That’s not to say we’ve been right with every investment. In fact, we wear our mistakes like tattoos, openly talking about and updating them annually on our website. The truth is that when you invest for a long time, you don't remember the successful investments as well as you remember the mistakes.

A lot happened over the first 15 years of our journey alongside our investors. What's stayed the same has always been (and will continue to be) our investment approach – business owners buying businesses. We take ownership stakes in businesses by conducting fundamental analysis and developing proprietary insights.

We don’t invest in businesses because of macro thoughts, however we keep macro-level market issues in mind when looking for potential risks or what to avoid. We’ve always done our best to communicate those risks to the likeminded investors willing to join us along the way.

Let’s take a walk down memory lane to revisit some of the times where we took the path less travelled and ended up far from the maddening crowd.

2008 to 2009
Non-obvious survivors
“If you know what everyone knows, you know nothin’ at all”

The Financial Crisis delivered market volatility not seen since the Great Depression. At the height of this uncertainty, the average investor was questioning whether the financial system would collapse. History has shown that in times of extreme fear, investors migrate towards “safety-type” businesses – what we referred to as obvious survivors. Essentially, investors felt safest with the essentials – grocery stores, packaged goods companies and utilities because people would always need food, personal goods, electricity and phone service. Many market participants found solace by flocking to these sectors.

We saw little opportunity in sectors where everyone was crowding. Moreover, we believed owning these businesses could be risky because investing with the consensus opinion historically hasn’t been financially rewarding.

Likewise, we saw little opportunity in businesses that required the economy to grow to experience growth themselves. Examples included most big leisure companies and the majority of the large transportation companies. Our belief was that that the global economy may be sluggish for longer than people expect, and therefore, businesses that require the economy to drive their growth may not be good investments.

Our focus turned to the non-obvious survivors that could grow irrespective of what happened (within reason) in the economy. Said another way, we looked for businesses that we thought could double in size over a period of five to seven years, where we weren't being asked to pay for that growth in earnings power. Examples of these types of businesses include Ryanair, a low-cost airline, and Pool Corp., a U.S. distributor of pool supplies.

Looking back at our first five years, it’s “obvious” that the path less travelled was the right long-term choice:

2010 to 2011
Slower for longer

In 2010, the mantra was the “New Normal” – a macro economic landscape which included high unemployment levels, household deleveraging, sovereign debt risks, austerity measures and the inflation/deflation battle. 2011 brought on another wave of concerns – a U.S. debt downgrade, European debt crisis and a potential slowdown in China. The consensus view was a slower-for-longer world, a view that we shared.

With the glass seemingly half-empty for many investors, they decided to fill their portfolios with the “safest” of options – cash and fixed income securities like 10-year Government of Canada bonds. Everyone expected to be “paid to wait” in government bonds until the global economy improved. The view was that global equity markets didn’t offer an attractive investment opportunity as bonds. In reality, anyone buying bonds at then-prevailing yields was locking in a near-guaranteed loss after adjusting for inflation if held to maturity. “Guaranteed loser” is not our definition of “safe.”

What the average investor seemed to forget was that safety is a function of the price that was paid for it. Pay too much and that “safe” investment can be the riskiest thing to own.

We continued with our focus on finding companies such as German engine manufacturer Tognum AG (now Rolls-Royce Power Systems AG) and medical-packaging manufacturer Gerresheimer AG that could grow regardless of the economy. This meant capitalizing on the prevailing outlook by investing in resilient businesses with solid growth potential that were being ignored by a highly pessimistic market.

Those who paid for the short-term peace of mind were rewarded in the long term with a return that barely beat inflation as evidenced by the ICE BofA Canada Broad Market Index (which includes Canadian government and corporate investment grade bonds).

2013
Canada – the one-trick moose?

At the end of 2012, what the average Canadian investor saw was a market that had outperformed both U.S and international indexes over 10 and 20 years:

Investors in the S&P/TSX Composite Index probably thought they were investing in Canada. Looking deeper showed that they were relying on an idea focused on other regions – China and the emerging markets. Their rapid growth made them the largest consumers of commodities. Almost 50% of the Canadian index was in energy and materials (precious and base metals). These segments were tied closely to the fortunes of China and emerging markets. The result of their economic growth was an increased demand for commodities, directly impacting the price of energy and materials. Investors expected that demand for natural resources would march steadily higher.

We saw significant risk in being overexposed to one idea. As a by product of this, our Canadian Portfolio’s combined weight in energy and materials was half of the index’s.

Sector breakdown

Dec. 31, 2012

Source, index: FactSet Research Systems Inc. In C$. The S&P/TSX Composite was chosen as the benchmark for the EdgePoint Canadian Portfolio because it’s a widely used benchmark of the Canadian equity market. See Important information – benchmarks and indexes for additional details.

So, how did our unconventional approach fare against the S&P/TSX Composite Index over the next five years?

2018 to 2020
The dangers of reaching for yield
“There’s no such thing as a (risk-)free lunch"

A decade after the Financial Crisis, the effect of multi-year low interest rates took their toll on fixed income investors. Since companies could borrow money at low rates, the debt they issued came with a lower interest payment and therefore a lower yield.ⁱⁱ One way to boost yield was to go further out on the yield curve by buying bonds with longer duration, meaning higher sensitivity to interest rate changes.ⁱⁱⁱ The index was happy to do so, regardless of the additional risk. The "investment" supermarket firms capitalized on this by launching high income/high yield funds.

We warned clients about the extreme level of complacency in fixed income markets. It was the forgotten part of people’s portfolios that many hoped they could just set and forget. We recognized that lower yields had forced the crowd to reach for what was available and that there were more risks in the system than many were willing to acknowledge.

As the yield came down, the duration (or level of risk) kept increasing. That’s the definition of reaching for yield.

ICE BofA Canada Broad Market Index Yield-to-Maturity vs. Duration

Jun. 30, 1992 to Dec. 31, 2021

Source: Bloomberg LP. The ICE BofA Canada Broad Market Index is shown to represent the Canadian fixed income market. See Important information – benchmarks and indexes and Importation information – definitions for additional details.

When everyone perceived long-duration bonds to be safe, our belief was this asset class had become very risky. We pointed out that a long history of low rates had provided a nice tailwind for a generation of fixed income investors. They thought such a favourable environment would last forever, but we opted for a different approach that didn’t rely on historically low rates moving even lower. We kept our duration short in our EdgePoint Global and Canadian Growth & Income Portfolios (less than one quarter of the index) to protect against the prospect of rising rates and enable us to reinvest our maturing principal payments into a more-favourable market as they rose.

By 2020, the fixed income bull market was about 40 years old. Rates continued to drop while the world stayed home because of COVID-19. We didn’t run a standalone prospectus fixed income mutual fund, but felt we had a responsibility to make our advisor partners aware of the risks we were seeing in the space.

Here was the list of Canadian bond funds that we sent in an Email to our advisor partners in the middle of 2020. These were actual funds sold by a “who’s who” in the industry, but we altered the names to protect the “not-so-innocent":

Source: Morningstar Direct. Total annualized return in C$. AUM and 5-year return as at May 31, 2020. The universe of funds analyzed only includes funds with available duration and yield-to-maturity values, as well as a minimum AUM of $2 billion in the Canadian Fixed Income category. Series A MER, duration and yield-to-maturity taken directly from fund websites. If not disclosed on fund websites, Morningstar was used. “Return % not received by client” is calculated as the MER divided by the fund’s YTM and assumes a one-year holding period. “Years of return lost if rates rise 1.5%” was calculated as the “% loss if rates rise 1.5%” divided by the “Net Return.” The U.S. 10-year Government Bond was used to represent rate increases in the hypothetical performance examples above.

The numbers behind the largest Canadian fixed income funds weren’t pretty. The average portfolio had a duration of 8.2, yield-to-maturity of 2.30% and an MER of 1.34%. 

Assuming the 10-year Treasury bond yield moved up by 1.5% (basically back to where we were pre-COVID-19), then the client would lose more than 12% of their investment.

If nothing changed, then the average investor in these funds would make 1% annually for eight years (i.e., slowly going broke after accounting for inflation). The “set-and-forget" part of their portfolio was suddenly “set-and-forget about getting to point B.”

We can’t predict macro events like rate changes, but we knew they were going to move eventually. If rates went up, the crowd who had over $134 billion invested in these funds would be hurt. That amount of money implied a strong bet that rates would go down – DOWN from the lowest point in history.

Despite not having an alternative standalone fund to offer, we recognized the inherent risks and made it our mission to alert our advisor partners so they could keep their clients from getting caught in a potential “income trap.” fund. The conversations weren’t always easy, but we felt it was the right thing to do for our partners and their clients.

Unfortunately for many investors who stayed in these funds, we now know that interest rates did go up.

The following chart compares the returns of the fixed income portion of our EdgePoint Global and Canadian Growth & Income Portfolios against the average return of the funds from the previous Email and the overall Canadian bond market.

2019
Oil and gas
The dirtiest words in investing

In 2019 Canadian oil and gas was the world’s most-out-of-favour industry, spurred on by misguided ESG-related initiatives. Over our many years of investing, we’ve learned that such negative sentiment starts becoming the underpinnings for longer-term value creation if the investment can overcome the reasons for falling out of favour in the first place.

We aren’t aware of any energy fund launches at the time – other than our prospectus-exempt Portfolio available to accredited investors that invested in the unloved western Canadian energy businesses (which you can read about here). We believe in energy transition, but it needs a thoughtful strategy for gradually weaning off oil and gas – and the world is still unprepared yet to function without them.

Over four years later, the commodity has stayed true to its pattern of high volatility from big swings in supply and demand. Given the COVID-19 pandemic and certain geopolitical issues that have greatly impacted the prices of oil and gas, it’s certainly been a wild, if lonely, ride. The annualized return of the S&P/TSX Composite Energy Index since we launched our Portfolio on November 22, 2019 has been 20%.^iv

Regarding our Portfolio, it’s closed to new investors and we look forward to returning money to existing investors once we believe the opportunity in this space has ended.

2021
Why Canada

Unlike 2013, the average investor wanted nothing to do with Canada almost a decade later. Money continued to flow out of domestic funds.

Taking a different path than the crowd, we saw an opportunity in the widest valuation discrepancy between the S&P/TSX Composite and the S&P 500 Indexesin over a decade. We believed the crowd was overlooking good opportunities to invest domestically.

Forward price-to-earnings ratios – S&P/TSX Composite Index relative to S&P 500 Index

2001 to 2021

Source: Bloomberg LP. Chart displayed from April 2, 2001 to March 30, 2021. Price-to-earnings ratios are using forward consensus earnings per share estimates in calculations. Consensus earnings as at March 31, 2021. The indexes are not investible. See Important information – benchmarks and indexes for additional details.

A byproduct of this conviction was the Canadian allocation in our Global Portfolio and Cymbria (both global mandates) reaching its highest level in both Portfolios’ history:

Historical weight of Canadian businesses in EdgePoint Global Portfolio and Cymbria

As at Feb. 28, 2021

Weights rounded to the nearest decimals. EdgePoint Wealth Management excluded from Cymbria’s Canadian content weight.

We were joined on this unpopular road by the management teams of our existing Canadian businesses as they bought back shares to capitalize on the lower prices:

Fast forward three years, the Canadian index has outperformed the MSCI World Index. We believe in owning businesses, not the market. Our proprietary insights into predominantly Canadian companies resulted in EdgePoint Canadian Portfolio materially outperforming during this time frame.

Today

Looking at the headlines today, it’s easy to see the road chosen by the crowd. Tech stock share prices have been fueled by what they can do in the future with the promise of artificial intelligence and other innovations in our life. Flows in tech dwarf other sectors.

Source: Deutsche Bank Asset Allocation. In US$. As at January 17, 2024.

Some of the early winners at the start of the 2020s that were seen as disruptors during COVID-19 (e.g., WeWork and Peloton) have in turn seen their share prices disrupted. The crowd has moved on to the "Magnificent Seven" (Apple, Microsoft, Amazon, Alphabet, Tesla, Nvidia and Meta). These businesses are household names – their stocks move the needle on market performance and are taking seemingly everyone along for the ride. We don’t know if this is a bubble, but only time will tell.

The view from the top isn’t always pretty. History has shown that, on average, companies joining the largest 10 names experienced high returns on the way there. Unfortunately, their fairy tales usually didn’t have happy endings after joining the top 10:

Today, in a market overshadowed by the top 7 companies, we believe there’s opportunity in looking beyond the mega-cap names. As more money managers gravitate towards owning the largest companies to minimize their risk of underperforming the index, there’s been less focus towards the mid-cap space. Many of these companies are well established with long track records and dominant positions in their respective markets, yet their relative valuation is much lower than their large-cap counterparts:

S&P 100 Index vs. S&P 400 MidCap Index Relative valuations (average)

Dec. 31, 1999 to Dec. 31, 2023

Source: FactSet Research Inc. The S&P 100 Index and S&P MidCap 400 Index are shown to compare the relative valuations of large- and medium-capitalization companies. The indexes are not investible. See Important information – benchmarks and indexes for additional details. Relative valuations are the daily average of five valuation metrics for the two indexes: price-to-earnings ratio, price-to-book value ratio, price-to-cash flow ratio, price-to-sales ratio and enterprise value-to-earnings before interest, taxes, depreciation and amortization.

In January of this year, we saw something that’s never happened before – the S&P 500 Index reached a new high while the small-cap Russell 2000 Index was in bear-market territory (i.e., down 20% from its peak). This is the clearest illustration of the growing levels of valuation distortion in today’s market.

S&P 500 Index vs. Russell 2000 Index – Growth of $100

Jan. 31, 2014 to Jan. 31, 2024

Source: FactSet Research Systems Inc. In US$. The S&P 500 Index and Russell 2000 Index are shown to compare return of large- and small-capitalization companies over a 10-year period. November 8, 2021 was the peak of the Russell 2000 Index. As of January 31, 2024, the price level of the Russell 2000 Index is 20% lower than its peak in November 2021, while the S&P 500 Index continues to reach new highs. The indexes are not investible. See Important information – benchmarks and indexes for additional details.

Our view is that looking beyond the mega-cap names may feel uncomfortable in the short term, but it has the potential to result in pleasing returns over the next five years. While other large Global Equity Funds are happy to invest in the consensus, we again happily find ourselves away from the crowd.

The willingness to look wrong in the short term

Reaching your financial goals can be a lonely road and it’s tempting to follow others along a well-worn path because it seems like the safest option. Crowdsourced financial decisions are usually based on “common knowledge.” Although it may feel safe, unfortunately an idea's widespread acceptance practically guarantees its failure. 

At EdgePoint, we firmly uphold the conviction that to outperform, you have to look different. Often, this means having the willingness to look wrong in the short term in order to be right in the long term.

Thank you for placing your trust in us. As always, we will work hard every day to continue earning it.