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%

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