Provided below are a few thoughts outlining how we plan to protect investors capital and continue to generate equity-type returns while managing the inevitable volatility that financial markets experience in the Spring and summer periods.
Market Insights for Spring 2015
We will continue to be long-biased with significant cash positions and short positions of between 20-35%. We remain constructive on the equity markets overall as most sectors offer stock valuations that are reasonably priced and market sentiment remains cautious, even bearish. When everyone is talking about a looming market crash, it likely will not happen. We find that very few investment firms are bullish and there is caution recommended everywhere. Therefore this six year old bull market will likely continue. Equities (outside of the biotech/pharma industry) remain reasonably cheap while bonds, appear to us to be significantly overpriced.
The Canadian equity markets will continue to underperform US markets, largely because the Canadian economy is verging on a recession and reeling from depressed energy prices, while the US continues to recover at a sustained pace. The best opportunities are likely to be through US focused growth companies that are listed in Canada. Thankfully there are a plethora of them. The Fund owns several including: Alimentation Couche-Tard, Canam Group, Convalo Health International, Guestlogix, Magna International, Martinrea International, Patient Home Monitoring (PHM), and Terra Firma Capital Corporation.
We believe the US Housing market shall continue to recover and new home construction will surpass the 1.1 million annual level. We remain constructive on the lumber stocks including West Fraser, Canfor and Interfor Corporation. There is however a seasonal aspect to this trade and the best time to own these names is in the Fall and Winter, so we have lightened up considerably after some very good performance recently.
The top performing sector over the past twelve months on both sides of the border has been Healthcare, including Biotechnology. The problem for us is of course finding the value in this gargantuan and complex industry. Thankfully we have been able to find a few plays that appear to be both inexpensive and poised for enormous growth. Concordia Health was a huge hit recently rising from $6.25 to over $100 and we can proudly claim to have done the first institutional trade on that stock at $7.00. Unfortunately we sold the last of our shares around $30 and watched it continue to soar on each new acquisition. We have not made that mistake with PHM, going from $0.15 to $1.70, simply managing our exposure along the way.
There are a number of related stocks that we are pleased to own at current levels, including CRH Medical and Revive Therapeutics, while we are shorting the IBB (NASDAQ Biotechnology ETF) which trades at stratospheric valuations.
We continue to largely avoid both oil and natural gas companies. The problem is rather simple, energy prices are being determined by geopolitical and not fundamental behavior. The price of both WTI and Brent oil could rebound to US$80 or fall into the US$35-40 range. Who knows which? We will be a buyer when prices stabilize and anticipate that new lows may well be the intention of several Western governments, giving investors a headache now, but a terrific opportunity later, likely sometime in Q3 2015.
One of the most exciting industries developing very rapidly in the Canadian equity markets is online Gaming. We see value in IT.to, The Intertain Group, at 9x current earnings. We like Amaya Gaming where we see upside to $50 plus and own Imperus Technologies Group, LAB.v, for dramatic growth. This industry may well form a new sub-sector of the TSX, as it is immensely profitable, with huge global growth opportunities and the Americans have been slow to adapt to this industry, much less finance it.
Investors continually ask us if equities are expensive ? While it is true we are in the sixth year of a recovering bull market, we continue to find value everywhere and the markets overall remain reasonably priced. Look at the largest company in the world by market cap, Apple inc. APPL trades at 10x 2016 PE (less the cash on the balance sheet). The S&P trades closer to 15-16 x PE. Why not own APPL, while shorting a group of slower growth, more expensive, related companies in the semi-conductor and IT space ? It is amazing to us how many large cap technology companies missed the wireless revolution, which APPL now seems to own, along with Samsung. Furthermore with earning season upon us and the strong upward move in the US $, many large cap tech stocks are vulnerable to earnings disappointments.
The Fund is doing well in 2015 while the TSX continues to struggle. A global perspective is required to extract value from our markets. The best hedges remain in the currency markets and we plan to stick with the successful trades of being short the Euro, Canadian Dollar and Japanese Yen in favor of the US dollar.
Finally we would like to point out that the Fund purchased equity in four private companies that were committed to a go-public transaction. Convalo Health International, CXV.v did so recently to considerable success as the stock rose from $0.20 to $0.70 in a few months. We have two other companies, Nano-Lumens and Inspira Financial that will be doing their own IPO transition this Spring which should be good for our near-term returns.
- We are committed to the first rule of investing: preserve capital.
- We believe value investing based on cash flow analysis is the best method to truly protect a portfolio. We stay away from the darling stocks, concept stocks, negative cash flow businesses and high-multiple stories, while seeking value plays that could easily double or triple over time.
- We will not use excessive leverage. In fact, the Fund is not permitted to be levered more than 30% of invested capital. This restriction includes using leverage in the form of options, futures, etc.
- We prefer to “average up” rather than “average down”. More than any other strategy for investing, this practice will keep the Fund out of trouble and ensure superior performance. In so doing, we reduce our mistakes and accentuate our successes.
- We believe the Canadian equity markets are anything but efficient. These volatile markets continue to produce extraordinary opportunities, with dozens of companies trading at very reasonable values, while highly speculative, underfunded or excessively levered companies often trade at surprising lofty valuations. We have observed relatively little market-making from the Canadian brokers on many equity names, resulting in considerable volatility and reduced volumes. We constantly witness $300-$500 million and even billion dollar companies having their value fall 10% in a day, based on minimal trades that total less than $1 million. Such short term volatility presents trading opportunities for value investors like ourselves.
- The current popular trend of Index investing (ETFs and Index Funds etc.) strikes us as somewhat ill-timed and practically guaranteed to disappoint. If there was ever an equity market to emphasize sector rotation strategies and stock picker expertise, this is it. Good managers should outperform the larger Indices over the next few years. Index investing shall likely prove to be a better tool for “shorting” strategies than anything else.
- Investing today requires a global perspective and experience, which the majority of Canadian investment professionals simply do not have. This presents a problem for many Canadian companies, which are more properly valued based on international, not domestic, parameters and allows us to continually arbitrage international investment opportunities.
- Investing on a long-only basis is inferior to long-short portfolio strategies. This is particularly true in either a low interest rate environment or highly volatility markets. Now and for the next several years, North American investors will likely continue to experience both. Our preferred philosophy is to embrace and accept the volatility.