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%

2 thoughts on “Q3-2016 Performance Report”

  1. Genworth puts out the following today:

    “Impact of Changes Related to Mortgage Rate Stress Tests and Low-Ratio Mortgage Insurance Eligibility Requirements

    Based on year-to-date 2016 data, we estimate that a little over one third of transactionally insured mortgages, predominantly for first time homebuyers, would have difficulty meeting the required debt service ratios and homebuyers would need to consider buying a lower priced property or increase the size of their down payment.

    Furthermore, approximately 50% to 55% of our total portfolio new insurance written would no longer be eligible for mortgage insurance under the new Low Ratio mortgage insurance requirements.”

    Looks like their revenue business maybe dramatically reduced? Thoughts?

  2. Hi Will,

    I have some pretty strong thoughts about this but I will save it for an entirely different post.

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