Q2-2017 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the second quarter of 2017, the three months ended June 30, 2017 is approximately +0.6%. The year-to-date performance for the 6 months ended June 30, 2017 is +19.3%.

My 11 year, 6 month compounded annual growth rate performance is +18.2% per year.

Portfolio Percentages

At June 30, 2017 (change from Q1-2017):

20% common equities (-4%)
28% preferred share equities (+8%)
31% corporate debt (-7%)
4% net equity options (+1%)
18% cash and cash equivalents (+3%)

Percentages may not add to 100% due to rounding.

USD exposure: 52% (+2%)

Portfolio is valued in CAD (CAD/USD 0.7714);
Other values derived per account statements.

Portfolio commentary

All things considered, the nearly flat performance was a good indicator of a relatively boring quarter – there was very little theatrics to discuss. Major portfolio decisions include liquidating my KCG Holdings equity stake, and retaining the equity options until the last possible nanosecond before expiration. I will promptly liquidate the position if the market is acceptably close to the USD$20.00 cash buyout number (or I will just wait for the transaction to proceed). This will result in an effective liquidation of another 4% of the portfolio. I also have another 4% position in their senior secured bonds which will be called out after the transaction completes, which should be around July 21st (after the quarter-end). The net result of these transactions are that the portfolio is effectively 25% cash and I have no idea where to deploy it beyond VGSH (USD) and VSB.TO (CAD) – at least with those I get paid around 125 basis points to wait.

Sadly my entries into the VGSH/VSB.TO short-term fixed income vehicles has been incredibly lacklustre – with continued threats of rising interest rates, even these short duration vehicles are taking a minor hit of capital value – an inexpensive lesson that yield is rarely risk-free.

I took a single digit percent position in a company trading well under tangible book value and earning positive income and cash flows during the quarter. I estimate when the market wakes up to this position (there has been little if any analyst coverage, nor has there been any public exposure to it at all) it will trade up to double its present value. I won’t write about this one until it appreciates or my original investment thesis is incorrect. There is a credible reason why there is still price pressure even at the depressed levels. The company has spent most of its public life trading around 25% higher than what it is trading at right now.

This was my first new common share position in over a year. I’ve been close to pulling the trigger on some other ones but they didn’t quite reach the correct price point.

I also took a non-trivial stake in DRM.PR.A preferred shares. I’ve been in and out of this over the past couple years, but this time I suspect it will be a staple position for quite some time. It only requires 33% margin so it is not too much of an anchor to keep, especially since the spread between the margin rate and the dividend rate is huge. This is effectively a “cash parking” vehicle until they get called away by the parent company (I was expecting this to happen quite some time ago). When it happens I will have the problem of more capital going from a near-guaranteed 7% tax-preferred income to 1%. It is my hope that management continues to ignore this issue (other than paying quarterly dividends). I wouldn’t buy it at the current premium.

That’s about it for the quarter.

In terms of price movements, there were three items which caused negative portfolio movements. Genworth MI took collateral damage with regards to the collapse of Home Capital Group, but has swiftly recovered from reaching a low of about $30.50/share. At that level, Genworth MI was in the low end of my price range, but it wasn’t low enough that I would re-purchase shares. Conversely, it is too cheap to sell at present prices. So I will be waiting and continuing to collect 44 cent quarterly dividends until the market decides that the equity is worth more.

Teekay Corporation unsecured debt also significantly declined to reflect the calamity that is hitting their offshore division, but I do not believe the underlying value of this debt is compromised by virtue of the value of their natural gas division. This was the primary detractor from my portfolio performance this quarter. At a YTM of 13%, investors have a decent risk/reward situation at current prices.

The third detractor to performance was the Canadian dollar – as it appreciates, although I appreciate the purchasing power, it does detract negatively on my US dollar components. Since my portfolio is nearly 50/50 CAD/USD, each percent the Canadian dollar rises means a half percent drop in my portfolio value.

Finally, Gran Colombia Gold announced they will be redeeming 5.7% of their 2020 senior secured debt outstanding at par. I will be pocketing the cash and looking forward to future payments – this series of debt is first in line, secured by a gold mine and an investor can be patient to collect on the debt. Although I do not have a place to deploy the cash, I look forward to receiving the payment and reducing my concentration in this particular debt issuer (I purchased most of the senior secured debt at around 55-60 cents on the dollar). The two relevant risks here are the political stability in Colombia (which is not bad at present) and the price of gold continuing to meander at its present level – or go higher. 75% of the free cash flows from the company have to go towards redeeming the senior secured debt due in 2020, so over time I will expect to get paid back.

The portfolio underperformed the S&P 500 slightly, while outperforming the TSX. I do not invest for relative returns, but psychologically it always feels better to know that somebody is losing more money than I am. The portfolio in the last quarter has also underperformed my 11.5 year CAGR (Compounded Annual Growth Rate), but this is to be expected given my very risk-adverse positioning at present. I will warn readers that my +18.2% CAGR is likely to decline in the upcoming quarters as making a percent or two each quarter is below the +18.2%/year benchmark.

Outlook

Crude oil markets are trending significantly lower than what most participants thought would be happening. This is having a significant impact on most Canadian oil and gas companies, whom have been continuing to address leverage matters. While prices imply there is pressure, it is not yet at a crisis point that it was back in February 2016, but if the prevailing trend continues, it definitely appears that there will be some more fractures in the Canadian oil and gas space due to excessive leverage levels. There may be opportunities in the debt market at this point (witness the calamity hitting Teekay right now).

In the USA broad market, the S&P 500 is dominated by the top 10 companies (Amazon, Facebook, Google, Netflix, etc.) and when extracting out those liquidity high-flyers, we have a market that is treading water and some targets of opportunity are starting to emerge that have value-like characteristics. However, the US federal reserve is slowly tightening the screws in terms of loose monetary policy and this most certainly will have a continued dampening effect on equity valuation as the cost of capital continues to rise. They are doing this slowly as to not trigger a market crash, but most participants should be alerted that the 30-year treasury bond, currently at a yield of about 2.8%, is not rising despite the rising-rate environment. This is something to be very cautious about.

The Bank of Canada also spooked the markets in the second week of June when they were making public noise about increasing the interest rates. Although I do not predict they will take much action, if any, until the corresponding long bond rates rise, this may have the effect of putting a bottom on the slow and steady decline of the Canadian dollar. Clearly the commodity markets are not helping Canadian currency, and if there is some sort of return in commodities, then the Canadian dollar would actually be better positioned for a rise.

In general, I continue to remain bearish. Although this stance has not been in correspondence with the major indicies (which have risen considerably), my portfolio continues to generate a positive return while remaining extremely risk-adverse at present time. I am of the general belief that index investing continues to dislocate pricing in the market from true value and this trend is not likely to abate until such a point that it is identified that pouring capital in a non-price discriminatory vehicle is not a prudent way to invest money – instead, it is diversifying through obscurity and not achieving true risk reduction.

I am finding it very difficult to invest cash in this environment. It is painful to wait, but waiting I will do.

The average maturity term on my debt portfolio is just a shade over 30 months. This will continue to lower as my issuers go down to maturity. I am not interested in long-duration bonds at all at the moment.

I project over the rest of this year, if things go to a reasonable level of fruition, that I will see another 2-3% of appreciation, while taking little risk. This is also assuming that I do not see further candidates for investing the non-trivial amount of cash in the portfolio. Nothing imminent is on the horizon. My research pipeline has been bone-dry.

To put a polite summary to my investment prospects, I feel stuck. Little in the pipeline and little of inspiration. Waiting is not popular, but it will allow me to preserve capital for the time where it will be more appreciated.

(Update, July 17, 2017: After doing my internal audit, the quarterly performance was revised from +0.7% to +0.6% for the quarter. The year-to-date was revised from +18.7% to +19.3% due to a rather embarrassing formula error on the tracking spreadsheet. The changes are reflected in the numbers above. The 11.5 year CAGR remains unchanged.)

Portfolio - Q2-2017 - Historical Performance

Performance and TSX Composite is measured in CAD$; S&P 500 is measured in US$. Total returns indices are with dividends reinvested at time of receipt.
YearDivestor PortfolioS&P 500 (Price Return)S&P 500
(Total Return)
TSX Comp. (Price Return)TSX Comp.
(Total Return)
11.5 Years (CAGR):+18.2%+5.9%+8.2%+2.6%+5.6%
2006+3.0%+13.6%+15.6%+14.5%+17.3%
2007+11.7%+3.5%+5.5%+7.2%+9.8%
2008-9.2%-38.5%-36.6%-35.0%-33.0%
2009+104.2%+23.5%+25.9%+30.7%+35.1%
2010+28.0%+12.8%+14.8%+14.5%+17.6%
2011-13.4%+0.0%+2.1%-11.1%-8.7%
2012+2.0%+13.4%+15.9%+4.0%+7.2%
2013+52.9%+29.6%+32.2%+9.6%+13.0%
2014-7.7%+11.4%+13.5%+7.4%+10.6%
2015+9.8%-0.7%+1.3%-11.1%-8.3%
2016+53.6%+9.5%+12.0%+17.5%+20.4%
Q1-2017+18.6%+5.5%+6.1%+1.7%+2.2%
Q2-2017+0.6%+2.6%+3.1%-2.4%-1.6%

Administrative note on the site

I have enabled full-text RSS feeds of the site’s posts (instead of just a summary). You will no longer have to click-through your RSS readers in order to view articles on this site. While I am curious who is reading the content on this site, there are RSS readers that are now smart enough to just download the whole content and display it for their readers. I don’t run advertising, but if you are one of those silent viewers, it would be mightily appreciated if you just write a comment saying “hello” and where you initially heard of this site since I get so little traffic from Google for the past few years (one of the consequences of not giving them advertising money). Don’t get me started about the rest of social media either!

I have also updated some site links on the right hand side concerning other Canadian Finance authors. My criteria is that the writer’s name be known and that they’ve written at least four decent pieces in a year. Sadly the quality of writing on the internet has decreased significantly over the years and I do not expect this trend to abate.

Q1-2017 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the first quarter of 2017, the three months ended March 31, 2017 is approximately +18.6%.

My 135 month compounded annual growth rate performance is +18.6% per year, an identical number that is strict coincidence.

Portfolio Percentages

At March 31, 2017 (change from Q4-2016):

24% common equities (-24%)
20% preferred share equities (-7%)
38% corporate debt (-6%)
3% net equity options (+2%)
15% cash (+35%)

Percentages may not add to 100% due to rounding.

USD exposure: 50% (+8%)

Portfolio is valued in CAD (CAD/USD 0.7508);
Other values derived per account statements.

Portfolio commentary

Needless to say this was a good quarter for me. Normally posting a return like this would be good for a year’s performance. Although I do not invest for relative performance, relative to the S&P 500 (+6% for the quarter) and the TSX (+2%) my portfolio had a smashingly good quarter.

I will warn this performance will not be matched in the next 9 months of this year. The upside potential of the current portfolio components is limited. My estimate of this potential, assuming an above-average ideal of things going correct, is 8%. This means about 2-3% a quarter for the next three quarters, and of course things never run that smoothly in portfolio management, unless if you invested in GICs.

In terms of buying activity, this quarter was relatively inactive (less than a percent of the portfolio). On the selling side, my two largest equity components (TSX: MIC, NYSE: KCG) had considerable rises in price, and as such, I did some significant trimming. They are now down to reasonable proportions of the portfolio. I also trimmed some preferred shares. Also assisting the +15% cash position was the maturity of Pengrowth Energy’s debentures (my initial post about them was here). My portfolio now has a positive cash balance for the first time in about a year.

In contrast, I ended 2016 with a -20% cash balance (i.e. a margin position of 20% of the equity of the portfolio). As you can see, it was time to cash some chips. Cashing in some chips results in capital gains taxes to be paid in the next year, but this is the cost of profitable portfolio management. Taxes are a secondary consideration in trading decisions – valuation is the primary driver. I am relatively happy to see the capital gains inclusion rate did not change in Budget 2017, but I do not take the government at its word at all that it will keep this rate steady.

The other corporate debt in the portfolio has an weighted average remaining term of slightly less than 3 years. The corporate debt will collect interest income and will otherwise sit there collecting dust until maturity or being called. At par value, I am not interested in liquidating them until maturity (or if they are called away). Given the short duration, I do not care if risk-free rates rise.

Portfolio Outlook

The decision to play safe this quarter (and likely for the remainder of the year) is obvious to me. Markets have risen significantly in the Trump honeymoon and I do not believe that risks (specifically the so-called “unknown unknowns“) are being truly appreciated at the moment. Everything is seemingly looking good. Things are comfortable. Look at what happened to the S&P 500 implied volatility after Donald Trump got elected (November 8, 2016):

When everybody thinks things are comfortable, this is a formula for future loss when less optimistic scenarios bakes into market pricing. I am not sure when negative sentiment will pervade throughout the market, but these things will always manifest themselves later than one expects – I am probably too early.

It is psychologically difficult to sell yielding securities for non-yielding cash (why sell something that gives away money for something that just sits there and earns zero?), but I must reload my ammunition for when the market truly decides to go into a tailspin. I don’t know the specific reason for the next tailspin will be (or when), but these things usually do occur when people least expect them. The future is always difficult to predict, but right now when I am looking microscopically across the markets for opportunities, I am drawing so many blanks that I need to crawl to a safe place. It might look foolish to duck into the shelter before there is even an inkling of a hurricane or tornado coming in the horizon, but this is how I feel, so I will bunker down.

I had written earlier in my 2016 year-end report that if everything goes well this year I should probably see a low-teens performance. Because of some unexpectedly positive developments in my two largest portfolio components, I have already made a year’s worth of gains in a single quarter. I will repeat that while one can extrapolate this quarter’s performance to future quarters, I would advise it would be a significant error to do so – there is no way this can continue. As I continue to cash up, it will continue to cap my performance gains. If markets rise to my additional sell points, the amount of cash can go 50%, which is a ridiculously high amount. I am also content to hold cash or cash-like instruments for extended periods of time.

Just imagine showing up to work in a finance firm as an asset manager and telling your bosses that you’re holding cash and going to watch movies until the markets drop. While I am not that lazy (I do run occasional stock/bond screens and try to look at the microscopic parts of publicly traded securities which are less prone to overall market fluctuations), when I do some detailed due diligence, it mostly ends up flat. Even worse yet are the IPO and secondary offerings that are hitting the market – there’s a lot of junk being shoved out the door to yield-hungry investors. It reminds me of what they did with the income trusts in the early 2000’s (most of them blew up and lost a lot of people money, other than investment banks and management insiders).

Sadly, market conditions and the selling nature of my portfolio at present means my writing will become more boring until things become more volatile. I recognize this is my shortest quarterly commentary in quite some time – I’m finding little to invest in.

My next challenge is to find a good location to park cash.

Some macroeconomic outlooks

I do have a few convictions that surround my decision-making (or lack thereof). One is that I am of the belief that the US dollar is undervalued and should perform relatively well against other world currencies, including the Canadian dollar. I have generally maintained a policy of keeping the US dollar exposure of the portfolio between 30-70%.

The other conviction I have is that I believe crude oil will continue to be a mediocre performer and indeed, in any sign of any world economic malaise, will take a tailspin from their existing price band. This makes Canadian oil producers (especially in the existing hostile federal and provincial environments) relatively prone if they have debt pressure, especially those contingent on higher oil pricing. At present, a lot of these companies have “value trap” written all over them. A good example will be Cenovus (TSX: CVE), who decided to leverage up, but just imagine the stress their shareholders will feel at US$40/barrel instead of US$50/barrel today. There will be a time to invest in fossil fuels, but not now.

Political outlook

My home province of British Columbia is having an election. Although I project the incumbent party is going to continue to win another majority government, there is a strong anti-incumbency undercurrent which appears to be brewing, which will make motivational aspects of elections (i.e. turnout) crucial. I am not nearly as certain as the result as I was at the beginning of this year when I projected the existing government would cruise to an easy victory.

The main opposition party, the BC NDP, still doesn’t appear to have their act together (I don’t see them focusing on issues that will actually win them the election), but this campaign is going to be quite volatile since the public is only going to pay attention during two weeks of the election period before deciding who they will vote for.

It doesn’t matter how incompetent the BC NDP have looked in the past, it matters how competent they look in exactly those two weeks when the public care.

Portfolio - Q1-2017 - Historical Performance

Performance and TSX Composite is measured in CAD$; S&P 500 is measured in US$. Total returns indices are with dividends reinvested at time of receipt.
YearDivestor PortfolioS&P 500 (Price Return)S&P 500
(Total Return)
TSX Comp. (Price Return)TSX Comp.
(Total Return)
11.25 Years (CAGR):+18.6%+5.8%+8.1%+2.9%+5.8%
2006+3.0%+13.6%+15.6%+14.5%+17.3%
2007+11.7%+3.5%+5.5%+7.2%+9.8%
2008-9.2%-38.5%-36.6%-35.0%-33.0%
2009+104.2%+23.5%+25.9%+30.7%+35.1%
2010+28.0%+12.8%+14.8%+14.5%+17.6%
2011-13.4%+0.0%+2.1%-11.1%-8.7%
2012+2.0%+13.4%+15.9%+4.0%+7.2%
2013+52.9%+29.6%+32.2%+9.6%+13.0%
2014-7.7%+11.4%+13.5%+7.4%+10.6%
2015+9.8%-0.7%+1.3%-11.1%-8.3%
2016+53.6%+9.5%+12.0%+17.5%+20.4%
Q1-2017+18.6%+5.5%+6.1%+1.7%+2.2%

2016 Year-End Report

Portfolio Performance

My very unaudited portfolio performance in the fourth quarter of 2016, the three months ended December 31, 2016 is approximately +3.1%. The year-to-date performance for the year ended December 31, 2016 is approximately +53.6%.

Portfolio Percentages

At December 31, 2016:

48% common equities
27% preferred share equities
44% corporate debt
1% options
-20% cash and cash equivalents

USD exposure: 42%

Portfolio is valued in CAD (CAD/USD 0.7420);
Equities are valued at closing price;
Values include accrued corporate bond interest;
Corporate debt valued at last trade price.

Portfolio commentary

What an interesting year, both in the portfolio and in the overall investment climate. The climate back in February 2016 was with much more peril than it is now. Prices are now reflecting the decreased amount of peril, hence they are higher. Much higher.

The TSX composite also had a good year – about 20% with dividends invested. This was undoubtedly on the back of the recovery in the energy sector – most issuers are all up over this year-to-year.

From the previous quarter, several positions appreciated, I bailed out in one position entirely, and also also added to another position. All of my common equity that I hold are in companies that are trading under tangible book value and generating cash.

My preferred share portfolio is mostly unchanged. They are half rate-reset and half of them have a fixed rate. I did do some slight additions of one issuer that was very temporarily trading about 10% lower than its ambient price for no good reason, but this addition was slightly less than 1% of the portfolio (which is too bad, since I wanted whoever was selling it to continue hitting the bid – I was willing to go another 4% or so). I am generally content with my holdings in these categories, and I will also note that my preferred share holdings of Birchcliff Energy (both TSX: BIR.PR.A and BIR.PR.C) have remained quite close to a point where I would want to liquidate and head for greener pastures. I am demanding a price, however, that prices in the circumstance that they will continue to pay out dividends for a very long time (and indeed, given how their common shares have performed this year, I should have just bought them to begin the year instead of the preferred shares). If my price gets hit, great, if not, I will keep collecting the cash flows since my cost of capital is cheap.

I have six issuers of corporate debt that I hold. One will mature early in 2017 (Pengrowth Energy, PGF.DB.B) which will add a not-inconsiderable amount of cash back to the portfolio. I was happy to see my analysis come to fruition back in March 2016 on this issuer. The underlying company will do well if oil continues to rise in price, but at the US$45-50 range they will not do so well as they have a series of debt maturities coming up and refinancing will not be trivial, although they seem to have taken good steps to mitigate the issue with a royalty sale.

The rest of the debt portfolio (minus Pengrowth) has an average weighted term of 3.2 years. One of the features of investing in debt directly instead of through an ETF is that over time, your interest rate exposure decreases. I am concerned that interest rate risk will continue to rise, hence a decreasing term to maturity of the portfolio will mitigate that risk. As long as solvency is not an issue (i.e. bondholders get paid), it should present no problem if rates do rise. In addition, some of the debt is callable and while this will decrease the interest payout over time, it would give me the opportunity to redeploy capital.

Teekay Corporation’s unsecured 8.5% debt maturing on January 15, 2020 has been behaving to thesis. Considering that the parent and daughter entities have been raising equity pursuant to a continuous equity offering, this can only be good for bondholders.

Currency-wise, the exchange rate differed a little bit – the CAD started the year at 72 cents, and closed the year at 74 cents, so this had a slightly negative impact on the portfolio performance.

Performance-wise, obviously this was a very good year for me. This seems to happen once every three years in generally market-positive years. I don’t have any specific insight why it happens when it does.

Finally, I will make a comment on the level of margin in the portfolio. It looks heavily leveraged at the moment (and historically this is quite high amounts of leverage for myself, who has been accustomed to holding significant amounts of cash in the past – up to half at times). Most of the margin is directly linked towards specific fixed income investments that have rather predictable cash outlay profiles. When considering the inexpensive (and tax deductible) financing provided, it makes a lot of financial sense to park idle capital into vehicles that can predictably give off stable streams of income and principal payments.

When looking strictly at the fixed (non-equity) component of the portfolio and offsetting it against the margin debt, the only conceivable scenario where there will be fast stress is if there is some sort of 6-sigma type event (such as a WMD (nuclear, chemical, biological) event in a major metropolitan center in the USA) that will fundamentally change variables. Despite the margin, there is quite a layer of safety embedded.

Reviewing the predictions of 2015

It is a time to look back at the predictions I made back in the 2015-year end report and see what I got right and what I didn’t.

1. Canadian Dollar, Canadian interest rates, Canadian Economy: Mixed bag. I was wrong on the trough on the Canadian dollar (I thought it would go to 65 cents), but I was right about the interest rates being fixed at 0.5%, and the general impact of natural resource extraction in Canada, although the late-year pipeline approvals from the federal government surprised me.

2. Crude Oil and natural gas: These were both a failed prediction. A lid was not kept on the price of crude, and natural gas, while performing better, was also considerably higher.

3. Canada Real Estate: Successful prediction, although BC enacting a foreign buyer transaction tax, coupled with the federal government’s change on mortgage financing is slowly putting a lid on credit conditions on this market.

4. Canada Federal Budget: Correct. The forecast deficit was higher than initial projections. Not a surprise considering the existing spend-everything government.

5. US Federal Reserve: Correct.

6. Next US President: Yes, I predicted Trump would win by a considerable margin. The definition of “considerable” can be debated, but a 304-227 margin, in presidential terms, is a very healthy victory. My prediction was 295-243.

Outlook

Similar to the Presidential election, 2016 was a unique year in that there were some very defined amounts of stress applied as a result of the oil and gas market reaching the trough of its leverage issues. Once this was done, there has been relatively little of opportunity in terms of reasonable risk/reward ratios. Most of my trades this year were done before April and the rest of it has served as a mild detriment to my own performance. Trading because one is bored and looking for thin value situations should only be limited to the smallest of percentages and thankfully I obeyed this rule.

I am projecting a rising price environment over the next couple months of the calendar year. My hunch is reliant on inflows of capital into the equity markets primarily as a result of past performance. While pension funds will have to execute on an equity-to-bond rebalancing, this will probably be offset by hordes of cash that will be dumped into robotic management (so called robo-investors).

Psychologically, it is one thing to invest in something and lose 20% of your capital. It hurts. It is even worse for an investor to have cash sitting in their bank account earning 1% (if that) and seeing the rest of the market rise 20%. Consider the vantage point of somebody prospectively wanting to buy real estate in the Vancouver area over the past decade (link to Teranet) – there was no decent time to not pull the trigger (until perhaps now).

I was fortunate enough to employ leverage at the best time possible, but it is time to harvest gains and bunker down a little.

Fiscal policy in Canada remains very deficit-driven. Politically-speaking, now that the Liberals have gotten their feet wet again in government, they will know that this year will be the year to enact the most publicly unpopular policies. They are also facing an issue of trying to raise money since they inherently have an inability to contain spending. An interesting document to scour is the report on tax expenditures (specifically this table), where you can be a finance minister and ask yourself what the best ways to net the government money would be. There already have been trial balloons floated on the taxation of health insurance plans for employers, and also an increase to the capital gains inclusion rate.

Predictions about how the Canadian government’s Budget 2017 tax proposals with my confidence factors:

1. (50%) Flow-through share deductions will be eliminated.
2. (75%) Employee stock option deduction will have a full, instead of half inclusion rate, OR the amount will be capped to some nominal amount (e.g. CAD$50k allowed or something).
3. (40%) Taxation of capital gains on principal residences is going to have some restrictions (time, or value) placed.
4. (75%) Partial inclusion of capital gains will rise. Using the year 2000 model, Canadians should consider crystallizing gains in early 2017 before the budget. The only question is whether this will apply to individuals or corporations, or whether there will be a limited dollar value applied to this condition.
5. (90%) I do NOT believe the non-tax exemption for private and public health plans will be scrapped. This would be a political nightmare for the government compared to the rather esoteric notions on the items.
6. (50%) The GST will rise (probably to 7%, but this prediction will be judged a success if it is simply raised at all).
7. (50%) Corporate income taxes, on large corporations, will rise.

Fiscally speaking, I see another CAD$25-40 billion deficit year coming ahead, with the low end only coming to fruition if they raise the GST. The budgetary projections will show a slow return to surplus, but in actuality I will be writing here in January 2018 and the same forecast will occur.

Switching to Canada’s largest trading partner: the election of Donald Trump everybody has been trying to figure out the impact, but until January 20 comes rolling around, it is all imagined at the moment. If he is able to execute on even half of his economic policies, it would suggest that the best analogy to be applied is what happened when Ronald Regan was elected – although the initial starting conditions between Jimmy Carter today are vastly different – unemployment in the USA is at record lows and the economy, despite everything the existing administration has tried, is not in bad condition.

The power of hope is something that is not easily captured in forward-looking economic statistics, but the messaging of the Trump administration (which has still yet to officially take power) is that domestic US concerns will “trump” all others, especially with respect to employment.

That said, I shudder to think about the application of the business acumen of Trump’s administration versus Canada’s government (think about the trade minister crying after the EU agreement broke off) and the simple fact that Canada is in a very poor negotiating position in relation to the USA.

It is clear that Canada will not be able to negotiate a favourable deal on softwood lumber, nor will it be able to with automobiles, energy, or anything else for that matter simply because our country’s primary export had been real estate, which will soon be evaporating. Also by pre-emptively stating that we are willing to renegotiate NAFTA after Trump got elected has to be one of the top damaging statements to make in 2016 (and there was a lot coming from the government in this category, thinking about the completely incompetent Minister of Democratic Reform). Once the counter-party knows that you’re willing to negotiate, you’re in deep trouble.

The net result of this is that the USA is going to obtain much higher benefits out of NAFTA than Canada in historical context. Once the USA also reduces their corporate tax rate, one of the only advantages that Canada has will evaporate and you can be pretty sure that capital that was previously slated for deployment here will be heading down south. This clearly will have a negative effect on the Canadian dollar.

The only predictable event that would save us is the re-emergence of high energy pricing, but this event would not be of the existing government’s actions – it would be by pure luck.

About 80% of Canada’s oil production comes from Alberta and the provincial government is as hostile to fossil fuels as it gets and will only be replaced in 2019 by a government very likely to be lead by Jason Kenney. So while this is still at least a couple years away, investors are not going to be putting anything but maintenance money into the Alberta oilpatch even if the federal government gets its act together.

Our economic malaise is amplified by the case that our second largest export (energy) is hampered by the inability to actually get the product to market – alternatives (such as crude by rail) costs a lot more than pipeline.

Outlook – broader markets

As it relates to the market, however, most of the price appreciation seems to be baked in. When scanning the equity markets and the preferred share markets and debt markets, most of everything appears to be trading at relatively lofty valuations. There is little out there that appears to be trading with distress, which typically means that one will only get market-sized gains as opposed to making extraordinary gains.

I face the confusing notion that even if I am able to appreciate my portfolio by 10% in 2017, that it results in a drop in overall performance! I manage my portfolio for absolute returns, so I do not take this into consideration. If I have to sit the year out mostly in cash because I don’t see good opportunities, I will. Ideally, however, short-duration bonds with likely payouts fit the bill for idle cash, but those have been difficult to find at acceptable risk-reward ratios.

Just like how Costco is a great corporation, their stock is another story. The US economy will likely be roaring in 2017, but will this result in stock market success? Has it already been priced in after the November election of Trump? It is difficult to say. I am not very good with macroscopic forecasts of stock markets, and can only concentrate on the microscopic – and I don’t see a lot of stocks out there trading at 52-week lows which leads me to think a lot has been priced in already, but think there is going to be plenty of cash inflows for “follow-alongs” that felt like they missed the party.

Scanning the Canadian corporate debenture market, just as an example, leads me to precisely zero leads. It is a great time for issuers to be issuing debt.

I’m afraid I don’t have much insight other than that when in this state, raising cash and being patient for opportunities is the order of the day. I intend on de-leveraging and doing just that. I might have to wait an extended period of time until stress is visible in the marketplace.

Currency-wise, while I usually don’t have any grand prognostications and as a result, I tend to keep a balance of CAD and USD in the portfolio, I’m generally of the belief that the US dollar is going to continue to strengthen. This will continue to keep a lid on commodities.

Outlook – Portfolio in 2017

If absolutely everything works in 2017, the gains should be in the low teens. It is more probable that it will be a mid-single digit percentage year for me. My research pipeline is relatively thin at the moment (not a good sign for gains). Keeping my past 11 year record of 17% right now is a pipe dream.

Predictions for 2017:

1. The 1st half of the year will contain the high water mark for the S&P 500, Nasdaq and TSX. (The TSX’s high water mark was on the last trading day of the year!).
2. The Bank of Canada will not raise the short-term interest rate (0.5%), UNLESS if the 10-year bond yield rises above 2.5% (right now it is 1.72%).
3. The Canadian dollar will depreciate below 70 cents USD at some point during the year.
4a. Kevin O’Leary becomes the next leader of the Conservative Party of Canada, first-ballot victory with around 60% of the vote.
4b. He will speak better Fran├žais better than the media expects (think about Facebook’s Zuckerberg speaking Mandarin).
5. The 2017 Budgetary proposals as written above (I’ll consider this prediction successful if at least 4/7 occur).
6. Spot WTIC pricing will spend the majority of its time around the USD$50-65 price band.
7. If China experiences something akin to Japan’s early 1990-type economic malaise, there will be significant ripple-down effects on Vancouver real-estate (let’s define this as a Teranet average of less than 220).
8. The US federal reserve will raise interest rates once to 1%, but will relax the interest re-investment policy on their balance sheet assets during the year and retain a tightening bias.
9. “Canada Recession” will register a Google Trends search index rating of higher than 10 sometime in 2017. This is basically a prediction that by year-end that it should be fairly evident that we are close or going into recession.
10. Minister of Democratic Reform Maryam Monsef will get shuffled out of her portfolio (in addition to others from theirs) during 2017. There will be some “face-saving” measure applied for the justification (e.g. she suffered an injury, or something to explain it other than her performance).
11. In the May 2017 BC election, the BC NDP win 20 seats or less (down from the 35 they currently hold). I note polling now has them neck-and-neck with the governing BC Liberals.
12. There will be at least one volatility spike (VIX index) that will take it above 30 as a result of some geopolitical (not economic) event.
13. (Added January 2, 2017) Canopy Growth Corp (TSX: CGC) trades below CAD$9.14/share (2016 year-end closing price) at 2017 year-end (background info).

Portfolio - Year-End 2016 - Historical Performance

Performance and TSX Composite is measured in CAD$; S&P 500 is measured in US$. Total returns indices are with dividends reinvested at time of receipt.
YearDivestor PortfolioS&P 500 (Price Return)S&P 500
(Total Return)
TSX Comp. (Price Return)TSX Comp.
(Total Return)
11 Years (CAGR):+17.2%+5.5%+7.7%+2.8%+5.8%
2006+3.0%+13.6%+15.6%+14.5%+17.3%
2007+11.7%+3.5%+5.5%+7.2%+9.8%
2008-9.2%-38.5%-36.6%-35.0%-33.0%
2009+104.2%+23.5%+25.9%+30.7%+35.1%
2010+28.0%+12.8%+14.8%+14.5%+17.6%
2011-13.4%+0.0%+2.1%-11.1%-8.7%
2012+2.0%+13.4%+15.9%+4.0%+7.2%
2013+52.9%+29.6%+32.2%+9.6%+13.0%
2014-7.7%+11.4%+13.5%+7.4%+10.6%
2015+9.8%-0.7%+1.3%-11.1%-8.3%
2016+53.6%+9.5%+12.0%+17.5%+20.4%

Q3-2016 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the third quarter of 2016, the three months ended September 30, 2016 is approximately +12.2%. The year-to-date performance for the nine months ended September 30, 2016 is +49%.

Portfolio Percentages

At September 30, 2016:

36% common equities
25% preferred share equities
43% corporate debt
-4% cash and cash equivalents

USD exposure: 41%

Portfolio is valued in CAD;
Equities are valued at closing price;
Values include accrued corporate bond interest, but not that from Canadian exchange-traded debentures;
Corporate debt valued at last trade price.
“cash equivalents” in this instance includes holdings of VSB.TO.

Portfolio commentary and outlook

I keep saying that good performance can’t last forever. Fortunately, the gravy train hasn’t stopped quite yet. Going back from my half-year report, at most I was expecting double-digit appreciation in my portfolio before hitting the sell button. As you can see, I have gone from 21% margin to 4% margin in a relatively short period of time, which means I have liquidated some holdings.

I have been disposing of equity securities (and some corporate debt) and have been using that cash to reduce the amount of margin.

So, I have decided to cash in some chips and wait for worse days ahead. Indeed, if the remaining portfolio appreciates, I will be cashing in even more chips. There are a few things on the horizon that will likely be cashed out, and there is some PGF.DB.B debt that will mature on March 31, 2017, likely at par. Items that are close (via market pricing) to being liquidated consist of another 15% of the portfolio and it is quite likely by year’s end the net cash balance will be positive.

While I can be considered in a cash-raising mood, my invested portfolio fraction is still quite high. It’s not as if I’ve decide to sell everything.

The majority of the portfolio (equity and preferred securities) remains relatively unchanged. I sold some equity components over the past quarter, but otherwise the names are still the same. I tried to acquire an old name that was trading cheaper, but sadly missed out by pennies before the market moved against (higher) me. I got a whopping 100 shares of this thing, which was frustrating since I was seeing thousand-share blocks trade a penny above my bid.

The remaining debt portfolio is invested in companies that I do not realistically expect to incur losses, while providing a steady stream of income. While my portfolio is targeting the best risk/reward ratio, I am rather agnostic about whether this comes in the form of capital gains, dividends, interest or pixie dust, as long as it can be translated into after-tax cash at some point in the future. One such debt investment I disclosed was Teekay Corporation, where most of their debt is in the form of an unsecured bond maturing on January 2020. There are a variety of reasons why bondholders will be made whole and all I have to do is just sit on it. While I bought the debt at roughly a 20% yield to maturity, it still presents a 13% yield to maturity today.

Unfortunately, like the previously stated cases and in most others, the time for superior returns is not now. Indeed, the stock I missed out on by pennies would have actually contributed a performance that is under my historical average, but the risk/reward was simply too alluring to ignore. If you can get a guaranteed 4% and only have to pay 2% interest for the privilege, why not do it?

Despite what most mutual fund marketing says, timing is a very important element in attaining superior financial returns. The theory of market timing is simple – you want to be purchasing things that are out of favour, ideally in panic situations, with the realistic chance of things not being as gloomy as the price might indicate. The actual practice of market timing is far, far different. Fund managers have pressures to be fully invested and attain steady returns for their clients (one reason why fixed income investing has become so popular since the financial crisis). People have itchy trigger fingers and have to “do something” with their money, lest it earn zero percent interest!

It is this reaction, “do something”, that causes capital to be pushed into securities with sub-par returns and as a result, will incur portfolio losses whenever the next crisis occurs.

Indeed, the emotion of seeing the market rise when you are sitting on cash is more powerful than the emotion of loss when you are invested in something going down.

Having a huge performance gain creates its own difficulty. Indeed, since I have outperformed the major indicies, on average, by more than 10 percentage points over the past 10 years, it creates its own performance issue when I decide to bunker down and play defensive. I am not concerned, nor do I face external pressure from clients to maintain a high level of performance. What is hidden in these performance numbers is the risk I took to obtain these numbers in relation to performance.

I am willing to hold onto cash for longer than most people in order to ensure that when the cash is invested again, it is invested in the best risk/reward opportunity that would give me an edge over the market. Sometimes the market presents opportunities (like last February) that are so obvious, and sometimes the markets are completely shut, like I am finding them now. There is no point for me to force the matter – instead, I should just take a long vacation and wait and see.

This is probably why I would never work well in a typical finance firm – telling my bosses that the best thing we can do for now is to entirely invest in cash would get me fired.

Something I find disturbing is that there are similar other prominent individuals, ones with a lot more cash in the piggy bank than me, in the marketplace that are positioned in a similar manner. When lots of participants in the market have cash, it is not a condition that is ripe for a market crash. My general thesis is that markets will remain choppy for the indefinite future and most of the money is likely to be made in yielding instruments.

This is why I’m not too afraid of my existing portfolio structure, which is heavily biased towards fixed-income securities.

In terms of portfolio outlook, I really do not see excessive outperformance between now and the end of the year. At the absolute highest, I’d expect to see another 5% for the quarter, but I think this is a stretch. I also believe there will be volatility caused by US Presidential Election antics. We will see.

The last thing I would like to remark upon is the gross performance figure over the past 10.75 years – there is a chance that this performance is just pure luck. I would not extrapolate 17% into the future – maintaining this type of performance is very, very difficult. I have outperformed 99% of all hedge fund managers out there, albeit I have an advantage with an incredibly smaller base of capital to work with than they do. That said, I am confident that I cannot keep this pace.

Portfolio - 2016-Q3 - Historical Performance

Performance and TSX Composite is measured in CAD$; S&P 500 is measured in US$. Total returns indices are with dividends reinvested at time of receipt.
YearDivestor PortfolioS&P 500 (Price Return)S&P 500
(Total Return)
TSX Comp. (Price Return)TSX Comp.
(Total Return)
10.75 Years (CAGR):+17.3%+5.3%+7.5%+2.5%+5.5%
2006+3.0%+13.6%+15.6%+14.5%+17.3%
2007+11.7%+3.5%+5.5%+7.2%+9.8%
2008-9.2%-38.5%-36.6%-35.0%-33.0%
2009+104.2%+23.5%+25.9%+30.7%+35.1%
2010+28.0%+12.8%+14.8%+14.5%+17.6%
2011-13.4%+0.0%+2.1%-11.1%-8.7%
2012+2.0%+13.4%+15.9%+4.0%+7.2%
2013+52.9%+29.6%+32.2%+9.6%+13.0%
2014-7.7%+11.4%+13.5%+7.4%+10.6%
2015+9.8%-0.7%+1.3%-11.1%-8.3%
2016-Q1+12.3%+0.8%+1.4%+3.7%+4.3%
2016-Q2+18.3%+1.9%+2.5%+4.2%+5.1%
2016-Q3+12.2%+3.3%+3.9%+4.7%+5.3%

Q2-2016 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the second quarter of 2016, the three months ended June 30, 2016 is approximately +18.3%. The year-to-date performance for the six months ended June 30, 2016 is +33%.

Portfolio Percentages

At June 30, 2016:

44% common equities
26% preferred share equities
52% corporate debt
-21% cash

Percentages do not add to 100% due to rounding.

USD exposure: 38%

Portfolio is valued in CAD;
Equities are valued at closing price;
Values include accrued corporate bond interest, but not that from Canadian exchange-traded debentures;
Corporate debt valued at last trade price.

Portfolio commentary and outlook

Back in February 11, 2016, I wrote the following:

I do have a general rule and that is whenever [financial market panic] hits the headlines of mainstream publications, it is likely closer to the 9th inning of the ballgame rather than the beginning.

The environment right now is once again reminding me of something like mid-2008 when everything is all panicky. Bargains that have good potential for double-digit appreciation are hitting the radar in huge frequency.

Just like what I did in 2008-2009, I listened to my own advice and started deploying some cash, for dramatic effect.

This quarter can only be described as insanely positive. It was a quarter where nearly everything worked. In relation to risk, the portfolio achieved returns that were far greater than anything ever done before since the 2008-2009 financial crisis (recall that 2009 was a year where I made +104% on my portfolio, an achievement that is not likely to be surpassed in my lifetime, but in my rational estimate there was more risk taken to achieve that return).

When everything is working, there are a couple attitudes:

1) Why change direction? Why not stick with a proven strategy?
2) Keep cautious, as something that works in the markets during one time period may not work in another time frame.

I am always of the #2 mentality, but apply discretion to “let winners run”. And indeed, I am letting my portfolio run.

The actual risk exposure of the portfolio is significantly less than what the asset allocation fractions above would suggest. The corporate equity portfolio consists entirely of companies that are trading under tangible book value and all of those entities are producing positive cash flows (with the exception of Genworth Financial (NYSE: GNW), where their LTC portfolio is going to be a huge negative cash drain, but financial challenge is to calculate how much of their asset base will go out the window to pay for future claims). GNW is a small equity holding.

I would not expect to liquidate any of these equity securities until they have appreciated further than present, but even then, I only like to sell when they are above my fair value band rather than at fair value.

The preferred share securities and corporate debt securities are higher up on the capital structure and for each and every of these investments I am expecting to be paid dividends or interest. In the case of the debt, my credit risk is mitigated with either security or functional first-in-line subordination status (i.e. little in the way of further senior or secured liabilities). There are a couple long-shot, distressed debt securities in the portfolio, but these have been kept to less than 1% position limits.

A notable debt highlight is Pinetree Capital (TSX: PNP) had their senior secured debentures mature on May 31, 2016 for cash, which ended a huge saga of the previous management’s inability to manage the balance sheet. I had actually liquidated most of these holdings at 101 cents before the rights offering was announced since my calculations showed that a cash maturity was going to be very tight (and indeed, if the rights offering did not come through that they likely would have had to go into CCAA to give them time to pay off debtholders with a mostly illiquid private asset portfolio). I wish Peter Tolnai, the new CEO and indirect 31% owner, the best of success in trying to unlock the value within the corporation’s huge pool of un-utilized capital losses. You can read the whole saga from November 2013 to May 2016 at this link. I expect things to be a lot more calm with Pinetree Capital in the future, except for them probably changing their company’s name to finally turn the page. I will disclose a very small equity holding by virtue of the January debenture redemption, which gave debtholders some shares.

For my fixed-income securities (bonds and preferreds), my yield at cost was in the low double-digits for something I consider to be between very low to low risk investments, despite the fact that such securities were trading at what I considered to be distressed price levels. The current yield of this basket of securities has decreased since purchase because of price appreciation (and will continue to drop because of rate-resets occurring over the next 12 months), but there is still room to run.

The beauty of debt securities is that I can fall into a coma and when I wake up, I very likely will have interest and principal deposited into my brokerage account. I do not have to take any action unless if I have a good reason to sell (which would likely be the securities trading above par value at a point where the call risk becomes meaningful). The preferred share securities are a different story – they have to be somewhat more actively monitored for both credit risk purposes and also if they are at a point where they have appreciated enough that their current yields are inferior to a superior alternative, measured from a risk-reward ratio. Due to the considerably low 5-year government bond rate, the rate-reset mechanisms of most preferred shares have taken their value well below the range where there is call risk so it is very likely that if I woke up from such a hypothetical coma, these shares will still be in the portfolio spinning away cash.

I do not have a good feel for the intermediate interest rate environment other than that there is continued downward pressure from the capital that is awash out there as a result of central bank liquidity. Let’s pretend you were given a trillion dollars with the provisio that you’ll have to pay it back in a decade – the easiest no-brainer is to dump it into US treasury securities and skim a few bucks of interest income. Enough players doing this will depress yields and then eventually pensions and institutions become so risk-adverse to the equity side that they invest in negative-yield securities like they are doing in Europe. Something is terribly amiss in the finance world, but it is tough to tell how this will play out.

It is ironic, however, with negative yields that a real cheap way for governments to pay down their sovereign debts is by issuing more negative yield debt. Forget about inflation for now!

Economics Sermon

The following few paragraphs are some of my opinions on economics. Please realize that I did not take more economics classes than Economics 100 when I was in university.

With all of these bits of paper (dollars and Euros) floating around, eventually it needs to be spent on something in order to realize their value – currency is about trading a unit of economic storage (dollars, gold coins, sea shells, bitcoins or whatever) into something tangible (planes, trains, automobiles, or the servitude of lawyers, accountants, engineers and management consultants). Optionally, if you don’t want to spend it on something today, you can put it into future claims (stocks, bonds) where you can then buy the tangible goods. This explains the rise in asset values, but not why we haven’t seen general inflation increases in tangible products.

Presently, the world is finding it quite difficult to spend money on the products, but is finding it much easier to spend on the entertainment components – explaining why service prices and the cost of specialized labour is going up much more than product prices – a product can be mass-produced a billion times over with reasonable economies of scale, but services that cannot be automated are ultimately supply-constrained by those that can practice it – and the price of this is skyrocketing above the ambient inflation rate.

So when published reports of GDP come out, it is important to distinguish between “stuff” and “non-stuff” components.

My general theory is that it will take some sort of world war, or massive natural disaster to spur “stuff-related” (i.e. physical production) related inflation. The big exception is the price of energy – while being eroded away by significant technological advances in solar power, I still do not see fossil fuels being displaced until well into the middle to end of the 21st century. The basic story is that people can only consume so much garbage and we are exceptionally efficient at mass-producing garbage, well beyond our ability to consume it. Just take a look inside a Walmart or Costco.

That ends my economic sermon for the quarter.

Quarterly Transactions

This quarter was also very bi-polar in terms of trading – most of the transactions were performed in April, while May was dormant and June had a couple transactions – one was a significant addition of an existing portfolio component, while the other was a new position in a corporate bond that should be an “easy” 10% yield to maturity.

Another bond purchase that happened earlier was my purchase of Teekay Corporation unsecured debt (maturing January 2020), which was purchased at a significant discount to par (link to article here). At my cost level, this will most likely provide the portfolio with a near 20% yield to maturity with a lot of bad news that would have to occur in order for a payout to not happen.

There were some other transactions that took place, but I do not feel like disclosing them at present.

Cash and Margin

The portfolio right now is utilizing a large amount of margin for the first time in many years. The cost of capital is extremely cheap, and is collateralized by certain fixed-income investments that give off increased cash flows than the floating rate interest expense.

On paper, it makes logical sense – invest at something with a 10% yield, and if this is financed with a 2%, 1.5% or 1% margin loan, you can skim the yield, earning 8%, 8.5% or 9% pre-tax yields, respectively. With most equities you can get at least 2:1 leverage (i.e. put up $10k to purchase $20k of stock) and bonds that have any sort of credit rating can be purchased with leverage.

It is finance 101 speaking: To convert a 5% yield into a 5%+X return on equity, you just need to use leverage that costs less than your yield. The bigger the differential between your yield and your cost of leverage, the less leverage you need to employ. Indeed, an investment that offers a “guaranteed” 5% yield that is financed with a 4.9% fixed rate loan can magically turn into a 10% return on equity with a hundred times of financial leverage – as long as you can find an institution willing to give you this leverage at the desired rates.

These sorts of products are structured and securitized and sold on the open market. You can even invent entire corporations that have a sole purpose of doing this in life. See (TSX: EQB) for an example. There are ETFs out there that will also employ such strategies with junk debt.

In practice, there are a few relevant issues, including doing this at an individual level:

1) The price of whatever you are investing in may fluctuate and you may be forced into a spontaneous liquidation scenario if you are too aggressively leveraged (and those sales will be at the most adverse prices). These fluctuations may happen for company-specific or general macroeconomic concerns and be well beyond your control to mitigate. The macroeconomic stuff you can’t really have control over but the company-specific concerns can be mitigated through diversification;
2) Interest rates might rise, killing the entire market. This can be mitigated somewhat with shorter duration investments, but you will have adverse impact on fixed-income streams as a result of a rise in rates;
3) Margin requirements might change, increasing the “stress point” where you get into a liquidation danger zone;
4) Leverage causes psychological stress and also by definition, does not allow you to take advantage of better price opportunities in the future (i.e. you can only take advantage of market opportunities by going further into leverage).

The most important consideration is:

5) Every single institution on this planet is trying to do the same thing and you are competing against them for exactly the same perceived low-risk, high-yield return on investment.

I am painfully aware that general funds flows are going into the corporate debt market, and this generally means that bond trading is going to get crowded. It is also very difficult to buy at the bid and sell at the ask for corporate bonds, although liquidity spreads on issues (such as Bombardier) are remarkably narrow (about a penny on average). Still, one cannot flip bonds around like one can with much more liquid equities.

In order to achieve outsized returns, one must always compete in marketplaces with less eyeballs and less capability for algorithimic investors to do their magic – and I do find that there have been some opportunities in the bond space as of late.

I will not go overboard doing this, however. The investment climate is not stressed enough and I generally prefer to make my investments in times of stress, such as what prevailed earlier this year and during Brexit.

Most of the retail market (at least locally here in the Greater Vancouver region) is getting into this game in the form of residential real estate – banks will give you money at 2.5%, you go buy a house with 20% down, and voila – you’ve leveraged yourself 4:1 on an asset. As long as your piece of real estate appreciates higher than 2.5% a year net of (not insignificant) carrying costs, you’re golden.

The leverage game usually (but not always) ends badly – the 2006-2008 blowup in the US residential real estate market was a great example. But a more modern example is with oil and gas producers that simply tried to squeeze too much juice out of their balance sheets – LINN Energy, Ultra Petroleum, Magnum Hunter, Sandridge Energy, etc. On the Canadian end we have a bunch of others, including some that are in the palliative care unit (best example is the company formerly known as PetroBakken, Lightstream Resources (TSX: LTS)). A lot of these oil companies are profitable, but they just ended up leveraging too deeply and financing brought them down.

Canadian Dollar vs. US Dollar thoughts

My USD allocation has crept up somewhat, but this due to appreciation of US-denominated holdings relative to the Canadian holdings. There were some minor purchases of US currency in the quarter which also added to the percentage. My policy with currency is to not pay too much attention to it other than keeping it at a band roughly between 30-70% CAD/USD. Appreciating Canadian dollars from the beginning of the year dragged portfolio performance somewhat, but this quarter the Canadian dollar was about the same. I have no big prognostications on the fate of the Canadian dollar and consider a 50/50 equilibrium to be perfectly satisfactory. I may change my opinion if the currency swings beyond 70 or 90 cents.

Anticipated future returns

In terms of future returns, I do not anticipate that my portfolio will achieve anywhere close to the returns that were achieved in the first half of this year – a stunning 33% year to date, most it achieved from March onwards. Still, if the prices of the assets in the portfolio march up to what I consider to be a fair value, there is a double-digit percentage that can still be realized and hence I am not particularly inclined to rapidly hit the sell button. Indeed, even if asset prices went nowhere over the quarter, the current yield alone would represent a passive gain of about 8% annualized with low risk, a lot better than sticking it in a zero-risk, 1% GIC.

Portfolio - 2016-Q2 - Historical Performance

Performance and TSX Composite is measured in CAD$; S&P 500 is measured in US$. Total returns indices are with dividends reinvested at time of receipt.
YearDivestor PortfolioS&P 500 (Price Return)S&P 500
(Total Return)
TSX Comp. (Price Return)TSX Comp.
(Total Return)
10.5 Years (CAGR):+16.47%+5.07%+7.26%+2.13%+5.09%
2006+3.0%+13.6%+15.6%+14.5%+17.3%
2007+11.7%+3.5%+5.5%+7.2%+9.8%
2008-9.2%-38.5%-36.6%-35.0%-33.0%
2009+104.2%+23.5%+25.9%+30.7%+35.1%
2010+28.0%+12.8%+14.8%+14.5%+17.6%
2011-13.4%+0.0%+2.1%-11.1%-8.7%
2012+2.0%+13.4%+15.9%+4.0%+7.2%
2013+52.9%+29.6%+32.2%+9.6%+13.0%
2014-7.7%+11.4%+13.5%+7.4%+10.6%
2015+9.8%-0.7%+1.3%-11.1%-8.3%
2016-Q1+12.3%+0.8%+1.4%+3.7%+4.3%
2016-Q2+18.3%+1.9%+2.5%+4.2%+5.1%

Q1-2016 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the first quarter of 2016, the three months ended March 31, 2016 is approximately +12.3%.

Portfolio Percentages

At March 31, 2016:

44% common equities
19% preferred share equities
19% corporate debt
1% options (net of long and short positions)
18% cash

Figures do not add to 100% due to rounding.

USD exposure: 26%

Portfolio is valued in CAD;
Equities are valued at closing price;
Equity options valued at closing bid;
Corporate debt valued at last trade price.

Portfolio commentary and outlook

This was one of the most active quarters I can recall in quite some time. I deployed about half of the remaining cash into a huge smattering of issues – my research queue was bombarded with so much volume that I had a very difficult time keeping track and current (especially with the avalanche of annual reports coming due at this time of the year).

Currently, the portfolio is at an all-time record for the sheer number of issuers I have in my portfolio. I hold 6 separate equity positions, 4 preferred share issuers, and 9 corporate debt issuers. While I am generally not a fan of diversification for the sake of diversification, other than the concentration of Genworth MI in the portfolio (which is at double-digits), the other issuers are at single-digit concentrations (some higher than others). There are some positions that I took that I wish were double-digits, however!

The portfolio is also quite “yieldly” – 3 of the equity positions give out income, while obviously the preferred share positions do as well – at a double-digit level at cost. While double-digit yields for preferred shares imply the market valuing the underlying entity as a significant credit risk, there are peculiar situations that make me rate the actual risk to be much less. For example, one entity giving out a double-digit yield has a debt-to-tangible equity ratio of less than 10%, while earning positive cash flow over the past 12 months in a low point in its industry cycle. Fascinating indeed! There are gems like this scattered about the market and it makes me really wonder what is going on. Markets normally should be more efficient than this.

My theory is that the advent of ETF investing and Robo-advisors has shifted a significant amount of capital toward large-cap and major index products. Likewise in the fixed income market, such ETFs and Robo-investments have gravitated most “default” capital toward A to AAA-type credits and in the preferred share space, P-1 and P-2 credits. In addition, institutional investors (pension funds, insurance companies and the like) receive far more regulatory capital credit for sticking to these credit profile ranges and thus the majority of capital go towards these particular products and not the lesser-rated securities – although those lesser-rated securities are just as credit-worthy and thus the risk/reward ratio for them is that much better – as long as you can do your homework properly.

Some other portfolio highlights include loading up on Genworth MI (TSX: MIC) between CAD$22-25 in January as the markets took their common equity down to panic levels, and also picked up shares of parent Genworth Financial (NYSE: GNW) after their not-so-stellar earnings report.

As long-time readers of this site know, I believe Genworth MI at those prices were deeply under-valued compared to a floor price of what should be around a 10% discount to book value, or about CAD$33-34/share. Of course, fair value should be north of this price and I will not be disposing of any shares until the entity does reach a level that I consider to be over a fair value – this will likely happen if the markets decide that they wish to grant their confidence in the stability of the overall Canadian real estate market. Right now what gets the press are the million dollar “crack-houses” that get sold in Vancouver for land value (usually from foreign buyers), but the reality of the situation is that when one looks away from the extreme factors (including the depreciation going on in oil-and-gas exposed geographies), Genworth MI is very healthy and profitable.

I finally completed my analysis of Genworth Financial and believe there is a real possibility they will appreciate north of US$10/share in the upcoming years. They do have exposure issues concerning their long-term care insurance contracts they have been writing, but this risk is quite well known and has been long baked into the common share price, culminating in their Q4-2015 report where they took yet another charge once their actuaries determined insufficient reserving. It takes a considerable amount of mental concentration to strip away the various elements of their consolidated financial statements and perform an entity-by-entity analysis and come to some probabilistic estimate that they will be able to face their major challenge – how to roll over their 2018, 2020 and 2021 debt maturities in an “elegant” manner. They are getting on the right track by repurchasing debt at a discount and it doesn’t require Warren Buffett-type skills to realize that buying back your own debt at 15% yield to maturity is the best financial decision one can make.

The corporate debt portfolio has a few interesting components. There are some convertible debt offerings that are trading relatively close to their conversion rates which give a reasonably good risk-reward ratio. For companies that are not going to become “broken convertibles”, these issues represent a free option on equity upside and priced at a modest premium. For instance, if a convertible debt issue is trading at par with a conversion rate of $10/share, a medium-grade credit in a cash-flow positive entity, with a 7% coupon and 5 year maturity; if the common shares are trading at $9.70, if you see the convertible debt trading at par, there is a significant amount of optionality that remains in the debt issue that is not represented in the debt market value. It would make sense in such instances to buy the debt rather than the equity because your downside is much more limited in exchange for the 3% price below strike value.

A few other highlights include my “favourite” capital management firm, Pinetree Capital (TSX: PNP.DB), where their first-line secured senior debentures edge closer to their May 31, 2016 maturity date. After curing their debt covenant default with a very aggressive liquidation and debt redemption, they are about to close the chapter on this very sad saga and ask themselves what they can possibly do to siphon the remaining morsels of cash out of the corporation. Unfortunately because their last debt redemption involved an equity component I own a few shares in this calamity and I patiently await their execution on hopefully arranging a sale of their capital loss tax assets, amounting to about half a billion squandered to date. I liquidated the round-lot amounts of my debentures at 101 cents on the dollar and the rest will presumably mature in the second quarter.

I do not expect the performance achieved in the first quarter to be sustainable over the next three quarters, but I do anticipate modest portfolio growth at relatively low levels of risk. For instance, all the equity securities I have purchased were under book value which provides a margin of safety. The preferred shares I have purchased are in corporations that are priced like there will be severe risk of defaults, but when reading the financial statements there are no obvious worries (and in industries that will not be going away – it is not like I’m investing in newspaper corporations!).

At quarter’s end, I do not see as much opportunity as I was seeing at the end of January (up until the middle of February), but I am still retaining plenty of cash to seize opportunities as they come around. While I believe this current market rally does have enough legs to last a couple more months, as we end up in the antics of the presidential election cycle, the world is going to go topsy-turvy once again, and fiscal prudence will be the order of the day. The good news is that I’m being paid to wait.

The gain in the Canadian dollar over the quarter also suppressed the reported performance figure a couple percent. My internal policy on currency is fairly simple – keep a relative balance between USD and CAD and buy more CAD when the US dollar is strong and sell CAD when the US dollar is weak. In general, I think the CAD is at a relatively high point (at 77 cents on the dollar), but I do not have strong opinions about it otherwise.

The TSX was up 3.7% over the same time period, while the S&P 500 was up 0.8%. While I am outperforming the major indicies (and have been doing so for over the past 10 years), I do not believe there is a valid benchmark that my portfolio can be compared to – it goes for the best risk/reward I can identify. Sometimes this will mean I can make an “easy” 7%, while sometimes it will reach for the stars and go for 50% in a year. Right now I think there’s a good 20-30% of upside remaining.

I am getting concerned, however, that the markets generally tend to crash during the presidential election cycles. So this optimism on my own portfolio is not translated to the broad market in general – I think there will be a lot of see-saw type action, as reflected by the following chart:

spx

In markets that go sideways, fixed income securities are your best friend. Fixed income securities will dip when the broad markets go down (momentum funds and margin liquidations will go hand-in-hand in these situations), but not as badly as the equities themselves.

The biggest trade not made and the power of managing your own psychology

Still kicking myself for not buying Data Group debentures (TSX: DBI.DB.A) post-recapitalization announcement (late 2015). I really have to congratulate the people getting in at 35 cents on the dollar or below here. Normally I have no psychological hurdles about just forgetting about bad trades or good trades I should have made but never executed on, but this one was my biggest all-time “the baseball is right in the middle of the plate on a slow pitch and never even took a swing at it for even a single” trades. It would have been a small position – around 2%, but still, when measured in absolute dollars I always like to think of how much (good) sushi it can buy.

C’est la vie.

That said, this quarterly performance result made me feel a little better for myself, and the fact that I have done so with a very conservatively positioned portfolio and high cash quotient is somewhat reassuring.

General advice to myself that has kept me out of trouble

Avoid all stocks that make headlines. Good examples include Valeant (TSX: VRX), SunEdison and daughters (Nasdaq: SUNE, TERP, GLBL), etc. While there might be days these stocks gain 20% on volatility, it is nearly impossible to time, there are too many eyeballs looking at these issuers and I have zero competitive edge actually trying to analyze the actual business prospects of these firms. While they may be entertaining to look at from a media standpoint, from an investment standpoint they all represent pits of money where there is no return.

Long-time readers of this site will then wonder what the heck I am doing investing in Bombardier preferred shares, but I believe I have an edge over the market in this instance with my technical and political knowledge of their specific situation.

Long-Term Performance

Interestingly, my 10.25 year performance, compounded annually, works out to +15.00%, rounded to two decimal places. For comparison, Berkshire Hathway’s share price performance over the past 10.25 years was +9.1%. This is not a fair comparison, as managing a two hundred billion dollar portfolio has much more complexity than my (by comparison) flea-sized portfolio. According to efficient market theory, I should not be able to outperform the markets. Yet, I continue to do so. Am I just getting lucky?

Portfolio - 2016-Q1 - Historical Performance

Performance and TSX Composite is measured in CAD$; S&P 500 is measured in US$. Total returns indices are with dividends reinvested at time of receipt.
YearDivestor PortfolioS&P 500 (Price Return)S&P 500
(Total Return)
TSX Comp. (Price Return)TSX Comp.
(Total Return)
10.25 Years (CAGR):+15.00%+5.01%+7.19%+1.77%+4.71%
2006+3.0%+13.6%+15.6%+14.5%+17.3%
2007+11.7%+3.5%+5.5%+7.2%+9.8%
2008-9.2%-38.5%-36.6%-35.0%-33.0%
2009+104.2%+23.5%+25.9%+30.7%+35.1%
2010+28.0%+12.8%+14.8%+14.5%+17.6%
2011-13.4%+0.0%+2.1%-11.1%-8.7%
2012+2.0%+13.4%+15.9%+4.0%+7.2%
2013+52.9%+29.6%+32.2%+9.6%+13.0%
2014-7.7%+11.4%+13.5%+7.4%+10.6%
2015+9.8%-0.7%+1.3%-11.1%-8.3%
2016-Q1+12.3%+0.8%+1.4%+3.7%+4.3%

2015 year-end report

Portfolio Performance

My very unaudited portfolio performance in the fourth quarter of 2015, the three months ended December 31, 2015 is approximately +0.4%. My year-to-date performance for the year ended December 31, 2015 is approximately +9.8%.

Portfolio Percentages

At December 31, 2015:

18% equities
24% preferred shares
16% corporate debt
42% cash

USD exposure: 33%

Portfolio is valued in CAD;
Equities and corporate debt are valued at last traded price;
USD Cash/Equity valued at closing exchange rate of 0.7228 CAD/USD.

Portfolio Commentary

This was a bit of a rollercoaster quarter for me, but a good year overall.

I substantially outperformed the S&P 500 and TSX Composite this year. Although I received a boost due to the depreciating Canadian dollar (this was not trivial – had the 86 cent Canadian dollar held during the year the portfolio would be sitting at a CAD-denominated +5% for the year instead of +10%) the portfolio choices for the most part performed as expected and I was able to take advantage of certain situations with very good precision. Bailing out of Dundee preferred shares (TSX: DC.PR.C) was near-perfect timing, and there was another situation involving a dutch auction tender which I managed to completely capitalize from (the common shares were tendered at the maximum range and subsequently cratered – I was busy dumping nearly my entire position while the stock was at its years’ high).

In terms of other liquidations, Pinetree Capital Debentures (TSX: PNP.DB) has continued to be redeemed and following their January 8 redemption will be an insubstantial fraction of my portfolio. This debt will most likely mature on May 31, 2016 with the remaining principal balance paid with 1/3rd converted into penny stock equity. Hopefully some of the larger debtholders can take their new-found equity and then requisition a special meeting to get some proper directors in place to monetize the rest of the shell.

The Canadian residential real estate market continues to be under pressure, with the new Liberal Canadian government not wasting much time early on in its administration to tighten the screws further on down-payment requirements on residential property valued at more than CAD$500,000. There is also significant fear in terms of the valuation of various real estate, including that in oil-linked Alberta/Saskatchewan, and the metropolitan areas of Vancouver and Toronto. Accordingly, Genworth MI (TSX: MIC) has been the worst performing component of the portfolio for the year, down approximately 25% for the year. If you do not believe that the real estate market in Canada will collapse anytime soon, it is trading in the deep, deep value range (trading more than a 25% discount to tangible book value).

Bombardier preferred shares (TSX: BBD.PR.B and BBD.PR.C) will have been my riskiest year-end investment. There’s still more in store with them that I do not wish to get into right now. The investment is currently in the black, although I wish I had bought more in the August liquidation spree that occurred. An investor hitting the buy button on August 18 or 19 was buying a 20% yield that should be trading at far less. Nobody wants to invest in them, which is one reason why they are likely a good investment at the moment.

A less risky way of playing them is purchasing their 2020 debt, which will give you a yield to maturity of about 13%. This is a very good return in our low interest rate environment in relation to the risk taken on the debt, but I am expecting Bombardier do much better. Simply put, if you believe they are going to succeed, you probably want a higher degree of exposure to their success than their debt as it appears to be a fairly binary situation.

I also took a material position (in both preferred shares and corporate debt maturing a few years out) of a company that is somewhat sensitive to the fortunes of the oil and gas industry. They have common, preferred and senior debt publicly traded on US exchanges. I bought the preferred cash stream of an organization that will be generating heaps of operating and free cash flows well into the future (to pay preferred shareholders), and it is senior to the payouts that are still being received by the common holders. The debt is of the same issuer, it is a senior unsecured debt issue that, upon maturity, should represent a CAGR of about 18%. There are huge incentives in place to ensure that both the preferred and senior debt holders get paid even in a very tepid oil and gas environment. This company is NOT Kinder Morgan.

I continue to hold minor positions in the debentures of three other issuers (two well known, one not-so-well known), combined consisting of about 5% of the portfolio.

The biggest mistake I made this quarter was one of omission – I badly messed up an entry into Data Group debentures (TSX: DGI.DB.A) when they plummeted for god-knows what reason to the mid 30’s in the second week of December well after they made their decision to catastrophically gut their existing shareholders in exchange for $33 million of debt relief. I was staring at the quotation on my computer screen thinking “What the heck is going on inside the company? Are they pulling the plug and doing CCAA?”, and just stood there like a deer in the headlights while KST Industries scooped them up and have made a killing. Fortunately my contemplated investment was going to be a very modest amount (about 1% of the portfolio), but that would have been an easy double of money. Oh well.

My ten-year track record is considerably better than the major indicies, while having substantial quantities of cash for the duration providing a drag at 0% yield in the interim. The 2015 calendar year was spent with roughly 1/3rd of the portfolio in cash on average.

Miscellaneous predictions

Here are a few predictions, in no particular order:

(I realize this post is dated slightly further into the start of the 2016 trading session which reduces the predictive impact of such statements since the markets have already moved in the direction stated).

* Canadian Dollar, Canadian interest rates, Canadian Economy: The Canadian dollar will slide to 65 cents sometime during the year. Currency depreciation (and specifically its effects on the economy) will be a considerable factor why the Bank of Canada will not reduce interest rates below 0.5% as it will become imminently clear that having a toilet paper currency comes at severe cost to the domestic populace. While most people will appreciate saving $5 or $10 on a fill-up of gasoline, they would gladly trade this for a monthly savings of hundreds or thousands of dollars in reduced import costs. Currency depreciation becomes less of a stimulus than in previous decades to the fact that countries such as Mexico have gotten extraordinarily better at manufacturing than Canada. In general, Canada remains a one-trick pony (natural resource exports) and the government will scramble to implement policies supporting nearly anything other than natural resource exports. Yes, this means Bombardier will get a lift.

* Crude Oil: Despite geopolitical chest-thumping in oil-producing states, overcapacity in relation to ambient demand will continue to put a lid on the price of crude oil. Less-leveraged smart producers will continue to survive by being intelligent about cost reduction rather than going for raw output. There will continue to be consolidation in the marketplace, but only after debt write-downs occur.

* Natural Gas: I expect this commodity to fare better, relative to crude oil. I do not expect any excitement in terms of price action. Natural gas is received better on the political end of things and will be less vilified than crude, which will facilitate the continued building of infrastructure that depends on natural gas (specifically peak load power generation). LNG export aspirations to east Asia continues to be a pipe dream.

* Vancouver Real Estate: The Yuan-CDN$ conversion, despite some minor depreciation by the PRC Government, will still lead to favourable conditions for capital migration to Vancouver dwellings (especially fee-simple lots, i.e. single-family dwellings). So unless if the PRC economy goes into recession (necessitating the liquidation of capital from foreign real estate back to the PRC), I do not see spillover into the Vancouver real estate market, which will continue to be dominated by foreign (mainly Chinese) investment.

* Canadian Real Estate in general: Despite media headlines and sob stories about mortgage defaults and price deflation in the Alberta and Saskatchewan markets, it will blow over with little financial consequence for the overall country.

* Canada Federal Budget: Despite the initial 2016 Budget headlines of a $19.4 billion deficit in the 2016-2017 fiscal year, it will become quite obvious through mid-year that the actual deficit will be larger (around the mid 20’s).

* US Federal Reserve: I do not expect chatter about another rate increase to commence until July at the earliest. If the US stock market begins to tank, a rate increase is much less likely. I do not expect the target fed funds rate to rise beyond 1% at year-end. In addition, if it gets to this point (which I doubt), I expect the federal reserve to reduce the size of securities held on their balance sheet by not reinvesting the interest proceeds of their various securities.

* Next US President: Donald Trump will be elected as the next president of the United States, by a considerable margin. This prediction is not an endorsement of him, but it is a reflection of my political analysis and my take on what is happening in the United States at present.

Outlook and commentary

My first remark is going to be about index investing. I have been relatively convinced that there is still a general aversion of the stock market, especially stemming from the equity wipeout that occurred from 2008-2009 when a lot of people that were fully invested panicked and sold at a generational low point.

Now the name is about safety in numbers – which should actually be called safety through obscurity – if you invest in 500 stocks instead of picking a few, surely your portfolio will be safer! This is basically an excuse to invest in things that you don’t know of and have done no research on in the name of diversification.

When looking at stock charts, I mentally blank-out the 24-month period between July 2008 and June 2010. If you look at index performance over the past 10 years with this exclusion, you can see that the TSX has been treading water. The S&P 500 has done a little better, but their performance profile has been less than stellar compared to the returns available in the universe of stocks outside of the main indicies. If you see mutual fund literature start their stock charts from Januray 1, 2009, be very cautious!

With the advent of “Robo-investing” where people can just plug in a bunch of money in accordance to their risk profile and algorithmic selection in the requisite low-MER ETFs, passive investment vehicles are becoming quite dominant vehicles of marginal asset pricing – they will mechanically purchase and sell in accordance to their money flows.

What this means is a lot of money becomes concentrated in what I deem to be the “usual suspects” and there is considerably less focus on assets that are more obscure. In other words: think very carefully about investing in anything that is on a major index. They will likely be more volatile than recent past history will suggest.

This also has some other side effects that create liquidity opportunities in the reverse direction – when a particular segment of the ETF world is out of favour, you can sometimes see the effects of indiscriminate dumping of stocks (or bonds) in particular market sectors.

The parasitic nature of mechanical ETF investing will be creating a bonanza of opportunity for active investors that pick narrowly targeted niches of securities that have had the “sell at market” button pressed multiple times without discrimination of price. The goal is simply to be on the other side of the trade when the last bit of liquidation occurs.

My second remark is going to be about oil and gas. Almost every active investor I know of has been dredging the aftermath of the train wreck and seeing what sort of value can be plucked out of the various companies. In general, most of the companies that are not major (i.e. exclude Suncor, CNQ, etc.) are over-leveraged and have cost structures that are barely making money (if not losing it). 2016 will be the year that most high-priced hedges will have expired and it will be a race to see who’s balance sheets can survive to live another day.

While all of these companies have very leveraged linkages to the underlying commodity price, some will rise more than others in the event of a commodity recovery. Likewise, some will drop more if the underlying commodity price does nothing and there are recapitalizations and other dramatic maneuvers that will tend to dilute (if not wipe out) the existing equity holders.

Investors are likely to bet on a “regression to the mean” scenario and anticipate some sort of recovery in pricing. In the short run, I am not so optimistic of this and it would suggest to me that the bulk of the returns to be made in oil and gas (and related service stocks) will be in the fixed income securities of such companies, not the equity. High yield spreads have ballooned to massive amounts (for a good large-cap example, look at bonds of Chesapeake Energy) and while equity holders will disproportionately profit if commodity prices do go on a 2009-style rip upwards, the most probable scenario is that debt holders will be the sweet spot in the risk-reward spectrum.

My third remark will be about Canadian preferred shares. Those 5-year rate-reset preferred shares have gotten absolutely killed over the past few years as 5-year bond yields have consistently hovered at very low rates. I’m not so sure that we will be seeing much of a recovery and instead these preferred shares will end up being a cheap financing vehicle for those issuers.

My fourth remark is that it is still obvious that anything with a significant yield has a bid associated with the yield value rather than the underlying earnings potential of the company in question. There are plenty of examples of dividend cuts in the oil and gas field and when these cuts occur, the equity plummets with it – this is a sign that people were investing purely for yield as opposed for earnings value. If you must invest in such types of companies, make sure that you are not paying a yield premium!

Right now there is no “home-run” potential in my portfolio where I anticipating seeing a huge gain like I did in 2013 (where I made a very targetted and directed bet which clearly worked), but my intuition does suggest that I will be seeing similar 2015-type performance in the upcoming year. There are a few more items in the research pipeline which I can hopefully capitalize on better than what happened with Data Group, but we will see. Nothing would please me more than seeing some sort of opportunity where I can report an outsized double-digit gain.

Also, I believe that patience will be my best virtue for 2016. Despite my aversion to yieldy products, there is a lot of yield in my existing portfolio by virtue of the nature of the fixed income investments – only 4% of the 18% invested in equities is zero-yield!

There is a gigantic amount of cash currently in the portfolio that I will be carefully holding onto when opportunities unveil themselves. I don’t like this huge mass earning 0%, but nothing destroys capital more than investing cash for the sake of having it invested.

Note on Performance Report

I would like to clarify that the TSX index I am using for comparative purposes is the TSX Composite. The other index that is sometimes implied with the phrase “TSX Index” is the TSX 60. There is a very high degree of correlation between the two indicies. I have also included a comparison to the total return indices, which assume the reinvestment of dividends. The indicies represent a 100% investment in the relevant constituents and a zero cash position, while the Divestor Portfolio at times has had substantial amounts of cash. The goal has always been to invest funds in the best risk/reward situations and not aim for relative outperformance, although the overall strategy would be mostly pointless if it underperformed the largest index funds!

Divestor Portfolio - 2015 Year-End - Historical Performance

Performance and TSX Composite is measured in CAD$; S&P 500 is measured in US$. Total returns indices are with dividends reinvested at time of receipt.
YearDivestor PortfolioS&P 500 (Price Return)S&P 500
(Total Return)
TSX Comp. (Price Return)TSX Comp.
(Total Return)
10.0 Years (CAGR):+14.08%+5.05%+7.24%+1.44%+4.38%
2006+3.0%+13.6%+15.6%+14.5%+17.3%
2007+11.7%+3.5%+5.5%+7.2%+9.8%
2008-9.2%-38.5%-36.6%-35.0%-33.0%
2009+104.2%+23.5%+25.9%+30.7%+35.1%
2010+28.0%+12.8%+14.8%+14.5%+17.6%
2011-13.4%+0.0%+2.1%-11.1%-8.7%
2012+2.0%+13.4%+15.9%+4.0%+7.2%
2013+52.9%+29.6%+32.2%+9.6%+13.0%
2014-7.7%+11.4%+13.5%+7.4%+10.6%
2015+9.8%-0.7%+1.3%-11.1%-8.3%

Q3-2015 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the third quarter of 2015, the three months ended September 30, 2015 is approximately -0.9%. The performance for the nine months ended September 30, 2015 (year to date) is approximately +9%.

Portfolio Percentages

At September 30, 2015:

43% preferred share equities
17% common equities
11% corporate debt
29% cash

USD exposure: 23%

Portfolio is valued in CAD;
Equities are valued at closing price;
Equity options valued at closing bid;
Corporate debt valued at last trade price;
Portfolio does not include accrued interest.

Notification

I am still considering an e-mail subscription service for these updates. When I am in a position to do so, I may give an abbreviated summary of the report on the website, but send something more detailed through email.

Portfolio Commentary and Outlook

Relative performance is great if you are a fund manager, but it is not so good from the perspective of an individual investor. That said, I can take some minor satisfaction that I have been able to navigate the stormy seas of the markets over the past quarter. The S&P 500 is -6.9% over the quarter and the TSX is -8.6%. My performance, at -0.9%, is roughly flat.

Despite the markets dropping, I still have not been able to find many suitable candidates for investment. I published my purchase of Bombardier preferred shares (of which is the minority of my 43% preferred share position, there are other low volatility issues in the mix there) which was the only real purchase of risk taken in the portfolio. Currently it is roughly at my purchase price and I would expect it will continue to deliver both income and capital gains over the upcoming quarters. I will let my prior writings speak for themselves although the actual research has been done in much more depth than I presented.

The performance of Genworth MI (TSX: MIC) has been lacklustre despite having reasonably good fundamentals. It trades as a proxy for the fortunes of the Canadian real estate market. There is also the pressure that its parent, Genworth Financial (NYSE: GNW), is facing (one look at Genworth Financial’s stock chart should tell the entire story) and this may cause pressure on Genworth to dump its 57% majority share of Genworth MI to some other suitor. Genworth Financial’s issues are significantly different than Genworth MI (i.e. GNW’s issue deals with liabilities created from ill-thought out life insurance policies, something that Genworth MI does not have).

Companies that are connect to the Canadian real estate market, especially mortgage financing, include Home Equity (TSX: HCG) and Equitable (TSX: EQB). Other comparable entities include the staple REITs (e.g. Canadian Apartment Rentals, RioCan, H&R, etc.) that generally show little sign of slowing down – is this because they are trading on the basis of income or asset value? One would believe that if there is going to be some impairment of asset value that the market would have reflected this somewhere.

Pinetree Capital (TSX: PNP) announced at the end of September that they will be redeeming another $5 million in par value of their debentures. This will bring the total outstanding from $14.8 million to $9.8 million at the end of October. They had to do this because otherwise they would have most likely (once again) breached their debt covenant which states their debt-to-assets ratio can be no higher than 33%. Without the redemption they would have been sitting at around 36%, while with this redemption they are at around 27%. My position in their debt has been reduced by 4/5ths since they started their redemptions and with the residual position I can sleep tight knowing that I’m first in line to be paid out. The 10% interest payment is a reasonable incentive to keep my money there instead of dumping it out at 99% of par value.

They have a funny situation where they have few level 1 assets remaining and they will have to dredge up another $10 million to pay the maturing debtholders on May 31, 2016. They will be able to do this, but it has been a grave cost to the corporation and a lesson on how borrowing money to invest can be dangerous. There is likely some residual value beyond what the existing market cap implies ($13 million), but can you depend on management and insiders to actually monetize the tax losses, sell out, and move on? I doubt it.

In terms of studying for future investments, while I have been time limited over the past couple months, my focus has been on debt securities of energy companies. There is a lot of junk out there, and most energy firms are currently locked into a race to see who goes insolvent first. Simply put, companies with better balance sheets will survive longer. Those that have weaker balance sheets are going to get squeezed in this brutal war of attrition. The likely portion of the capital structure that will be profiting off the industry will not be the equity, but rather the people that hold the debt.

There is no shortage of energy debentures that trade on the TSX that warrant valuations far south of 100 cents on the dollar. Most of these debentures are going to be very dangerous to hold, especially considering that Alberta’s government is obviously doing what they can to make further oil sands development impossible.

Over the last quarter of the year, I do not anticipate any outsized gains. About 30% of my portfolio I could see trading 10-20% higher than present values, but the rest of it is mostly fixed income-type investments that is simply parked and waiting for better days. There is currently nothing in the pipeline that would constitute a good potential for a double or triple. Still looking.

Divestor Portfolio - 2015-Q3 - Historical Performance

YearPerformanceS&P 500TSX CompositeGeneral Comments
9.75 Years:+14.4%+4.5%+1.7%Compounded annual growth rate.
2006+3.0%+13.6%+14.5%Performance marked by several "wins" and several "losses" which nearly offset each other.
2007+11.7%+3.5%+7.2%One holding was acquired at a moderate premium; nothing otherwise remarkable about this year.
2008-9.2%-38.5%-35.0%Avoided market meltdown by holding significant cash; bought heavily discounted corporate debt at and around year-end.
2009+104.2%+23.5%+30.7%Most gains this year were in the corporate debt market. Anybody holding anything from February onward would have made money, but I mostly selected securities that were more heavily depreciated. I completely realized the once-in-a-generation opportunity that occurred here and was able to take advantage of it.
2010+28.0%+12.8%+14.4%Continued to realize gains and lighten up on corporate debt holdings which were mostly trading at par at year's end.
2011-13.4%+0.0%-11.1%Very poor performance, most of which stemmed from poor decisions around the August timeframe, and also completely missing on two targeted trades which completely fizzled. Wounds in this year were completely self-inflicted.
2012+2.0%+13.4%+4.0%Spent most of the year in cash, which explains the relative underperformance. Did not feel confident about significantly getting into equity or debt, but did dive into "value" equities at the end of the year.
2013+52.9%+31.8%+10.6%Despite making several unforced errors in the year, not to mention having a generally bearish outlook on the marketplace, insurance industry holdings appreciation and one very timely trade contributed for the bulk of performance. Half the year had more than 20% cash in the portfolio.
2014-7.7%+11.8%+7.7%Spent the most of this year about 1/3rd in cash; given my performance, probably a good decision. Performance was negatively affected by a series of unforced errors, and having absolutely nothing work out this year.
2015 (Q1-Q3)+9.4%-6.7%-9.1%

Inattention to the site caused errors

A very rare administrative post.

For some reason, the links on the specific articles were breaking. I’ve now fixed them. I have no idea why this happened and do not care to investigate further in case if something else breaks. It had to do something with the permalink structure of the site.

This affected commenting and thank you to Safety once again for sending me an email informing me of the problem on this site.