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%

7 thoughts on “2015 year-end report”

  1. Don’t beat yourself up too much about those Data Group Debentures. I was buying them at $35 but you only missed out on about 42% (not close to a double) if you sold the stock at 1.5 cents like I did and if you sold the bonds at the current market price at 67.5 and not much has really traded there.

    Thanks for the summary and predictions. Good luck this year!

  2. “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%.”

    Cmon Sasha…..please share, throw me a New Year bone, will ya.

  3. Marc: Can’t. Did too much work on this one. I really should just open up a subscription newsletter and post streams of consciousness on it.

  4. A subscription newsletter – why not? You have great insights on “special situations” (pinetree, yellow page, etc.)

  5. Does Genworth continue to be priced solely on the expectation of a collapse in the CDN real estate market? Price vs. NAV continues to widen. I would expect buy backs to accelerate at this level but I always wonder if I am missing out on something. Has this become an emotional trade?

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