Author: Cole Heideman

Performance Summary

During the quarter, both the US and Canadian Equity Strategies continued to outpace their respective benchmarks in terms of dividend growth. From a return perspective, US Equity Strategy portfolio outperformed the S&P 500 Total Return Index during the quarter. Our Canadian Equity Strategy underperformed the S&P/TSX Composite Total Return Index in the quarter. For a more detailed discussion on performance see each Strategy’s respective section below.

Dividend Growth

Note: LTM Dividend Growth is the median of the actual trailing 12-month dividend growth of the individual stocks held by Strategies or Index constituents as reported by Bloomberg as at Dec 31, 2022. FTM Dividend Growth is the median of the Bristol Gate Model’s forward 12-month prediction for the individual stocks held by the Strategies and the median of consensus estimates for the constituents of the Indices as of quarter end. Companies without a consensus dividend forecast were excluded. Return commentary based on gross returns.

Source: Bloomberg, FactSet, Bristol Gate Capital Partners.

Commentary

2022 proved to be a difficult year for public market investors. There was no escaping the negative effects rising inflation and tightening monetary policy had on asset values. The S&P 500 had its worst year since the Global Financial Crisis, declining over 18% and investors were unable to find shelter in fixed income with the US Aggregate Bond Index declining over 12%.

During periods like these, it is easy to get caught up in the here and now. Focusing on the daily fluctuations of the market can make investors lose sight of the bigger picture, often resulting in hasty decisions based on short-term market trends. Whenever we are faced with difficult market conditions, we always remind ourselves to zoom out. 

Zooming out can be important in a number of contexts, as it allows one to take a broader perspective on a situation or problem. This can help to identify patterns or trends that might not be immediately visible when focused on the details. It can also provide a sense of context and help to put things into perspective, which can be useful when making decisions or trying to understand a complex issue.

Lastly, zooming out can help to identify the bigger picture and facilitate the development of long-term strategies or plans.[1] Often when zooming out, things don’t look so bad. If we look at the last five years instead of just the last one, our US strategy has generated a compounded annual return (CAGR) of 10.2% (gross) (9.1% net), the S&P 500 Total Return Index a CAGR of 9.4%, and the S&P Dividend Aristocrats Total Return Index a CAGR of 9.8%. We think those are attractive results considering experiencing two bouts of Fed tightening (2016-2019 and again now), a global pandemic and the economic fallout resulting from it, a major war in Europe and rising tensions between the world’s two superpowers, amongst other negative events. Even after the market decline this year, many investors are well ahead of plan in reaching their long-term financial goals.

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Exhibit 1. Bristol Gate US Equity Strategy and Select S&P Index Total Returns (Growth of $100)

As at Dec 31, 2022. Source: Morningstar, Bristol Gate Capital Partners.  There is a risk of loss inherent in any investment; past performance is not indicative of future results. Please see Exhibit 5 below for full performance history of the Bristol Gate US Equity Strategy and see Important Disclosures at end of document.

[1] This paragraph was written by OpenAI’s ChatGPT, which we spent some time fiddling around with over the holidays.

Zooming out also allows us to focus on the things we can control and continue making the investments necessary to drive our business or investor financial goals forward. While we don’t know when the Fed will stop raising rates or whether we will be pushed into a recession before they do, a broader perspective tells us that markets will eventually recover. They always have, particularly the good companies with solid balance sheets and underlying fundamentals. That knowledge allows us to continue investing for the future, with the goal of those investments driving improved outcomes for our investors.

In that regard, we wanted to take this opportunity to update our clients on two investments made in the last year. The first focused on our continuous efforts to optimize the decision making and performance of our Investment Committee (IC) and the second related to our dividend predictions.

Investment Committee Review

Renowned behaviour psychologist Daniel Kahneman wrote ‘wherever there is judgement, there is noise – and more of it than you think… To understand error in judgment, we must understand both bias and noise.

We believe a disciplined, evidence-based approach will serve our investors and partners better. This is why we built our firm with evidence and data at the centre, rather than individual and ego. Understanding bias and noise is important to our decision-making process and ensuring we don’t stray from our focus.

In this vein, we hired BehaviorQuant (“BQ”), the brainchild of Thomas Oberlechner, an expert in behavioral finance and financial psychology to examine our IC. Mr. Oberlechner holds a psychology doctorate and three Masters’ degrees in law, psychology, and consulting psychology from Harvard University and University of Vienna. BQ use psychometrics and machine learning to quantify decision makers’ behavioral characteristics, preferences, and biases. BQ has worked with hundreds of different teams of investment managers and some of the world’s largest trading floors to build a database to determine what drives people in the financial business. Behavioral Quant’s own findings have shown that by choosing the wrong investment team an investor’s return is approximately 33% below that of a team well suited to one another.

We think a thorough evaluation of all firm risks, including an expert analysis of the people responsible for the stewardship of client assets should be undertaken regularly. If we can ensure that our Investment Committee fits well together, use our collective strengths and improve on our weaknesses, we will be better at understanding how to optimize our investment decision making for the benefit of investors. By identifying invisible decision biases and harmful behavioral tendencies, we think we are better able to limit the harmful noise Kahneman is referring to.

Our intention in engaging BQ was to systematically evaluate all members of the investment team, identify any red flags, and develop a plan to improve our individual and collective decision making. Each member was subjected to a test, measuring their personality characteristics, assessing competencies and measuring risk capacity and tolerance. Scores were measured individually and then consolidated into an overall team analysis. Our team scores were then analyzed against hundreds of other investment teams.

While there are always areas for improvement, our overall team results were exactly what we were hoping for. We have a team that operates with strongly shared convictions regarding the process, believe in the power of dividend growth, but are also not afraid to share their ideas and challenge convention and each other in a respectful and open manner.

Distant Future Prediction

Bristol Gate uses data-science driven predictions as part of its investment process in conjunction with fundamental analysis. Through the research being done by our data science team, we have concluded we can materially improve our performance potential if we can extend our dividend prediction horizon.  This is aligned with the fact that the earlier a signal is captured, the greater its potential. Exhibit 2 below details the results of our testing based on having perfect foresight. That is, knowing and investing in the fastest dividend growers in advance of the forecast horizon. Portfolio 1 (blue line) is composed of the top quartile of the fastest dividend growers over period “X”. We will call it the “Near Future Prediction”. Portfolio 2 (red line) is composed of the top quartile of the fastest dividend growers over period “Y”. Period “Y” is greater than period “X”. We will call it the “Distant Future Prediction”. Both portfolios are reconstituted annually, with no other trading occurring in the intervening period.

Exhibit 2. Annual Excess Return vs. S&P 500 Total Return Index – Perfect Foresight

Note: Dashed lines are median excess returns over the period presented.

Source: FactSet, Bristol Gate Capital Partners.

You can see that based on perfect foresight, the Distant Future Prediction consistently and meaningfully outperforms the Near Future Prediction. This is the theoretical alpha opportunity of moving to a Distant Future prediction.

One issue with which all forecasters struggle is that the further out the prediction, the higher the uncertainty. This is because the range of possible outcomes expands exponentially the further out we look. Real world challenges (changing macro conditions, random events like COVID, unforeseen competitive responses, etc.) mean that we never expect to fully capture the theoretical alpha opportunity. We will never be able to predict with 100% accuracy. 

However, Exhibit 3 tells us that we should be willing to sacrifice accuracy for a longer prediction horizon. Again, based on the perfect foresight portfolio, at anything better than a 20% hit rate (we only get one in five of the top quartile of dividend growers over the forecast horizon right), the probability of outperforming our benchmark Index is higher with Distant Future Prediction (the red line is above the blue line in the graph below).

Exhibit 3. Probability of Outperformance vs. Hit Rate – Perfect Foresight

Source: FactSet, Bristol Gate Capital Partners.

Said another way, having an 80% hit rate with Near Future Prediction Horizon provides the same probability of outperformance (70%) as a 40% hit rate with the Distant Future Prediction horizon. The historical data suggests that we are well compensated despite being less accurate. In addition, the slope of the line (hit rate vs probability of outperformance) for the Distant Future Prediction is steeper, almost twice that of its counterpart for the Near Future Prediction. Therefore, any improvement in forecast accuracy has a much larger impact on the Distant Future model compared to the Near Future one. 

Given the results above, we have spent the last year building a new model to extend our prediction horizon. The new model is built leveraging the knowledge we accumulated over years of predicting dividend growth and the early results are encouraging.

Exhibit 4. Distant Future Prediction vs Current Prediction Annual Return Difference – 1Y Holding Period

Source: FactSet, Bristol Gate Capital Partners.

Exhibit 4 plots the excess return of the top quartile of dividend growers of our new Distant Future model compared to our current one. Despite an approximate 30% lower hit rate in terms of accuracy, our Distant Horizon model outperformed our current version in back testing. Upon analysis, this model outperformance is consistent over holding periods ranging from one to three years. Extending our forecast, even with lower accuracy, clearly tilts the odds of outperforming our benchmark further in our favour. While that annual outperformance may seem minimal, even small differences compounded over time can add up to meaningful amounts.

While we are excited with all the above, we do not want to set unrealistic expectations. We are early in the process of eventually putting the Distant Future Prediction into production. We have a lot of work ahead of us and the new prediction does not come without its own set of challenges. We will be spending the coming months continuing to work to improve our hit rate and analyzing the data to better understand such things as impact on turnover, volatility and other risk related metrics. We want to ensure what we have seen in the lab ultimately translates to real world application. If we can improve our hit rate from these initial results, the opportunity appears very interesting.

US Equity Strategy (all returns USD)

The US Equity strategy outperformed the S&P 500 Index during the quarter. While we are never happy with a negative return, we were encouraged that the portfolio was able to make up almost all of the 700 basis point performance deficit (net basis) it faced relative to the S&P 500 Index at the end of Q1/22. At the time we wrote the following:

We believe our investment discipline of owning high quality companies, with good balance sheets that can grow their dividends at exceptional rates over the longer term will eventually return in favour and will provide competitive returns through the entire economic cycle. Although our investment performance has been disappointing this quarter, we have not been disappointed with the aggregate financial results of our companies.

We followed that up with this in our Q3/22 note:

During times like these quality matters because stability and consistency of earnings combined with dividend growth is often more appreciated by the market when there is a lack of it available. We believe we are in one of those periods now. The quality and resilience of our portfolios are critical in allowing us to look through the current turbulence with optimism and predict into the future with some degree of confidence. Our holdings have the ability and willingness to continue investing through the uncertainty, increasing their competitive advantages and coming out stronger on the other end. They have done so in the past and we expect the same going forward.

Over the trailing 12 months (the December quarter has yet to be reported), our portfolio companies have averaged double digit revenue and EPS growth and their latest quarterly dividends were ~18% higher than the year ago period. After some great companies were thrown out with the bathwater to start the year, we believe the quality of the companies we own was better reflected by the market as the year wore on, with the portfolio rising ~5% in the second half of the year compared to the market’s ~2% increase.

Exhibit 5: US Equity Strategy Risk and Return Metrics

Source: Bristol Gate Capital Partners. There is a risk of loss inherent in any investment; past performance is not indicative of future results. Please see important dislosures at end of document.

Relative to the S&P 500 Index, stock selection was the primary driver of outperformance in the quarter. Sectoral allocation was again negative, largely due to our overweight in Consumer Discretionary and zero weight in Energy. 

During the quarter, Broadcom, Starbucks and Roper Technologies were among the largest absolute contributors to returns. Advance Auto Parts (AAP) and Zoetis were our only two negative returning stocks. AAP was the largest detractor after reporting another disappointing quarter.

When we initially invested in AAP in mid-2021, our thesis was that company was in a solid industry but operationally lagged its public peers. Management had embarked on a multi-year operational improvement plan and the process changes they were making were significant.

We knew going in improvements would not come in a straight line and not be without challenges. However, given the combination of our dividend prediction (amongst the best dividend growth in the market at the time), the attractive industry dynamics and the inexpensive valuation (AAP was trading at a 6.5% FCF yield on enterprise value at the time), we were willing to take on the execution risk around the improvement plan.

The company struggled on two fronts this year. The first was that they could not meet demand for certain products where the assortment was moved to private label due to supply chain challenges. Management has identified and implemented actions to address these issues and we expect to see improvement going forward.

Secondly, two of AAP’s largest competitors decided to sacrifice their own margins to gain share in the do-it-for-me (DIFM) channel, where they both trail AAP. AAP’s management had a decision to make, protect margins to achieve their guidance and lose further share or respond in kind. They chose the latter. We think they made the right decision as any loss in sales would have had a negative effect on margins regardless. This current pricing dynamic is uncharacteristic for the industry which has generally been well behaved from that perspective. We continue to monitor the situation closely but believe management has taken a prudent stance in their outlook and the initial share price decline following the quarter went too far.

As part of our regular rebalancing process in November, Dollar General and Starbucks were trimmed. The proceeds were allocated to Intuit, Zoetis, Mastercard, Lowe’s and Moody’s.

For the year, the top contributors to portfolio returns were Activision Blizzard, UnitedHealth Group and Dollar General, while the bottom three were Zoetis, Intuit and Applied Materials. All three detractors experienced significant multiple contraction during the year despite solid underlying fundamentals.

Exhibit 6. Top Annual Detractors Underlying Fundamentals

Note: EPS is based on adjusted EPS comparable to consensus estimates. Dividend growth is based on the last quarterly payment.

Source: FactSet, Bristol Gate Capital Partners.

Relative to the benchmark, our stock selection was positive but entirely offset by sector allocation. Our zero weight in Energy had an almost 220 basis point negative impact on relative annual returns. As we have highlighted previously, it is not unusual for us to have low exposure to commodity related markets due to our process and their unpredictable nature.

It has undoubtedly been a trying year. From our perspective, times like these offer attractive opportunities for long-term investors. Valuations have been reset. Inflation, while persistent, appears to have peaked. The Fed is likely closer to the end of the hiking cycle than the beginning. An economic recession sometime in 2023 has become a consensus view and markets have already discounted some of that. Although we continue to believe 2023 consensus expectations for double digit earnings growth for the broader market look optimistic considering slowing economic growth and rising costs, we are not investing in the entire market. We are looking for 22 companies that can grow their dividends at above average rates on the back of solid underlying fundamentals. Our disciplined process and philosophy aim to eliminate the noise market volatility creates and instead take advantage of it. There is a broader offering of investment opportunities available at more attractive valuations than existed a year ago, and we enter the new year enthusiastic about the future for our clients.

Canadian Equity Strategy (all returns CAD)

The Canadian Equity strategy underperformed the S&P/TSX Composite Index during the quarter, finishing in line with the benchmark for year (net basis), erasing almost all of a significant relative deficit to the index (~700bps) that we faced after Q1/22.

Source: Bristol Gate Capital Partners. There is a risk of loss inherent in any investment; past performance is not indicative of future results. Please see important disclosures at end of document.

Stock selection in the Industrials, Materials and Consumer Discretionary sectors and having no exposure to the Energy sector drove the relative underperformance in the quarter. This was partially offset by both our overweight and stock selection in the Information Technology sector, and no exposure to Utilities. Stella Jones, Enghouse and Element Fleet were among the largest absolute contributors to returns, while CCL Industries, Waste Connection and Brookfield Corp. were among the largest detractors.

As part of our regular rebalancing process, in November we trimmed both Waste Connections and Intact Financial to our target equal weights. The proceeds were allocated to Open Text, Premium Brands and Zoetis.

On a relative basis for the year, not having any exposure to Energy cost us over 400bps of relative performance. This was larger than what we experienced in the US due to the sector’s weight in the Canadian Index. Our portfolio was able to overcome that hurdle due to solid stock selection and the underlying fundamental strength of our holdings. Over the trailing 12 months (the December quarter has yet to be reported), our portfolio companies delivered median ~16% revenue growth, ~15% EPS growth and their latest quarterly dividends were ~11% higher than the year ago period.

Firm Update

This year we were thrilled that we were able to once again see many of our valued clients in person as our sales and investment teams have slowly resumed traveling. We have returned to a new normal, hybrid work environment this year. Our culture is one of trust and accountability, and we are proud of how we navigated the challenges that the pandemic brought to the workplace.

As we look ahead to the next year, our priority remains on finding the best possible ways to help our clients achieve their goals. We are always looking for ways to improve and make our investment process more robust. In addition to the two projects discussed earlier, others remain at various stages of completion.

We are also delighted to welcome Laura Hall to the team in the role of Operations Analyst. Laura is an avid learner, evidenced by the fact that she has a double major undergraduate degree, which is only outnumbered by how many pet dogs she has (3!). 

To all our clients, thank you for your ongoing support and trust. We are determined to do everything we can to provide you continued income growth and strong investment returns going forward. If we have not done so already, we hope to see you in person sometime soon. In the meantime, we wanted to highlight two upcoming webinar events.  On January 31^st, our CIO, Izet Elmazi, will be presenting at the CFA Society Toronto’s Annual Equity Symposium. He will be discussing our investment process and highlighting a company we own in the portfolio. Then on February 9^th, we will be hosting the third installment of our Speaker Series. This edition will feature Chris Miller, author of the 2022 FT Business Book of the Year, Chip War: The Fight for the World’s Most Critical Technology. We believe Chris will provide fascinating insight on a very relevant current event. We hope you can join us for both.

Sincerely,

The Bristol Gate Team

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Important disclosures

There is a risk of loss inherent in any investment; past performance is not indicative of future results. Prospective and existing investors in Bristol Gate’s pooled funds or ETF funds should refer to the fund’s offering documents which outline the risk factors associated with a decision to invest. Separately managed account clients should refer to disclosure documents provided which outline risks of investing. Pursuant to SEC regulations, a description of risks associated with Bristol Gate’s strategies is also contained in Bristol Gate’s Form ADV Part 2A located at www.bristolgate.com/regulatory-documents.

Gross returns in this report refer to the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite. No allowance has been made for custodial costs, taxes, operating costs, management and performance fees, which will reduce performance. Past performance is not indicative of future results. Allowance for withholding tax in the US strategy composite is partially reflected in the composite returns for periods commencing January 2017 and after. The Net returns for the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite are reflective of the maximum management fee charged by Bristol Gate of 1% and 0.70%, respectively.

The Bristol Gate US Equity Strategy Composite was formerly known as the Bristol Gate US Dividend Growth Composite until April 1, 2015. The Composite inception date was May 15, 2009. The Composite consists of equities of publicly traded, dividend paying US companies and is valued in US Dollars.

The Bristol Gate Canadian Equity Strategy Composite was formerly known as the Bristol Gate Canadian Dividend Growth Composite until April 1, 2015. The Composite inception date was July 1, 2013. The Composite consists of equities of publicly traded, dividend paying Canadian and US companies and is valued in Canadian Dollars.

The S&P 500® Total Return Index measures the performance of the broad US equity market, including dividend re-investment, in US dollars. This index is provided for information only and comparisons to the index has limitations. The benchmark is an appropriate standard against which the performance of the strategy can be measured over longer time periods as it represents the primary investment universe from which Bristol Gate selects securities. However, Bristol Gate’s portfolio construction process differs materially from that of the benchmark and the securities selected for inclusion in the strategy are not influenced by the composition of the benchmark. For example, the strategy is a concentrated portfolio of approximately equally weighted dividend-paying equity securities, rebalanced quarterly whereas the benchmark is a broad stock index (including both dividend and non-dividend paying equities) that is market capitalization weighted. As such, strategy performance deviations relative to the benchmark may be significant, particularly over shorter time periods. The strategy has concentrated investments in a limited number of companies; as a result, a change in one security’s value may have a more significant effect on the strategy’s value.

SPDR S&P 500 ETF Trust (SPY US) sourced from Bloomberg has been used as a proxy for the S&P 500® for the purpose of providing non-return based portfolio statistics and sector weightings.

The S&P/TSX Total Return Index measures the performance of the broad Canadian equity market, including dividend re-investment, in Canadian dollars. This index has been provided for information only and comparisons to the index has limitations. The benchmark is an appropriate standard against which the performance of the strategy can be measured over longer time periods as it represents the primary investment universe from which Bristol Gate selects securities. However, Bristol Gate’s portfolio construction process differs materially from that of the benchmark and the securities selected for inclusion in the strategy are not influenced by the composition of the benchmark. For example, the strategy is a concentrated portfolio of approximately equally weighted dividend-paying equity securities, rebalanced quarterly whereas the benchmark is a broad stock index (including both dividend and non-dividend paying equities) that is market capitalization weighted. As such, strategy performance deviations relative to the benchmark may be significant, particularly over shorter time periods. The strategy has concentrated investments in a limited number of companies; as a result, a change in one security’s value may have a more significant effect on the strategy’s value.

iShares Core S&P/TSX Capped Composite Index ETF (XIC CN) sourced from Bloomberg has been used as a proxy for the S&P/TSX Total Return Index for the purpose of providing non-return based portfolio statistics and sector weightings.

There is the opportunity to use leverage up to 30% of the net asset value. Leverage is not used as an investment tool to enhance returns, but for cash management needs of certain composite portfolios.

This Report is for information purposes and should not be construed under any circumstances as a public offering of securities in any jurisdiction in which an offer or solicitation is not authorized. Prospective investors in Bristol Gate’s pooled funds or ETF funds should rely solely on the fund’s offering documents, which outline the risk factors associated with a decision to invest. No representations or warranties of any kind are intended or should be inferred with respect to the economic return or the tax implications of any investment in a Bristol Gate fund.

Bristol Gate claims compliance with the Global Investment Performance Standards [GIPS®]. To receive a list of composite descriptions and/or a presentation that complies with the GIPS® standards, please contact us at info@bristolgate.com. Bristol Gate Capital Partners Inc. has been independently verified for the periods commencing May 2009 until December 2015 by Ashland Partners International PLLC and from January 1, 2016 – December 31, 2020 by ACA Group, Performance Services Division.

This piece is presented for illustrative and discussion purposes only. It should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities and it does not consider unique objectives, constraints, or financial needs of the individual. Under no circumstances does this piece suggest that you should time the market in any way or make investment decisions based on the content. Investors are advised that their investments are not guaranteed, their values change frequently, and past performance may not be repeated. References to specific securities are presented to illustrate the application of our investment philosophy only, do not represent all of the securities purchased, sold or recommended for the portfolio, and it should not be assumed that investments in the securities identified were or will be profitable and should not be considered recommendations by Bristol Gate Capital Partners Inc. A full list of security holdings is available upon request. For more information contact Bristol Gate Capital Partners Inc. directly. The information contained in this piece is the opinion of Bristol Gate Capital Partners Inc. and/or its employees as of the date of the piece and is subject to change without notice. Every effort has been made to ensure accuracy in this piece at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and Bristol Gate Capital Partners Inc. accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. We strongly recommend you consult with a financial advisor prior to making any investment decisions. Please refer to the Legal section of Bristol Gate’s website for additional information at bristolgate.com.

A Note About Forward-Looking Statements

This report may contain forward-looking statements including, but not limited to, statements about the Bristol Gate strategies, risks, expected performance and condition. Forward-looking statements include statements that are predictive in nature, that depend upon or refer to future events and conditions or include words such as “may”, “could”, “would”, “should”, “expect”, “anticipate”, “intend”, “plan”, “believe”, “estimate” and similar forward-looking expressions or negative versions thereof.

These forward-looking statements are subject to various risks, uncertainties and assumptions about the investment strategies, capital markets and economic factors, which could cause actual financial performance and expectations to differ materially from the anticipated performance or other expectations expressed. Economic factors include, but are not limited to, general economic, political and market factors in North America and internationally, interest and foreign exchange rates, global equity and capital markets, business competition, technological change, changes in government regulations, unexpected judicial or regulatory proceedings, and catastrophic events.

Readers are cautioned not to place undue reliance on forward-looking statements and consider the above-mentioned factors and other factors carefully before making any investment decisions. All opinions contained in forward-looking statements are subject to change without notice and are provided in good faith. Forward-looking statements are not guarantees of future performance, and actual results could differ materially from those expressed or implied in any forward-looking statements. Bristol Gate Capital Partners Inc. has no specific intention of updating any forward-looking statements whether as a result of new information, future events or otherwise, except as required by securities legislation.

Performance Summary

During the quarter, both the US and Canadian Equity Strategies continued to outpace their respective benchmarks in terms of dividend growth. From a return perspective, US Equity Strategy portfolio performed in line with the S&P 500 Total Return Index while our Canadian Equity Strategy outperformed the S&P/TSX Composite Total Return Index. For a more detailed discussion on performance see each Strategy’s respective section below.

Dividend Growth Summary

Note: LTM Dividend Growth is the median of the actual trailing 12-month dividend growth of the individual stocks held by Strategies or Index constituents as reported by Bloomberg on September 30, 2022. FTM Dividend Growth is the median of the Bristol Gate Model’s forward 12-month prediction for the individual stocks held by the Strategies and the median of consensus estimates for the constituents of the Indices as of September 30, 2022. Companies without a consensus dividend forecast were excluded.

Source: Bloomberg, FactSet, Bristol Gate Capital Partners.

Commentary – Quality is Job 1

We usually end our quarterly notes thanking clients for their continued support. In turbulent times like these, that unwavering confidence in our investment process is worth noting up front and is particularly appreciated as it allows us to remain focused on the long term.

A cocktail of high inflation, aggressive global central bank policy, an ongoing war in Europe, a growing Cold War with China, the global consequences a strong US dollar, amongst other risks has resulted in a highly uncertain macro environment. As US Federal Reserve Chair Jerome Powell said in September, “The chances of a soft landing are likely to diminish (as the Fed keeps raising rates)…No one knows whether this process will lead to a recession or, if so, how significant that recession would be.”

Financial conditions are tightening, economic growth is slowing, and things are starting to break. One current high-profile example in the financial press is the UK pension scheme, where a strategy to leverage their bond portfolio to generate additional returns has spectacularly backfired, forcing them to sell assets to cover losses and margin loans. More than a decade of virtually free money funded a lot of questionable ideas that usually involve unsustainable leverage and/or poor business models. Those two characteristics can be a death blow when rates are rising rapidly as they currently are. We would not be surprised if more things start to break.

The damage stock markets have sustained thus far has largely been sentiment related. Valuation multiples have contracted significantly, accounting for all of the S&P 500’s decline to date. Its 12-month forward P/E ratio has fallen 29% since year end compared to the Index’s price decline of 25% to the end of September. We believe the next phase of this cycle, if it has further to go, will be driven by a revision of earnings expectations. Consensus earnings forecasts for the S&P 500 have largely remained stable to this point, inadequately reflecting the deteriorating macro environment in our view. 

In markets like these, we are always reminded of the 1980’s Ford commercial slogan, “Quality is Job 1”. Business quality is one of the four pillars of our investment process and is something that we do not compromise on when building our portfolios, believing it inherently builds resilience. In ecology, resilience is defined as the capacity of an ecosystem to respond to disturbances by resisting damage and recovering quickly. Resilience accepts that uncertainty and change are inevitable and focuses on withstanding the unexpected. While the definition of quality may slightly vary from person to person, we think US Supreme Court Justice Potter Stewart put it best in his landmark case defining obscenity, “I know it when I see it.” At Bristol Gate we define quality based on the nine traits in Exhibit 1 below.

Exhibit 1. Quality Traits of Bristol Gate Dividend Growers

Source: Bristol Gate Capital Partners Investment Presentation.

We believe quality companies exhibit stable and persistent earnings, high returns, strong cash flows, stable and wide profit margins, and low debt levels. All our portfolio companies are investment grade rated by the major credit rating agencies. We believe these characteristics fundamentally reduce risk and often provide us the conviction to stick with our companies when stock prices are gyrating wildly, as they currently are. Leverage especially matters because too much of it significantly reduces resiliency. Often, companies with too much leverage do not make it to the other side of the challenges we are currently facing. The free money to fund excessive risk taking is no longer there.

As with everything we do, we seek objective evidence to corroborate our views and conclusions, including our assessment of our portfolio’s quality. S&P Global has provided Quality Rankings on common stocks since 1956. Their ranking is driven by the long-term growth, cyclicality and stability of a company’s earnings and dividend record. They recognize that a company’s earnings and dividend performance are the end results of the interaction of a wide variety of factors including but not limited to, market demand for a company’s products or services; product development, production, and marketing strategies; the strength of its executive leadership; its industry position and competitive advantage; its capital structure and capital investment policies. As S&P states, “Over the long run, we believe a company’s record of earnings performance and dividend distributions can tell investors a lot.”

Companies rated “A-” or higher are considered above average quality. “B+” is considered average and anything ranked “B” or lower is considered low quality. Companies without a 10-year history are not rated (“NR”).

Exhibit 2. S&P Global Quality Rankings

As at September 30, 2022.

Source: Bristol Gate Capital Partners, FactSet, S&P Global.

Approximately 60% of the constituents of our US Equity Strategy have above average quality rankings, compared to approximately 30% of the S&P 500. Over 80% of our portfolio is average or better versus 55% for the Index. We believe the three companies (14%) in our portfolio not rated will eventually be classified as average or better once they have a 10-year history. Our sole below average ranking is

Microchip Technology Inc., a company we believe will also graduate to higher rankings in due course now that it has committed to and is executing against a clearly defined capital allocation strategy.

During times like these quality matters because stability and consistency of earnings combined with dividend growth is often more appreciated by the market when there is a lack of it available. We believe we are in one of those periods now. The quality and resilience of our portfolios are critical in allowing us to look through the current turbulence with optimism and predict into the future with some degree of confidence. Our holdings have the ability and willingness to continue investing through the uncertainty, increasing their competitive advantages and coming out stronger on the other end. They have done so in the past and we expect the same going forward.

US Equity Strategy (all returns USD)

During the quarter, the US Equity Strategy performed in line with the S&P 500 Total Return Index. Central banks globally are seeking to reign in persistently high inflation with aggressive policies. Higher rates, higher costs and the growing risk of an economic slowdown further soured investor sentiment.

Exhibit 3. US Equity Strategy Risk and Return Metrics

Source: Bristol Gate Capital Partners Inc. Please refer to “Important disclosures” section below.

Both our overweight and stock selection in the Communication Services sector were the primary contributors to performance in the quarter. Starbucks Corp. was the largest absolute individual contributor to portfolio returns following strong quarterly results in August and a very positive outlook during its Investor Day in September.

Both our overweight and stock selection in the Real Estate sector were the primary detractors from returns in the quarter. On an absolute basis, American Tower Corp. was the largest detractor on growing concerns regarding its high foreign exposure in a strong US dollar environment and fixed contractual annual price increases in its core U.S. market that are below current inflation rates. On the currency issue, we believe that the long-term growth available in the international segment more than compensates us for the currency risk. We suspect that the international segment will once again be looked at as a positive when the macro environment normalizes, and the U.S. dollar potentially gives up some of its recent gains versus other currencies. In terms of the margin concerns related to high inflation, we just do not believe it is as significant a risk as the market does. American Tower has a high fixed cost base including ground rent, which is primarily fixed under long-term lease agreements with its own annual cost escalations, property taxes and depreciation and amortization. These are not significantly affected in the near term by inflation. In fact, high inflation and by extension higher interest rates, may actually lower the price of its land-related costs over time. In the case of certain variable costs such as power and fuel, some or all are directly passed through to tenants.

In addition, in the past we have discussed how businesses with high margins have inherent inflation protection, not needing to raise prices as much as low margin businesses to cover cost increases and maintain dollar profits. American Tower has extremely attractive incremental margins. A cellular tower with one tenant produces gross margin of approximately 40% and a 3% return on investment. Moving to three tenants on the same tower increases gross margin to over 80% and return on investment to approximately 25%. The characteristic is an inflation shock-absorber in our opinion.

Year to date, the US Equity Strategy has lagged the S&P 500 Total Return Index. Our zero weights in Energy, Staples and Utilities have overwhelmed the positive contribution from stock selection. It is not unusual for us to underperform the Index when those sectors are performing relatively well as they have historically offered little opportunity to find high quality, high dividend growers consistent with our investment philosophy.

We added to Applied Materials Inc. and trimmed Cintas Corp. and Dollar General Corp. as part of our regular quarterly rebalancing process that brings positions back to equal weights after they exceed targeted thresholds. The macroeconomic backdrop remains uncertain. We believe owning quality companies that are financially sound and can grow their dividends at above average rates will allow our portfolio to successfully navigate this challenging environment. We believe quality is more than just an idea and can be measured. Sixteen of our 22 portfolio companies have announced dividend increases thus far in 2022, averaging 19.3%. In addition, as shown in Exhibit 4, our holdings in aggregate have delivered higher revenue and earnings growth compared to the Index, while paying out a lower portion of their earnings to shareholders and generating significantly superior return on equity. We believe the willingness and ability to increase their dividends at such a high rate in the context of the current macro environment speaks to the strength and durability of our investments’ business models.

Exhibit 4. US Equity Strategy Portfolio Characteristics

As at September 30, 2022.

Source: Bristol Gate Capital Partners, Bloomberg.

Canadian Equity Strategy (all returns CAD)

During the quarter, the Canadian Equity Strategy outperformed the S&P/TSX Composite Total Return Index. As we outlined earlier, central banks globally are seeking to reign in persistently high inflation with aggressive policies. Higher rates, higher costs and the growing risk of an economic slowdown further soured investor sentiment.

Exhibit 5. Canadian Equity Strategy Risk and Return Metrics

Source: Bristol Gate Capital Partners Inc. Please refer to “Important disclosures” section below.

Outperformance was primarily driven by stock selection in the Financials and Materials sectors, as well as having no exposure to the Energy sector. Element Fleet Management Corp. was the largest absolute contributor to returns over the quarter as the company is in a unique position to benefit from higher interest

rates, energy prices as well as inflationary pressures. Company management also raised their full year guidance.

We added to Enghouse Systems Ltd. and InterRent Real Estate Investment Trust and trimmed Element Fleet as part of our regular quarterly rebalancing process that brings positions back to equal weights after they exceed targeted thresholds.

Fourteen of our 23 portfolio companies have announced dividend increases thus far in 2022, averaging ~12%. In addition, our holdings in aggregate have delivered revenue and earnings growth of ~14% and ~11%. Like our U.S. Strategy, we believe the willingness and ability to increase their dividends at such a high rate in the context of the current macro environment speaks to the strength and durability of our investments’ business models.

Firm Update

To all our clients, thank you for your continued trust and confidence. Since our inception, we have continually invested for the long-term by owning the best prospective dividend growers for the coming year. Dividends and dividend growth have played a significant role in terms of their contribution to total returns in other tumultuous periods such as the inflationary 1940s and 1970s or the stock market’s “lost decade” of the 2000s. We believe rising income leading to rising value is a fundamental investment “truth” across markets and time and do not believe the concept has lost its relevance in today’s environment.

Sincerely, The Bristol Gate Team

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Important disclosures

There is a risk of loss inherent in any investment; past performance is not indicative of future results. Prospective and existing investors in Bristol Gate’s pooled funds or ETF funds should refer to the fund’s offering documents which outline the risk factors associated with a decision to invest. Separately managed account clients should refer to disclosure documents provided which outline risks of investing. Pursuant to SEC regulations, a description of risks associated with Bristol Gate’s strategies is also contained in Bristol Gate’s Form ADV Part 2A located at www.bristolgate.com/regulatory-documents.

Gross returns in this report refer to the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite. No allowance has been made for custodial costs, taxes, operating costs, management and performance fees, which will reduce performance. Past performance is not indicative of future results. Allowance for withholding tax in the US strategy composite is partially reflected in the composite returns for periods commencing January 2017 and after. The Net returns for the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite are reflective of the maximum management fee charged by Bristol Gate of 1% and 0.70%, respectively.

The Bristol Gate US Equity Strategy Composite was formerly known as the Bristol Gate US Dividend Growth Composite until April 1, 2015. The Composite inception date was May 15, 2009. The Composite consists of equities of publicly traded, dividend paying US companies and is valued in US Dollars.

The Bristol Gate Canadian Equity Strategy Composite was formerly known as the Bristol Gate Canadian Dividend Growth Composite until April 1, 2015. The Composite inception date was July 1, 2013. The Composite consists of equities of publicly traded, dividend paying Canadian and US companies and is valued in Canadian Dollars.

The S&P 500® Total Return Index measures the performance of the broad US equity market, including dividend re-investment, in US dollars. This index is provided for information only and comparisons to the index has limitations. The benchmark is an appropriate standard against which the performance of the strategy can be measured over longer time periods as it represents the primary investment universe from which Bristol Gate selects securities. However, Bristol Gate’s portfolio construction process differs materially from that of the benchmark and the securities selected for inclusion in the strategy are not influenced by the composition of the benchmark. For example, the strategy is a concentrated portfolio of approximately equally weighted dividend-paying equity securities, rebalanced quarterly whereas the benchmark is a broad stock index (including both dividend and non-dividend paying equities) that is market capitalization weighted. As such, strategy performance deviations relative to the benchmark may be significant, particularly over shorter time periods. The strategy has concentrated investments in a limited number of companies; as a result, a change in one security’s value may have a more significant effect on the strategy’s value.

SPDR S&P 500 ETF Trust (SPY US) sourced from Bloomberg has been used as a proxy for the S&P 500® for the purpose of providing non-return based portfolio statistics and sector weightings.

The S&P/TSX Total Return Index measures the performance of the broad Canadian equity market, including dividend re-investment, in Canadian dollars. This index has been provided for information only and comparisons to the index has limitations. The benchmark is an appropriate standard against which the performance of the strategy can be measured over longer time periods as it represents the primary investment universe from which Bristol Gate selects securities. However, Bristol Gate’s portfolio construction process differs materially from that of the benchmark and the securities selected for inclusion in the strategy are not influenced by the composition of the benchmark. For example, the strategy is a concentrated portfolio of approximately equally weighted dividend-paying equity securities, rebalanced quarterly whereas the benchmark is a broad stock index (including both dividend and non-dividend paying equities) that is market capitalization weighted. As such, strategy performance deviations relative to the benchmark may be significant, particularly over shorter time periods. The strategy has concentrated investments in a limited number of companies; as a result, a change in one security’s value may have a more significant effect on the strategy’s value.

iShares Core S&P/TSX Capped Composite Index ETF (XIC CN) sourced from Bloomberg has been used as a proxy for the S&P/TSX Total Return Index for the purpose of providing non-return based portfolio statistics and sector weightings.

There is the opportunity to use leverage up to 30% of the net asset value. Leverage is not used as an investment tool to enhance returns, but for cash management needs of certain composite portfolios.

This Report is for information purposes and should not be construed under any circumstances as a public offering of securities in any jurisdiction in which an offer or solicitation is not authorized. Prospective investors in Bristol Gate’s pooled funds or ETF funds should rely solely on the fund’s offering documents, which outline the risk factors associated with a decision to invest. No representations or warranties of any kind are intended or should be inferred with respect to the economic return or the tax implications of any investment in a Bristol Gate fund.

Bristol Gate claims compliance with the Global Investment Performance Standards [GIPS®]. To receive a list of composite descriptions and/or a presentation that complies with the GIPS® standards, please contact us at info@bristolgate.com. Bristol Gate Capital Partners Inc. has been independently verified for the periods commencing May 2009 until December 2015 by Ashland Partners International PLLC and from January 1, 2016 – December 31, 2020 by ACA Group, Performance Services Division.

This piece is presented for illustrative and discussion purposes only. It should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities and it does not consider unique objectives, constraints, or financial needs of the individual. Under no circumstances does this piece suggest that you should time the market in any way or make investment decisions based on the content. Investors are advised that their investments are not guaranteed, their values change frequently, and past performance may not be repeated. References to specific securities are presented to illustrate the application of our investment philosophy only, do not represent all of the securities purchased, sold or recommended for the portfolio, and it should not be assumed that investments in the securities identified were or will be profitable and should not be considered recommendations by Bristol Gate Capital Partners Inc. A full list of security holdings is available upon request. For more information contact Bristol Gate Capital Partners Inc. directly. The information contained in this piece is the opinion of Bristol Gate Capital Partners Inc. and/or its employees as of the date of the piece and is subject to change without notice. Every effort has been made to ensure accuracy in this piece at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and Bristol Gate Capital Partners Inc. accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. We strongly recommend you consult with a financial advisor prior to making any investment decisions. Please refer to the Legal section of Bristol Gate’s website for additional information at bristolgate.com.

A Note About Forward-Looking Statements

This report may contain forward-looking statements including, but not limited to, statements about the Bristol Gate strategies, risks, expected performance and condition. Forward-looking statements include statements that are predictive in nature, that depend upon or refer to future events and conditions or include words such as “may”, “could”, “would”, “should”, “expect”, “anticipate”, “intend”, “plan”, “believe”, “estimate” and similar forward-looking expressions or negative versions thereof.

These forward-looking statements are subject to various risks, uncertainties and assumptions about the investment strategies, capital markets and economic factors, which could cause actual financial performance and expectations to differ materially from the anticipated performance or other expectations expressed. Economic factors include, but are not limited to, general economic, political and market factors in North America and internationally, interest and foreign exchange rates, global equity and capital markets, business competition, technological change, changes in government regulations, unexpected judicial or regulatory proceedings, and catastrophic events. Readers are cautioned not to place undue reliance on forward-looking statements and consider the above-mentioned factors and other factors carefully before making any investment decisions. All opinions contained in forward-looking statements are subject to change without notice and are provided in good faith. Forward-looking statements are not guarantees of future performance, and actual results could differ materially from those expressed or implied in any forward-looking statements. Bristol Gate Capital Partners Inc. has no specific intention of updating any forward-looking statements whether as a result of new information, future events or otherwise, except as required by securities legislation.

Dividend Growth Summary

Source: Bloomberg, FactSet, Bristol Gate Capital Partners.

Commentary – Patience Pays Dividends

“Good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild.”

– Morgan Housel – “The Psychology of Money: Timeless Lessons on Wealth, Greed and Happiness”.

Investing involves a lot of analysis, numbers and data. The most underrated part of investing, however, is psychological. The psychological challenges are particularly difficult during times like these where global markets posted one of their worst first half year results in decades. Not only are human beings prone to numerous behavioural biases, but our challenges are compounded with us being constantly bombarded with new information and instant analysis from 24-hour cable news and online pundits. Unfortunately for investors, this often involves those so-called experts usually manufacturing a reason that all this information matters. We imagine it might not make for much “must-see tv” if the hosts repeatedly keep telling the audience to ignore most of what is going on.

The average person has never had an easier time accessing the financial markets and products, whether it be through traditional stocks, bonds, mutual funds, and ETFs or new-fangled products based on cryptocurrencies, blockchain technology, NFTs, etc. At the same time, information has become almost infinitely abundant and instantly accessible. It has never been harder to sift through the daily noise and focus on long-term goals. To guide us, our evidence-based approach means the question we ask ourselves everyday is how much of the daily tsunami of information is useful for a long-term fundamental investor.

Bristol Gate has a single approach to investing: We build concentrated portfolios of high-quality companies that we expect will grow their dividends at much faster rates than the market because we believe that will lead to attractive long-term returns. In the short-term however, we also know that quite often, as a result of that concentration, our performance will be quite differentiated from that of the broad market. We have no control over how our holdings will be perceived by the market in the short-term but attempt to benefit from the market overlooking their strong fundamentals.

Part and parcel of being a successful long-term investor is understanding the difference between poor performance and returns that are not correlated with the index. Academic research has shown that portfolios that closely resemble the index are unlikely to outperform over the long-term[1], even though their relative performance may make them easier investments to stick with. Morningstar also published two pieces of research that highlight how important it is to stick with an investment if the fundamentals remain sound, regardless of relative returns. The first[2] showed that over a 15-year period, the average number of months that accounted for a strategy’s outperformance was six months. If an investor was unable to remain invested for the full period and missed that critical, but small, window, they did not benefit from the manager’s outperformance. The second piece of research[3] showed that funds that outperformed their benchmarks over 15 years, underperformed in 60% of calendar years. In other words, the investor would have had to tolerate underperformance for nine of those 15 years.

Achieving long-term success is neither simple nor easy. The evidence is clear however that patience pays dividends. Investors who can look past the short-term noise put the odds of success in their favour. An example of this is our investment in Broadcom, which we first made in mid-2017. As the stock chart below shows, when we bought the stock the company’s stock price grew in line with their free cash flow growth, but starting in 2018 the company’s market price did not keep up with the continued growth in free cash flow per share the company was generating:

Exhibit 1. Broadcom

Source: Bloomberg. As at June 30, 2022

At the time, Broadcom’s 2018 acquisition of CA Inc. was, in our view, broadly misunderstood by the market. As we outlined in our third quarter note of that year, we had a different view that CA’s mainframe software revenue stream was very attractive, providing high margins and stability to Broadcom’s existing business. Following our process and doing the fundamental work alongside the dividend growth prediction allowed us to look through both the market’s perception of the acquisition and the short-term stagnation of the company’s share price. Although it took almost four years, eventually the market price of the company came back in line with the fundamental operating performance of the business. In the meantime, the company was able to grow its quarterly dividend from $1.75/share when it announced the CA acquisition in July 2018 to $4.10/share last quarter, a 234% increase.

As long-term investors, we are willing to be patient with the companies we own. As they continue to grow their dividends, we have the added benefit of being paid to wait for the market to reward our company’s superior fundamentals. We believe this year is another example of this in action.

The macroeconomic backdrop has challenged many asset classes, not just stocks. We are still experiencing the effects the global pandemic supply chains and what was expected to be transient inflation has proven to be much more persistent. As a result, interest rates are rising much faster than previously expected. However, focusing on the short-term price return of the companies in our portfolio rather than underlying operating performance and long-term drivers of the businesses would be a disservice to our clients. At Bristol Gate, we invest differently. We focus on the evidence; on the companies we own (or would like to own) and on finding high quality companies with high dividend growth trading at attractive valuations. We trust our process and remain confident that over the long-term our clients and our partners will be rewarded for their patience.

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[1] Cremers, K. J. Martijn and Petajisto, Antti, How Active is Your Fund Manager? A New Measure That Predicts Performance (March 31, 2009).

[2] Kaplan and Kowara, “Is there a ‘Good’ time to buy or sell actively managed funds? Staying Invested is the name of the game”, Morningstar, July 11, 2019.

[3] Kaplan and Kowara, “How Long Can a Good Fund Underperform its Benchmark?”, Morningstar, March 2018

US Equity Strategy (all returns USD, gross)

During the quarter, the portfolio outperformed the S&P 500 Total Return Index, and a significant amount of progress was made in closing Q1’s performance gap. Unfortunately, both the market and our portfolio continued their year-to-date declines in an environment where interest rates are rising much faster than previously expected, fueling investor concerns over a possible central bank induced recession.

Exhibit 2. US Equity Strategy Risk and Return Metrics

Source: Bristol Gate Capital Partners Inc. Please Refer to “Important disclosures” section below

Security selection was the driver of the positive relative results, as our more defensive holdings in Consumer Discretionary and Communications Services benefited the portfolio compared to the benchmark. Dollar General, Activision Blizzard and American Tower were the largest relative contributors to returns. Activision’s share price continues to hold up well on the back of Microsoft’s $95/share all cash offer but remains at a large discount to the deal price given regulatory approval concern. Our belief in the deal closing within the June 2023 goal Microsoft outlined remains unchanged. Dollar General reported better-than-expected first quarter results that saw them maintain healthy gross margins despite inflationary cost pressures on the supply side. Dollar General is an example of our patience ultimately being rewarded. After lagging the S&P 500 for most of the time since acquiring the company in June 2020, its defensive growth characteristics that initially attracted us to the investment are paying off. Dollar General is benefiting from an environment where consumers have become more price sensitive.

Two of our three semiconductor related stocks, Applied Materials and Broadcom as well as Zoetis were the largest detractors on a relative basis. Our semiconductor stocks have experienced significant multiple compression on fears of a possible recession. In addition, Applied Materials continues to face short-term revenue and margin pressures due to lockdown-related supply chain issues. We view these issues as short-term in nature. The growing semiconductor intensity within the global economy and a slowing of Moore’s Law help us remain confident in the visibility of longer-term demand. Zoetis’ share price performance over the quarter does not reflect the operating performance of the business, which continues to demonstrate strong revenue growth and healthy margins.

Sector allocation detracted from relative returns. Our overweight in Consumer Discretionary and underweights in Consumer Staples and Energy were the largest negative contributors.

On an absolute basis, Dollar General, American Tower and UnitedHealth were the largest contributors while Broadcom, Applied Materials and Microchip were the largest detractors.

In April, we rebalanced the portfolio, reducing our allocation to UnitedHealth Group as it exceeded our weighting threshold. Proceeds were allocated to Starbucks and Allegion, our two lowest weights at the time.

Staying invested through the volatility we have experienced this year is an example of the mental tax investors must pay to earn the attractive long term returns equity markets have provided. While we recognize that there are still several significant headwinds we face from a macro perspective, including the risk of a recession, there are some reasons for optimism.

As we enter the Q2 reporting season, the intra period commentary provided by several of our holdings has generally been positive. Despite the year-to-date price return challenges and macro concerns, 11 of our 22 holdings have announced dividend increases thus far in 2022. They have averaged 21%, indicating what we believe is the confidence our holdings’ management teams have in their longer-term business fundamentals.

We are also encouraged by the historical results after a significant market decline in the first half of the year. The S&P 500 Total Return Index has declined 20% to June 30, 2022. Since 1928, there have been six instances where the index has declined more than 15% in the first half of the year, including this year. Of the five previous instances (1932, 1939, 1940, 1962, 1970) all had positive returns in the second half, with an average return of 26%, median of 18% and minimum of approximately 10%. After the tough start to the year, we think investors will once again be well-served exercising a bit of patience.

Canadian Equity Strategy (all returns CAD, Gross)

During the quarter, the portfolio outperformed the S&P/TSX Composite Index, and a significant amount of progress was made in closing Q1’s performance gap. Unfortunately, both the market and our portfolio continued their year-to-date declines.  Interest rates are rising much faster than previously expected, fueling investor concerns over a possible central bank-induced recession.

Despite the year-to-date price return challenges and macro concerns, 13 of our 23 holdings have announced dividend increases thus far in 2022. They have averaged over 10%, indicating what we believe is the confidence our holdings’ management teams have in their longer-term business fundamentals.

Exhibit 3. Canadian Equity Strategy Risk and Return Metrics

Source: Bristol Gate Capital Partners Inc. Please refer to “Important disclosures” section below

Security selection was the primary driver of the positive relative results. Sector allocation detracted from relative returns, as our lack of Energy, and to a lesser extent, Utilities and Real Estate holdings were the largest negative contributors.

Zoetis Inc., CCL Industries Inc. and Element Fleet Management Corp were the largest contributors to relative returns. Zoetis, one of our two non-domestic holdings, saw its share price performance over the quarter decline less than the broad Canadian market. The business continues to demonstrate strong revenue growth and healthy margins. CCL reported strong first quarter earnings driven by margin expansion and resilient demand. Management also announced a bolt-on acquisition that was well-received by the market. Element also reported strong first quarter results. The company continues to win new business adding to an already strong the backlog which we expect to convert to revenue over the next 12-18 months. 

InterRent Real Estate Investment Trust (IIP), Premium Brands Holdings Corp. and Brookfield Asset Management Inc. (BAM) were the largest detractors on a relative basis over the quarter. InterRent struggled as concerns over possible changes to the Federal government’s taxation of multifamily REITs weighed on sentiment. We believe the concern is overblown and does not necessarily address the government’s goal of improving housing affordability. Premium Brands’ share price has suffered due to worries over higher input prices, which we believe will be at worst a short-term margin issue for the company due to the strength of the overall business. Despite reporting strong quarterly results, Brookfield’s shares lagged in the quarter. We view the company’s plans to spin-off their investment management business as a potential catalyst in coming quarters.

On an absolute basis, Element Fleet Management Corp., CCL and Dollarama Inc. were the largest contributors while InterRent, Enghouse Systems Limited and Brookfield were the largest detractors.

During the first half of April, we followed our quarterly rebalancing process, trimming Alimentation Couche-Tard, Telus and Dollarama, while bringing up CCL Industries, Open Text, Colliers and Premium Brands to equal weights. One name change took place during the rebalancing, as we exited Quebecor and introduced Element Fleet in the portfolio.

Quebecor was an underperformer in the past year due to the uncertainty surrounding national wireless expansion aspirations. We believe the company’s dividend growth prospects have deteriorated given a limited growth opportunity within Quebec and the possibility of a costly expansion nationwide.

Element Fleet Management is the largest company in the North American fleet leasing and management industry. It is an attractive industry dominated by a few large firms due to high barriers to entry and switching costs. It has both defensive and growth characteristics, is well positioned for an inflationary environment, and is insulated from increasing interest rates. The company itself has had an impressive turnaround led by the current management and has an attractive growth opportunity ahead based on multiple levers. The COVID induced global supply chain challenges resulted in reduced OEM vehicle production and therefore lower originations, offering an attractive entry point for us. The company is sitting on a record backlog which we believe will be realized in the coming years.

Staying invested through the volatility we have experienced this year is an example of the mental tax investors must pay to earn the attractive long term returns equity markets have provided. While we recognize that there are still several significant headwinds we face from a macro perspective, including the risk of a recession, there are some reasons for optimism.

We are encouraged by the historical results after a significant market decline in the first half of the year. The S&P/TSX Composite Total Return Index has declined by just under 10% to June 30, 2022. Since 1957, there have been six instances where the index has declined more than 10% in the first half of the year. In all but one of those instances (1962, 1970, 1982, 1984, 2001) the index had positive returns in the second half, with an average return of over 12% and a median return of over 11%.  After the tough start to the year, we think investors will once again be well-served exercising a bit of patience.

Firm Update

Like all our companies, we continue to invest through this challenging period with an eye on the future opportunities we see. We welcomed two new members to the Bristol Gate team during the quarter. Patrick Hamm joined the firm in April and will lead our sales efforts in the family office, endowments, and foundations channel. Shehryar Khan joined in June as an Investment Specialist and will support business development and investment functions, creating content and analysis relevant to our investment philosophy and process.

To all our clients, thank you for your continued trust and confidence. Since our inception, we have continually invested for the long-term by owning the best prospective dividend growers for the coming year. Our strategy has served us well over time and we look forward to being rewarded in the future once again.

Sincerely,

The Bristol Gate Team

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Important disclosures

There is a risk of loss inherent in any investment; past performance is not indicative of future results. Prospective and existing investors in Bristol Gate’s pooled funds or ETF funds should refer to the fund’s offering documents which outline the risk factors associated with a decision to invest. Separately managed account clients should refer to disclosure documents provided which outline risks of investing. Pursuant to SEC regulations, a description of risks associated with Bristol Gate’s strategies is also contained in Bristol Gate’s Form ADV Part 2A located at www.bristolgate.com/regulatory-documents.

Gross returns in this report refer to the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite. No allowance has been made for custodial costs, taxes, operating costs, management and performance fees, which will reduce performance. Past performance is not indicative of future results. Allowance for withholding tax in the US strategy composite is partially reflected in the composite returns for periods commencing January 2017 and after. The Net returns for the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite are reflective of the maximum management fee charged by Bristol Gate of 1% and 0.70%, respectively.

The Bristol Gate US Equity Strategy Composite was formerly known as the Bristol Gate US Dividend Growth Composite until April 1, 2015. The Composite inception date was May 15, 2009. The Composite consists of equities of publicly traded, dividend paying US companies and is valued in US Dollars.

The Bristol Gate Canadian Equity Strategy Composite was formerly known as the Bristol Gate Canadian Dividend Growth Composite until April 1, 2015. The Composite inception date was July 1, 2013. The Composite consists of equities of publicly traded, dividend paying Canadian and US companies and is valued in Canadian Dollars.

The S&P 500® Total Return Index measures the performance of the broad US equity market, including dividend re-investment, in US dollars. This index is provided for information only and comparisons to the index has limitations. The benchmark is an appropriate standard against which the performance of the strategy can be measured over longer time periods as it represents the primary investment universe from which Bristol Gate selects securities. However, Bristol Gate’s portfolio construction process differs materially from that of the benchmark and the securities selected for inclusion in the strategy are not influenced by the composition of the benchmark. For example, the strategy is a concentrated portfolio of approximately equally weighted dividend-paying equity securities, rebalanced quarterly whereas the benchmark is a broad stock index (including both dividend and non-dividend paying equities) that is market capitalization weighted. As such, strategy performance deviations relative to the benchmark may be significant, particularly over shorter time periods. The strategy has concentrated investments in a limited number of companies; as a result, a change in one security’s value may have a more significant effect on the strategy’s value.

SPDR S&P 500 ETF Trust (SPY US) sourced from Bloomberg has been used as a proxy for the S&P 500® for the purpose of providing non-return based portfolio statistics and sector weightings.

The S&P/TSX Total Return Index measures the performance of the broad Canadian equity market, including dividend re-investment, in Canadian dollars. This index has been provided for information only and comparisons to the index has limitations. The benchmark is an appropriate standard against which the performance of the strategy can be measured over longer time periods as it represents the primary investment universe from which Bristol Gate selects securities. However, Bristol Gate’s portfolio construction process differs materially from that of the benchmark and the securities selected for inclusion in the strategy are not influenced by the composition of the benchmark. For example, the strategy is a concentrated portfolio of approximately equally weighted dividend-paying equity securities, rebalanced quarterly whereas the benchmark is a broad stock index (including both dividend and non-dividend paying equities) that is market capitalization weighted. As such, strategy performance deviations relative to the benchmark may be significant, particularly over shorter time periods. The strategy has concentrated investments in a limited number of companies; as a result, a change in one security’s value may have a more significant effect on the strategy’s value.

iShares Core S&P/TSX Capped Composite Index ETF (XIC CN) sourced from Bloomberg has been used as a proxy for the S&P/TSX Total Return Index for the purpose of providing non-return based portfolio statistics and sector weightings.

There is the opportunity to use leverage up to 30% of the net asset value. Leverage is not used as an investment tool to enhance returns, but for cash management needs of certain composite portfolios.

This Report is for information purposes and should not be construed under any circumstances as a public offering of securities in any jurisdiction in which an offer or solicitation is not authorized. Prospective investors in Bristol Gate’s pooled funds or ETF funds should rely solely on the fund’s offering documents, which outline the risk factors associated with a decision to invest. No representations or warranties of any kind are intended or should be inferred with respect to the economic return or the tax implications of any investment in a Bristol Gate fund.

Bristol Gate claims compliance with the Global Investment Performance Standards [GIPS®]. To receive a list of composite descriptions and/or a presentation that complies with the GIPS® standards, please contact us at info@bristolgate.com. Bristol Gate Capital Partners Inc. has been independently verified for the periods commencing May 2009 until December 2015 by Ashland Partners International PLLC and from January 1, 2016 – December 31, 2020 by ACA Group, Performance Services Division.

This piece is presented for illustrative and discussion purposes only. It should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities and it does not consider unique objectives, constraints, or financial needs of the individual. Under no circumstances does this piece suggest that you should time the market in any way or make investment decisions based on the content. Investors are advised that their investments are not guaranteed, their values change frequently, and past performance may not be repeated. References to specific securities are presented to illustrate the application of our investment philosophy only, do not represent all of the securities purchased, sold or recommended for the portfolio, and it should not be assumed that investments in the securities identified were or will be profitable and should not be considered recommendations by Bristol Gate Capital Partners Inc. A full list of security holdings is available upon request. For more information contact Bristol Gate Capital Partners Inc. directly. The information contained in this piece is the opinion of Bristol Gate Capital Partners Inc. and/or its employees as of the date of the piece and is subject to change without notice. Every effort has been made to ensure accuracy in this piece at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and Bristol Gate Capital Partners Inc. accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. We strongly recommend you consult with a financial advisor prior to making any investment decisions. Please refer to the Legal section of Bristol Gate’s website for additional information at bristolgate.com.

A Note About Forward-Looking Statements

This report may contain forward-looking statements including, but not limited to, statements about the Bristol Gate strategies, risks, expected performance and condition. Forward-looking statements include statements that are predictive in nature, that depend upon or refer to future events and conditions or include words such as “may”, “could”, “would”, “should”, “expect”, “anticipate”, “intend”, “plan”, “believe”, “estimate” and similar forward-looking expressions or negative versions thereof.

These forward-looking statements are subject to various risks, uncertainties and assumptions about the investment strategies, capital markets and economic factors, which could cause actual financial performance and expectations to differ materially from the anticipated performance or other expectations expressed. Economic factors include, but are not limited to, general economic, political and market factors in North America and internationally, interest and foreign exchange rates, global equity and capital markets, business competition, technological change, changes in government regulations, unexpected judicial or regulatory proceedings, and catastrophic events. Readers are cautioned not to place undue reliance on forward-looking statements and consider the above-mentioned factors and other factors carefully before making any investment decisions. All opinions contained in forward-looking statements are subject to change without notice and are provided in good faith. Forward-looking statements are not guarantees of future performance, and actual results could differ materially from those expressed or implied in any forward-looking statements. Bristol Gate Capital Partners Inc. has no specific intention of updating any forward-looking statements whether as a result of new information, future events or otherwise, except as required by securities legislation.

Dividend Growth Summary

Both the US and Canadian Strategies trailed their respective benchmarks during the quarter, however both portfolios continue to deliver dividend growth well above market rates. Focusing on high quality, high dividend growers has served us well over time.

Source: Bloomberg, FactSet, Bristol Gate Capital Partners.

Commentary

The U.S. Army War College introduced the acronym VUCA to describe the more volatile, uncertain, complex, and ambiguous environment resulting from the end of the Cold War. The framework was used to help senior military officers navigate the turbulent times they were about to face.

Exhibit 1. The VUCA Framework

Source: Harvard Business Review, Bennett & Lemoine.

With Russia’s invasion of Ukraine, broader geopolitical risks, an ongoing global pandemic, disrupted supply chains, rising commodity costs, persistently high inflation, and a hawkish Fed, we cannot think of a better term than VUCA to describe the current market environment. Shifting monetary policy and a myriad of interconnected uncertainties have clouded the outlook and resulted in higher market volatility.

Each of the four elements of VUCA represent challenges in and of themselves. The more volatile the world, the more significant and faster things change. The more uncertain, the harder to predict. Higher complexity makes analysis more difficult and increased ambiguity makes outcomes harder to interpret. Combined, the four pose significant challenges to effective decision making. The single biggest enemy of long-term returns is the emotion we feel during turbulent times like these. It is easy to get side tracked with all the macro concerns and second guess your portfolio when things are not working. In a heightened VUCA environment, we believe it is important to go back to basics and revisit why we do what we do. Often the basics can provide appropriate perspective in moving forward.

Over the long term, we believe portfolio returns are driven by the returns our companies’ operations generate +/- the price we pay to acquire those earnings. The combination of high operating returns and an ability to reinvest those earnings back in the business at the same high returns allows intrinsic value to compound and leads to attractive long-term investment results. We believe dividend growth is an effective signaling mechanism in this regard.

We believe that there is an inherent link between the income an asset produces and its value over the long term. Just as a piece of real estate rises in value as its rental stream does, so too do companies with their dividend streams. Over the last 20 years, the S&P 500’s dividend has almost quadrupled. The Index’s price has increased by the same amount.

Exhibit 2. S&P 500 Dividend & Price Growth (March 2002 to March 2022)

Source: Bloomberg, Bristol Gate Capital Partners.

This is not surprising to us and is not just the case at the broad index level. The longest tenured stocks in our US portfolio currently are UnitedHealth, Starbucks and Roper Technologies. Averaging across the three companies, you can see that their dividends and capital appreciation have both slightly more than tripled over our holding period.

Exhibit 3. UNH, SBUX and ROP Dividend & Price Growth Since Initial Acquisition

Source: Bloomberg, Bristol Gate Capital Partners.

Dividends have traditionally been less volatile than price and are more predictable. Changes in dividends are easier to understand compared to changes in prices and there is less ambiguity. A dollar in your pocket is a dollar in your pocket. Focusing on dividend growth helps us avoid the roller coaster ride of emotions VUCA and price movements take us on. It keeps us thinking about business performance and the long-term cash generation that drives that dividend growth. Ultimately, it helps us make better decisions for our long-term wealth.

US Equity Strategy (all returns USD, Gross)

During the quarter, the portfolio lagged the S&P 500 Total Return Index by 680 basis points. From a price return perspective there were few bright spots, with only Activision, Visa and UnitedHealth generating positive returns. Activision was by far the largest positive contributor following a $95/share all cash takeout offer by Microsoft, a 45% premium to the prior day’s closing price. Given the regulatory scrutiny large technology companies have received lately, particularly related to their dominance of certain markets, Activision is trading at an approximate 15% discount to the transaction price. We find this spread attractive given our assessment of the deal closing and the uncertain macro environment we find ourselves in.

Exhibit 4. US Equity Strategy Risk and Return Metrics

Source: Bristol Gate Capital Partners. Please refer to “Important disclosures” section below

Amongst the detractors, Sherwin-Williams, Intuit and Zoetis had the largest impact on a relative and an absolute basis. Sherwin’s near-term earnings outlook has deteriorated as raw material availability was a challenge and input costs continued to rise rapidly. The company has aggressively increased the price of its products to offset these challenges, albeit with a lag. We believe the current environment the company is facing is analogous to the one experienced in 2010-2011 from an input cost perspective. Exiting that period, Sherwin’s gross margins grew as raw material costs eventually abated but previous pricing actions were not rolled back. We expect a similar outcome this time around.

After rising 19% and 26% respectively in Q4/21, Intuit and Zoetis both experienced a healthy dose of multiple contraction during the first quarter. We remain positive on their long-term business fundamentals despite the recently struggling stock prices.

In Q1, market attention turned toward value, high dividend yield and smaller cap stocks. Growing companies that are very profitable and have limited variability in their operations – several of the traits our portfolio companies typically exhibit – were the worst performing factors to kick off the year.

Exhibit 5. S&P 500 Factor Performance

Source: Bloomberg.

According to S&P Global Indices, on a cumulative three-month basis, the spread in performance between Value and Growth “lies at the 94th percentile of historical data…The advantage of value over growth in the first quarter, in other words, is almost at the limit of historical experience.”

There are many signposts to suggest we are in the tail-end of this economic expansion. We are experiencing rising inflationary pressures. March’s US Consumer Price Index was 8.5%, the largest increase since January 1982. Energy and other commodity prices have risen, and the US unemployment rate is below 4%, suggesting tight labour markets. In response to all this, the Fed raised rates in March for the first time in three years and more hikes are expected throughout the year. While GDP growth is still positive, it is slowing. The Atlanta Fed Nowcast is forecasting just 1% growth in Q1/22. Corporate profit margins are near all time highs and have likely peaked given the growing cost pressures and slowing growth.

Exhibit 6. The Economic Cycle

Source: Fidelity.

In the late economic cycle, certain sectors have historically performed better than others. Energy and Materials typically do well as inflation hedges. Defensive sectors such as Consumer Staples, Healthcare, Utilities also do well on a relative basis as people begin preparing for a possible recession (particularly with the 2 year Treasury to 10 year Treasury yield curve inverting in April). This is very consistent with what happened in the first quarter.

Exhibit 7. S&P 500 Q1/22 Sector Performance

Source: Bloomberg.

Unfortunately for us, those are not sectors from which we are able to consistently source high quality, high dividend growers. They are characterized by highly cyclical cash flows or they have a combination of high dividend yield and low dividend growth. As such, we expect the latter stages of an economic cycle to be amongst the most challenging for our Strategy from a relative return perspective.

We believe our investment discipline of owning high quality companies, with good balance sheets that can grow their dividends at exceptional rates over the longer term will eventually return in favour and will provide competitive returns through the entire economic cycle. Although our investment performance has been disappointing this quarter, we have not been disappointed with the aggregate financial results of our companies. Over the last 12 months, they have generated average revenue growth of 15% and EPS growth of 34%. Despite the broad inflationary cost pressures, consensus is forecasting double digit revenue and EPS growth for the coming 12 months as well. We believe this underlying performance will support dividend growth well above the market in the coming year once again.

Three changes to the portfolio occurred in early January. Broadridge, Home Depot and Texas Instruments were replaced with Lowe’s, Microchip and MSCI. The sales were a result of lowered dividend growth projections and our hurdle rate. The additions improved the portfolio’s average projected dividend growth by 200 bps. Lowe’s was a direct substitute for Home Depot, allowing us continued exposure to the favourable home improvement market but with better forecasted dividend growth, a lower dividend payout ratio on free cash flow, and a more attractive valuation. Lowe’s was trading at a 25% discount to its larger peer.

We believe the company can close its valuation gap to Home Depot if it shows some progress on the operating margin front, where it trails its main competitor. 

Like the Lowe’s/Home Depot trade, Microchip allowed us to continue benefiting from some of the same macro themes driving growth at Texas Instruments but via a company with a lower valuation and much earlier in its capital return strategy. Microchip has embarked on a shareholder return journey that will eventually see it mimic Texas Instruments’ policy of 100% of free cash flow returned to shareholders. Microchip currently returns a quarter of its free cash flow to shareholders, and we think the new policy will drive 30%+ annual dividend growth for several years.  We believe Microchip has an opportunity to close the valuation gap to peers as it executes against the new shareholder return policy, its strategy focused on organic growth and deleveraging following a period of acquisitions to round out the product offering.

In MSCI, we have acquired a high-quality company, whose products are deeply embedded into customer workflows. Industry-leading margins, low capital intensity, limited working capital needs and solid free cash flow have allowed the company to grow its quarterly dividend at 28.5% a year since Q3/14 while reducing its diluted share count by 28.7% over the same period. The crown jewel in the company’s offering is its indices business which is the standard in active benchmarking and passive investing in international markets. Today, the company’s ESG and climate solutions are defining sustainable investing and we believe the company has a significant opportunity ahead of it, combining its various data-sets into novel solutions (for example private company + ESG) and expanding into new use cases.

Canadian Equity Strategy (all returns CAD, Gross)

During the quarter, the portfolio returned negative 3.8% compared to a positive 3.8% for the S&P/TSX Total Return Composite Index. Most of the underperformance was due to the Strategy’s sector allocation. During the first quarter of 2022, oil prices were up over 30% leading to a 29% return for the Energy sector. Other commodities also saw significant prices increases causing the Materials sector to rise over 20%. With a combined 30% weight in the Index and significantly underrepresented in our portfolio, the two sectors accounted for a significant relative performance headwind. Our sector positioning is not due to a call on the underlying commodity prices, rather an outcome of our focus on sustainable and high dividend growth.

CCL Industries and Stella-Jones were two of the largest individual detractors on a relative basis to the Index, as both companies fall under the Materials sector and trailed much of their peers in the sector exposed to mining. Zoetis was the third largest relative detractor, giving up its outperformance over 2021. Visa, Open Text and Dollarama were our holdings with largest relative contribution, while not owning Shopify also had a significant positive impact.

On an absolute basis, Zoetis, FirstService and Enghouse were the largest detractors. Dollarama, Intact Financial and Canadian Pacific Railway were the largest contributors.

Exhibit 8. Canadian Equity Strategy Risk and Return Metrics

Source: Bristol Gate Capital Partners. Please refer to “Important disclosures” section below

Although our strategy’s relative performance struggled this quarter, the businesses it owns did not. They continue to grow, generating excess free cash flows and attractive returns on invested capital. Thirteen out of twenty-three holdings announced dividend increases during the quarter, averaging at over 11% and the entire group reported an average 10.6% year-over-year revenue growth and 16.1% on earnings growth during the last quarterly reporting cycle.

One change to the portfolio occurred in late January. TC Energy was replaced by Colliers. The sale was primarily driven by lowered dividend growth projections and our hurdle rate.

Colliers is one of the largest global Commercial Real Estate service providers that participates in a growing market that favors large full-service operators. The company and its management have created tremendous value over the years via a well defined and executed capital allocation strategy both as part of

First Service and since Colliers’ spin-off in 2015. The company is early on its journey to return capital to shareholders through a growing dividend, with significant room for future growth.

Firm Update

To all our clients, thank you for your continued support and trust. We are determined to do everything we can to provide you continued income growth and strong long-term investment returns going forward.

Sincerely,

The Bristol Gate Team

Important disclosures

There is a risk of loss inherent in any investment; past performance is not indicative of future results. Prospective and existing investors in Bristol Gate’s pooled funds or ETF funds should refer to the fund’s offering documents which outline the risk factors associated with a decision to invest. Separately managed account clients should refer to disclosure documents provided which outline risks of investing. Pursuant to SEC regulations, a description of risks associated with Bristol Gate’s strategies is also contained in Bristol Gate’s Form ADV Part 2A located at www.bristolgate.com/regulatory-documents.

Gross returns in this report refer to the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite. No allowance has been made for custodial costs, taxes, operating costs, management and performance fees, which will reduce performance. Past performance is not indicative of future results. Allowance for withholding tax in the US strategy composite is partially reflected in the composite returns for periods commencing January 2017 and after. The Net returns for the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite are reflective of the maximum management fee charged by Bristol Gate of 1% and 0.70%, respectively.

The Bristol Gate US Equity Strategy Composite was formerly known as the Bristol Gate US Dividend Growth Composite until April 1, 2015. The Composite inception date was May 15, 2009. The Composite consists of equities of publicly traded, dividend paying US companies and is valued in US Dollars.

The Bristol Gate Canadian Equity Strategy Composite was formerly known as the Bristol Gate Canadian Dividend Growth Composite until April 1, 2015. The Composite inception date was July 1, 2013. The Composite consists of equities of publicly traded, dividend paying Canadian and US companies and is valued in Canadian Dollars.

The S&P 500® Total Return Index measures the performance of the broad US equity market, including dividend re-investment, in US dollars. This index is provided for information only and comparisons to the index has limitations. The benchmark is an appropriate standard against which the performance of the strategy can be measured over longer time periods as it represents the primary investment universe from which Bristol Gate selects securities. However, Bristol Gate’s portfolio construction process differs materially from that of the benchmark and the securities selected for inclusion in the strategy are not influenced by the composition of the benchmark. For example, the strategy is a concentrated portfolio of approximately equally weighted dividend-paying equity securities, rebalanced quarterly whereas the benchmark is a broad stock index (including both dividend and non-dividend paying equities) that is market capitalization weighted. As such, strategy performance deviations relative to the benchmark may be significant, particularly over shorter time periods. The strategy has concentrated investments in a limited number of companies; as a result, a change in one security’s value may have a more significant effect on the strategy’s value.

SPDR S&P 500 ETF Trust (SPY US) sourced from Bloomberg has been used as a proxy for the S&P 500® for the purpose of providing non-return based portfolio statistics and sector weightings.

The S&P/TSX Total Return Index measures the performance of the broad Canadian equity market, including dividend re-investment, in Canadian dollars. This index has been provided for information only and comparisons to the index has limitations. The benchmark is an appropriate standard against which the performance of the strategy can be measured over longer time periods as it represents the primary investment universe from which Bristol Gate selects securities. However, Bristol Gate’s portfolio construction process differs materially from that of the benchmark and the securities selected for inclusion in the strategy are not influenced by the composition of the benchmark. For example, the strategy is a concentrated portfolio of approximately equally weighted dividend-paying equity securities, rebalanced quarterly whereas the benchmark is a broad stock index (including both dividend and non-dividend paying equities) that is market capitalization weighted. As such, strategy performance deviations relative to the benchmark may be significant, particularly over shorter time periods. The strategy has concentrated investments in a limited number of companies; as a result, a change in one security’s value may have a more significant effect on the strategy’s value.

iShares Core S&P/TSX Capped Composite Index ETF (XIC CN) sourced from Bloomberg has been used as a proxy for the S&P/TSX Total Return Index for the purpose of providing non-return based portfolio statistics and sector weightings.

There is the opportunity to use leverage up to 30% of the net asset value. Leverage is not used as an investment tool to enhance returns, but for cash management needs of certain composite portfolios.

This Report is for information purposes and should not be construed under any circumstances as a public offering of securities in any jurisdiction in which an offer or solicitation is not authorized. Prospective investors in Bristol Gate’s pooled funds or ETF funds should rely solely on the fund’s offering documents, which outline the risk factors associated with a decision to invest. No representations or warranties of any kind are intended or should be inferred with respect to the economic return or the tax implications of any investment in a Bristol Gate fund.

Bristol Gate claims compliance with the Global Investment Performance Standards [GIPS®]. To receive a list of composite descriptions and/or a presentation that complies with the GIPS® standards, please contact us at info@bristolgate.com. Bristol Gate Capital Partners Inc. has been independently verified for the periods commencing May 2009 until December 2015 by Ashland Partners International PLLC and from January 1, 2016 – December 31, 2020 by ACA Group, Performance Services Division.

This piece is presented for illustrative and discussion purposes only. It should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities and it does not consider unique objectives, constraints, or financial needs of the individual. Under no circumstances does this piece suggest that you should time the market in any way or make investment decisions based on the content. Investors are advised that their investments are not guaranteed, their values change frequently, and past performance may not be repeated. References to specific securities are presented to illustrate the application of our investment philosophy only, do not represent all of the securities purchased, sold or recommended for the portfolio, and it should not be assumed that investments in the securities identified were or will be profitable and should not be considered recommendations by Bristol Gate Capital Partners Inc. A full list of security holdings is available upon request. For more information contact Bristol Gate Capital Partners Inc. directly. The information contained in this piece is the opinion of Bristol Gate Capital Partners Inc. and/or its employees as of the date of the piece and is subject to change without notice. Every effort has been made to ensure accuracy in this piece at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and Bristol Gate Capital Partners Inc. accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. We strongly recommend you consult with a financial advisor prior to making any investment decisions. Please refer to the Legal section of Bristol Gate’s website for additional information at bristolgate.com.

A Note About Forward-Looking Statements

This report may contain forward-looking statements including, but not limited to, statements about the Bristol Gate strategies, risks, expected performance and condition. Forward-looking statements include statements that are predictive in nature, that depend upon or refer to future events and conditions or include words such as “may”, “could”, “would”, “should”, “expect”, “anticipate”, “intend”, “plan”, “believe”, “estimate” and similar forward-looking expressions or negative versions thereof.

These forward-looking statements are subject to various risks, uncertainties and assumptions about the investment strategies, capital markets and economic factors, which could cause actual financial performance and expectations to differ materially from the anticipated performance or other expectations expressed. Economic factors include, but are not limited to, general economic, political and market factors in North America and internationally, interest and foreign exchange rates, global equity and capital markets, business competition, technological change, changes in government regulations, unexpected judicial or regulatory proceedings, and catastrophic events.

Readers are cautioned not to place undue reliance on forward-looking statements and consider the above-mentioned factors and other factors carefully before making any investment decisions. All opinions contained in forward-looking statements are subject to change without notice and are provided in good faith. Forward-looking statements are not guarantees of future performance, and actual results could differ materially from those expressed or implied in any forward-looking statements. Bristol Gate Capital Partners Inc. has no specific intention of updating any forward-looking statements whether as a result of new information, future events or otherwise, except as required by securities legislation.