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%

7 thoughts on “Q1-2016 Performance Report”

  1. Would be interested in the names of your prefs and converts. I am in AIM, Atlantic, CF, Dundee and Transalta prefs. Own the converts of Discovery Air, IBI Group, Fortress, Western One and Zargon.

  2. I’ve disclosed PGF.DB.B, and PNP.DB (very small amount remaining now, patiently waiting for May 31 maturity). As for preferreds, disclosed are BBD.PR.x, and I did briefly own DC.PR.C but got rid of them after the amendment offer became public. Some of my corporate debt is from USA issuers.

    The rest of it I haven’t written about. I might one day.

    I will observe your list of preferreds and convertibles are on the “top 10” highest yield list available in Canadian exchange-traded markets. I’ve done research on all of them and some of them aren’t the “slam dunk” that they might appear to be.

  3. Do pray tell…

    I’ve done research on all of them and some of them aren’t the “slam dunk” that they might appear to be.””

  4. Yielding double digit with a debt-to-equity ratio less than 10% – the 2nd would be a relatively rare bird as most firms do have some form of borrowing / debt.

  5. Will, I think the Canaccord Preferred fit that description. CF.PR.A and CF.PR.C but not sure if those names are what Sacha is referring to.

  6. Thanks, Safety.

    Following that track – GMP’s prefers is trading at a substantial premium to CF’s A series prefers despite the latter will probably have a higher reset (+289bps for GMP vs +321 for CF).

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