178, Center for Research in Security Prices, Un. of Chicago, February SIZE, JANUARY, & NEGLECT • Barry, C. & S. Brown. 1986. "Limited information as a source of risk." Journal of Portfolio Management 12 (2): 66-72. SIZE, JANUARY, & YIELD • Keim, D. 1983. "The interrelation between dividend yields, equity values & stock returns: Implications of abnormal January returns." Ph.D. dissertation, Un. of Chicago• Keim, D. 1985 "Dividend yields & stocks returns: Implications of abnormal January returns." Journal of Financial Economics 14: 473--489. • Keim, D. 1986 "Dividend yields & the January effect." Journal of Portfolio Management 12 (2): 54-60. SIZE, NEGLECT, & PRICE/EARNINGS RATIO • Dowen, R. & S. Bauman. 1986. "The relative importance of size, PIE, & neglect." Journal of Portfolio Management 12 (3): 30-34. SIZE, NEGLECT, PRICE/EARNINGS RATIO, & JANUARY • Arbel, A.1985. "Generic stocks: An old product in a new package." Journal of Portfolio Management 11 (4): 4-13. PRICE/EARNINGS RATIO & RESIDUAL RISK • Goodman, D. & J. Peavy. 1985. "The risk universal nature of the P IE effect." Journal of Portfolio Management 11 (4): 14-16. PRICE/EARNINGS RATIO, CONTROVERSY, & NEGLECT • Carvell, S. & P. Strebel. 1984. "A new beta incorporating analysts' forecasts." Journal of Portfolio Management 11 (1): 81-85. PRICE/EARNINGS RATIO & PRICE/SALES RATIO • Senchack, A. & J. Martin. 1987. "The relative performance of the PSR & PER investment strategies." Financial Analysts Journal 43 (2): 46-56. SIZE & TRANSACTION COSTS • Blume, M.E. & Stambaugh, R.F. (1983) 'Biases in Computed Returns: An Application to the Size Effect,' Journal of Financial Economics, November, 387-404. • Brown, P., Kleidon, A. W. & Marsh, T .A. (1983a) 'New Evidence on the Nature of Size-Related Anomalies in Stock Prices,' Journal of Financial Economics, June, 33-56.• Kato, K. & Schallheim, J.S. 1985. 'Seasonal & Size Anomalies in the Japanese Stock , Market,' Journal of Financial & Quantitative Analysis, 20, 107-18.• Reinganum, M.R. 1981. 'Misspecification of Capital Asset Pricing: Empirical Anomalies Based on Earnings Yields & Market Values,' Journal of Financial Economics, 19-46.SIZE & TAX LOSSES• Reinganum, M.R. 1983. 'The Anomalous Stock Market Behavior of Small Firms in January: Empirical Tests for Tax-Loss Selling Effects,' Journal of Fin. Economics, June, 89-104. SIZE & RISK• Roll, R. (1981) 'A Possible Explanation of the Small Firm Effect,' Journal of Finance, 36, : 879-88. • Roll, R. (1983a) 'Vas ist das? The Turn of the Year Effect & the Return Premium of Small Firms,' Journal of Portfolio Management, 9, 1, 18-28. • Roll, R. (1983b) 'On Computing Mean Returns & the Small Firm Premium,' Journal of Financial Economics, November, 371-86. • Stoll, H.R. & Whaley, R.E. (1983) “Transaction Costs & the Small Firm Effect,” Journal of Financial Economics, June, 57-70.
41
Why There Is A Small Cap EffectSIZE & PRICE/EARNINGS RATIO • Banz, R. & W. Breen. 1986. "Sample-dependent results using accounting & market data: Some evidence," Journal of Finance 41 (4): 779-793. • Basu, S. 1983. "The relationship between earnings yield, market value & return for NYSE common stocks: Further evidence." Journal of Financial Economics 12 (1): 129-156. • Cook, T. & M. Rozeff. 1984. "Size & earnings/price ratio anomalies: One effect or two?" Journal of Financial & Quantitative Analysis 19 (4): 449-466. • Goodman, D. & J. Peavy. 1986. "The interaction of firm size & price-earnings ratio on portfolio performance." Financial Analysts Journal 42 (1): 9-12. • Peavy, J. & D. Goodman. 1982. "A further inquiry into the market value & earnings yield anomalies." Southern Methodist University Working Paper #82-114, Dallas.• Reinganum, M. 1981. "Misspecification of capital asset pricing: Empirical anomalies based on earnings' yields & market values." Journal of Financial Economics 9 (1): 19-46. SIZE & NEGLECT• Arbel, A., S. Carvell, & P. Strebel. 1983. "Giraffes, institutions & neglected firms." Financial Analysts Journal 39 (3): 57-62. Arbel, A. & P. Strebel. 1982. “Pay attention to
neglected firms”. Journal of Portfolio Management 9 (2): 37-42SIZE & JANUARY • Blume, M. & R. Stambaugh. 1983. "Biases in computed returns: An application to the size effect." Journal of Financial Economics 12 (3): 387-404. • Constantinides, G. 1984. "Optimal stock trading with personal taxes: Implications for prices & the abnormal January returns." Journal of Financial Economics 13 (1): 65-90. • Givoly, O. & A. Ovadia. 1983. "Year-end tax-induced sales & stock market seasonality." Journal of Finance 38 (1): 171-185. Keirn, 0.1983. "Size-related anomalies & stock
return seasonality: Further empirical evidence." Journal of Financial Economics 12 (1): 13-32. ' • Keim o. & R. Stambaugh. 1986. "Predicting returns in the stock & bond markets." Journal of Financial Economics 17 (2): 357-390. • Lakonishok, J. & S. Smidt. 1984. "Volume & turn-of-the-year behavior." Journal of Financial Economics 13 (3): 435-455. • Lakonishok, J. & S. Smidt. 1986. "Trading bargains in small firms at year-end." Journal of Portfolio Management 12 (3): 24-29. • Reinganum, M. 1983. "The anomalous stock market behavior of small firms in January: Empirical tests for tax-loss selling effects." Journal of Financial Economics 12 (1): 89-
104. • Rogalski, R. & S. Tinic. 1986. "The January size effect: Anomaly or risk mismeasurement?" Financial Analysts Journal 42 (6): 63-70. • Roll, R. 1983. "Vas ist das? The turn of the year effect & the return premia of small firms." Journal of Portfolio Management 9 (2): 18-28.• Schultz, P. 1985. "Personal income taxes & the January effect: Small firm stock returns before the War Revenue Act of 1917: A note." Journal of Finance 40 (1): 333-343. SIZE & RESIDUAL RISK • Basu, S. & S. Cheung. 1982. "Residual risk, firm size, & returns for NYSE common stocks: Some empirical evidence." McMaster University Working Paper, Montreal, January. • Lakonishok, J. & A. Shapiro. 1984. "Stock returns, beta, variance & size: An empirical analysis." Financial Analysts Journal 40 (4): 36-41. • Reinganum, M.R. (1982) 'A Direct Test of Roll's Conjecture on the Firm Size Effect,' Journal of Finance, 37, 27-35. • Tinic, S. & R.. West. 1986. "Risk, return & equilibrium: A revisit." Journal of Political Economy 94 (1): 127-147. SIZE & EARNINGS SURPRISE • Foster, G., C. Olsen, & T. Shevlin. 1984. "Earnings releases, anomalies & the behavior of security returns." The Accounting Review 59 (4):574-603. • Freeman, R. 1986. "The association between accounting earnings & security returns for large & small firms." CRSP Working Paper #192, Center for Research in Security Prices,
University of Chicago, October. • Rendleman, R., C. Jones, & H. Latane.1986. "Further insight into the S.U.E. anomaly: Size & serial correlation effects." University of North Carolina at Chapel Hill Working
Paper, April. SIZE, YIELD, & CO-SKEWNESS • Cook, T. & M. Rozeff. 1982. "Size, dividend yield & co- skewness effects on stock returns: Some empirical tests." University of Iowa Working Paper #82-20, Ames.
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Why There Is A Small Cap Effect
• Neglect• Reversals• Value • Earnings Surprise• Residual Risk• January Effect• Transactions Costs• Risk• Irrational Investor Behavior
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A Behavioral Approach
Irrational Investor Behavior
Biased Decision Making
Overconfidence
Overreaction
“A Psychologist Is A Man Who Watches Everyone Else When A Beautiful Girl Enters the Room.”
Why A Small Cap Effect (Premium?)
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Why Small Cap Is Beautiful
There Has Been Significant Alpha (Excess Return) In Active Investment Management of Small Cap
There is Still A Compelling Case for the Persistence of This Alpha
There is Enormous Breadth (i.e. Choice) in the Small Cap Stock Universe
Canadian and US Markets Are Good Offsets At the Sector Level
Small Cap Managers Compliment Large Cap Managers Diversifying Your Sources of Excess Returns
Very Attractive Valuations
Source: Why Small Is Still Beautiful, by Harry Marmer, Defined Benefits Monitor, Feb 200545
Sector Weight Comparison: Canadian Small Cap vs Composite
Sector Weights vs. TSX SCI
46Investments in the Hillsdale US Performance Equity Fund and the Hillsdale Cdn Micro Cap are accounted for by allocating their individual stock holdings on a weighted basis.Source: See Footnote 1.
Sector Weights vs. Index, March 31, 2016
13.9%
8.2%
2.0%
1.4%
0.4%
-0.2%
-1.6%
-3.0%
-4.4%
-6.1%
-14.2%
-20.0% -10.0% 0.0% 10.0% 20.0%Cdn Small Cap TSX SCI
Industrials 24.8% 10.9%
Materials ex. Gold 12.1% 3.9%
Technology 7.5% 5.5%
Consumer Staples 8.8% 7.4%
Telecommunication 0.4% 0.0%
Consumer Discretionary 8.6% 8.8%
Utilities 3.0% 4.6%
Health Care 1.2% 4.2%
Gold 20.1% 24.5%
Financials 8.1% 14.3%
Energy 1.8% 15.9%
Lessons Learned
• The Small Cap Effect: Small Capitalized Stocks Perform Differently Then Large Capitalized Stocks Over A Market Cycle
• The Small Cap Return Premium: Smaller Companies Have on Average Higher Returns Adjusted for Risk Relative to Larger Companies
• Compelling Case For Excess Returns or Alpha
• Broader and Complimentary Opportunity Set
• Small Cap Managers Compliment Large Cap Managers Diversifying Your Sources of Excess Returns
• Persuasive Reasons for Alpha Potential to Persist
• As Good, If Not Better, Than Private Equity
• Attractive Market Outlook
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Footnotes and ReferencesFootnote 1All data presented is from Hillsdale’s proprietary database unless indicated otherwise. This database consolidates information from over 30 vendors to support Hillsdale’s research, portfolio management and reporting activities.
Footnote 2Performance and other data in this presentation are shown for illustrative purposes only. Back tested returns are based on a quantitative testing where stocks are selected based on Hillsdale’s proprietary stock selection systems. All back test returns are shown gross of fees and are calculated in Canadian or US dollars as indicated. No representations are being made that the investment process will achieve similar returns on a going forward basis. Investors should not consider the data included in the presentation as an indication, assurance, estimate or forecast of future results. Actual returns may differ materially from the returns shown for reasons including, but not limited to, investment restrictions and guidelines, fees and other expenses, cash holdings, timing of trade execution and fluctuations in the market.
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Institutional Investment ServicesHarry Marmer, BBA, MBA, CFA, Executive Vice President and Partner, joined Hillsdale Investment Management in 2008. Prior to joining Hillsdale, Mr. Marmer led the Canadian institutional investment business of Franklin Templeton Investments and before that the institutional business of the Russell Investment Group. He was also a principal and co-head of Mercer's Canadian Investment Consulting Practice. Mr. Marmer is a frequent conference speaker and has authored more than 47 articles. His book, Perspectives in Investment Management, was published in September 2002. He has served on a number of professional and industry boards and was past president of the Toronto CFA Society. Mr. Marmer received the Volunteer of Distinction Award from the Toronto CFA Society and was awarded the Society’s Research Award. He has an MBA and a BBA, finance and investments, York University.