Jeff Evans, Executive Director of Quantitative Strategy at CIBC World Markets, describes his firm’s scientific, process-driven approach to identifying investment opportunities and mentions why he’s bullish on Canadian equities and Canadian small caps. He also explains why he is focusing on one particular area of the resource sector and reveals seven stocks that he thinks will outperform.
Video transcription
Mark Thorburn: Today on SmallCapPower, we’re pleased to feature an interview with Jeff Evans. Mr. Evans is an Executive Director at CIBC Wholesale Banking and heads up the firm’s quantitative equity research team. Prior to joining CIBC, Mr. Evans held roles at two other Canadian investment dealers, including more than 12 years as a key member of one of Canada’s top ranked quantitative research teams. Welcome, Jeff. Please tell us a bit about your firm as well as your role there.
Jeff Evans: So I work for CIBC World Markets, it’s the investment bank and brokerage arm of CIBC. For corporate clients, we provide underwriting and advisory services, and then on the brokerage side, it also provides trade execution, trade facilitation services, as well as research. So that’s my role within the firm as a research analyst, focusing on the Canadian and U.S. markets and providing coverage through quantitative models. So we’re using mathematical and statistical techniques to identify predictive relationships and broader trends in markets, and trying to identify the stocks that are attractive in those spaces.
Mark Thorburn: I understand your research relies on a scientific, process-driven approach to identifying investment opportunities. Can you explain what this means?
Jeff Evans: Sure. So I think one of the biggest challenges that investors face today is the volume of information that exists on the market. If you think about even a single company, there’s hundreds of data points, from the balance sheet, the income statement and so on, press releases, management interviews, and then multiply that by the hundreds of stocks that are actually in the marketplace. The challenge is: where do you start processing that information, how do you sort good companies from bad and ultimately how do you arrive at an investment decision?
So what we’re trying to do in the quant model is take all of that data, analyze it statistically using mathematical techniques and a lot of computing power to try to identify predictive relationships. What we’re doing is looking for a small number of variables that, over time, have shown the ability to predict stock returns and then use those relationships to identify what’s currently attractive in the market. So as a good example, one of the best-known techniques over time has been to focus on valuation. Companies that trade at low valuation multiples usually outperform over time, and if we can identify the periods of time or the economic conditions where that’s most predictive, we’ll rotate into those firms and increase our weight in the portfolio to those characteristics.
Mark Thorburn: You’ve recently been quite bullish on Canadian equities and Canadian small caps in particular. Could you discuss some of the factors in your quant model that led you to this view?
Jeff Evans: So one of the things that we’ve been seeing in the U.S. for the last two years or so is a significant rotation into the higher risk equities, so companies with high volatility and high betas. Small cap stocks in the U.S. have been performing very well over time. And we’ve also been seeing the lower quality firms, companies that are unprofitable but tend to work very well as the economy’s growing. The trouble is, Canada didn’t show that same rotation until recently. A lot of that was driven by the weakness in emerging markets and ultimately the weakness in commodity prices. We’ve seen a lot of, essentially, delay in the Canadian universe, rotating the same way that the U.S. has. Starting about midway through last year, though, we started to see in the energy sector and also in the financials, some of those higher risk and more economically sensitive names outperforming. So it was high-beta stocks doing well, small caps, value stocks, and then also some of the lower-yielding stocks, companies with low yields or low payout ratios. These are firms that aren’t distributing their cash to shareholders, they’re actually reinvesting it in their own businesses because they have opportunities and they see good growth opportunities. That’s played out through the course of this year. We’re still seeing that in the U.S., but in the Canadian case, there’s a much greater opportunity to catch up to where the U.S. has been over the last few years.
Mark Thorburn: Quantitative investing is somewhat underdeveloped in the Canadian market and particularly so among small cap stocks. Why should a small cap investor consider a quantitative model, and how have quantitative strategies performed over time in the Canadian small cap universe?
Jeff Evans: We’ve actually, out of all the models that we’ve run, the opportunities in small caps are some of the largest. We’ve seen very significant alpha from a properly structured model. And the main reason we think that’s the case is because a lot of these names are under-researched by the Street. In the large-cap space, it’s not uncommon to have 10 or 15 analysts covering a name, whereas in our small cap universe, you’re lucky, often, if there’s two or three analysts. In many cases, nobody’s covering those stocks. And that’s where a quantitative model can add a significant amount of value. By doing even relatively simple screens, focusing on valuation and systematically rotating into the less expensive firms. Right now, with some of the higher risk firms, we’re focusing on different profitability or predictive metrics. We think there’s a great opportunity from a quant strategy that can analyze a large group of names that are otherwise under-researched.
Mark Thorburn: After a sharp collapse in 2013, gold stocks are rallying dramatically this year and feature prominently in your quantitative models. Could you discuss some of your preferred gold stocks and what you believe will drive returns over the coming year?
Jeff Evans: So the gold industry’s been a very interesting one in Canada, with a bumpy ride over the last few years. About two years ago, we were actually, for the most part, net short or selling a lot of the gold names, which was driven, in part, by valuation. A lot of gold stocks were some of the most expensive companies in Canada, particularly relative to profitability. They were also very, very high-risk, in a period where low-risk stocks were outperforming. And then in many cases, these firms were also over-investing in CAPEX and mine growth, right at the tail-end of the gold price move. What we’ve been seeing this year, now that valuations have come down significantly and adjusted, with gold firms deferring or in some cases canceling their CAPEX, we’re now starting to see that de-risking process take place. Generally speaking, better balance sheets, a recovery in profitability, and on top of that as well, valuations far more attractive than they have been in several years, in fact, probably more than a decade. A few of the names that we’ve been focused on in the small and mid-cap space would be OceanaGold Corporation (TSX: OGC) or SEMAFO Inc. (TSX: SMF). Both of these are in roughly the $1-2 billion market cap range. What really jumps out to us in both cases are that for Oceana, very profitable gold company, 20% ROE today, up over the last few years. Semafo’s a little different, we’ve seen ROE turn negative because of some of their investments, but consensus estimates expect that to come back over the next two to three years and move up to about 10-15% ROE. And then really the important thing for me here is that these are higher-risk companies, with betas of two to two and a half relative to the TSX. Ordinarily I wouldn’t want to go after names that are risky like that, but in the environment that we’re in today, with the economy gradually improving, growth getting better, and interest rates moving higher, that’s usually a period where the high beta names outperform. Another name, if you’re willing to go down the small cap size a little bit further, is Lake Shore Gold Corp. (TSX: LSG): $500 million market cap, very strong production growth, and also starting to see profitability, again, recover recently. I should mention in this case as well, too, that we do have positions in all of those names.
Mark Thorburn: Energy stocks have also been strong performers this year. What should investors be looking for when selecting a small cap energy firm, and what are a few of your current recommendations?
Jeff Evans: So within our quant model, when we look at the resource sectors, a lot of the characteristics that are working well and showing strong predictive accuracy these days would be small cap stocks outperforming value stocks and high-risk stocks. What we’re also seeing is that low-profitability companies are outperforming. So these are firms with low profit margins or low ROE levels, but where we’re starting to see revenue growth and margin expansion.
A couple of the things we’ve been seeing this year, I guess if you go back to 2013, it was a lot of the gas-weighted producers that were doing well as natural gas prices came back. We’re seeing in 2014 a switch to a lot of the oil-weighted names. So a similar process playing out, not so much with spot prices. The spot price has been around $100 a barrel pretty consistently, but it’s the back-end 2015, 2016 expectations that are starting to come up. What that’s doing now is driving higher earnings revisions and profitability ultimately over the next few years.
What we’ve been doing is focusing again on the junior gold companies that have been showing strong revenue growth and strong production growth. Again, in the small to mid cap segment, a couple of names that jump out, and again these are names that we generally have positions in as well, would be Bankers Petroleum Ltd. (TSX: BNK) or Birchcliff Energy Ltd. (TSX: BIR), or in the smaller cap space, RMP Energy Inc. (TSX: RMP) and Rock Energy Inc. (TSX: RE). What all those stocks have in common is significant double-digit revenue growth. A lot of that’s coming from the results of investment over time now starting to actually translate through into actual profitability. They’ve moved in a lot of cases from either unprofitable positions over the last few years or very low profitability to now 10-15% ROEs. We’re seeing that process of margin expansion take place.
And then as well the other important characteristic is that volatility or beta component. So we’re seeing a lot of these names trade at beta of 1.5 to 1.7. Again, ordinarily not the type of companies that we want to buy, but in this period of time where interest rates are expected to rise over the rest of 2014 and economic growth is expanding, that’s actually the ideal condition to be buying the higher risk, more economically sensitive names.
Mark Thorburn: Thank you for taking the time for the interview today, Jeff.
Jeff Evans: Thanks for having me here today.
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