2017 Year-End Report

Portfolio Performance

My very unaudited portfolio performance in the fourth quarter of 2017, the three months ended December 31, 2017 is approximately +5.6%. The year-to-date performance for the year ended December 31, 2017 is approximately +31.2%.

Portfolio Percentages

At December 31, 2017 (change from Q3-2017):

24% common equities (+4%)
35% preferred share equities (+9%)
29% corporate debt (-1%)
13% cash and cash equivalents (-12%)

Percentages may not add to 100% due to rounding.

USD exposure: 46% (-2%)

Portfolio is valued in CAD (CAD/USD 0.7944);
Other values derived per account statements.

Portfolio commentary

In terms of portfolio movement, this quarter was mostly inactive other than adding some cash to a preferred share position that is akin to “parking cash” in something reasonably stable while I wait for better market opportunities.

Specific line items in the portfolio include Genworth MI (TSX: MIC), gaining an appreciable amount during the quarter, and one otherwise undisclosed equity position that I wish I had taken more of a stake considering the excessive cash situation. Although I do not write about it very often, the position in Gran Colombia Gold debt (TSX: GCM.DB.V) has also increased during the quarter, and I expect after the issuance of the year-end financial statements that management will be conducting another debt repurchase at par value, resulting in additional cash that I will find difficult to re-deploy. My initial position was taken at roughly 60 cents.

Gran Colombia is a play on gold prices, but as the debt itself is secured by all assets of the company and has rights to 75% of excess cash flow, I suspect it will be safe. 2018 should be a very eventful year for the equity of the company as their junior debt (TSX: GCM.DB.U) will be maturing on August 11, 2018 – 81% of it will convert to shares and this will result in the issuance of 18.76 million shares (in addition to the 20.9 million currently outstanding). As the company expects $16 million in excess cash flow for 2017, this would be 36 cents per share on an adjusted basis and one can see the equity as relatively cheap.

All debentures in Gran Colombia Gold are currently convertible to 512.82 shares per USD$1000 par value (they are all denominated in US currency, while the shares are in CDN currency).

There is really little else to write about. The year-end portfolio is about as boring as watching paint dry.

My performance for the year can be attributed to the KCG transaction proceeding through, and also some non-trivial increases in the value of Genworth MI (if you can remember, mid-year it got hit by the Home Capital Group fallout). I will note this is the function of two decisions (both MIC and KCG) I made earlier in time (many, many years ago) to purchase. The real decision in the subsequent years was to remain patient by doing nothing.

In 2017, I only bought one stock for the year. This stock is up over 30% since I bought it. Everything else has been minor portfolio adjustments – the risk I have been taking is minimal.

Performance Notes

The last time I had a quarterly loss was in September 2015, making this report the 9th quarter in a row with gains. Normally quarterly performance should be punctuated by losses here and there. This lack of see-sawedness should normally be an indicator of fraudulent reporting, but I assure you it is not.

I observe the S&P 500 and TSX are up about 20% for the year and my portfolio is up even further. I always remember the phrase “a rising tide lifts all boats”, but my job is to ensure that when the tide goes down, my boat is still at the same elevated position. My 2009 performance was only made possible by not being involved with the tsunami of 2008.

Predictions in 2018

These will come in a later post.

Outlook

I know I sound like a broken record when saying this, but presently I do not believe my 2018 portfolio performance will match historical levels (my 12 year hurdle rate of 18% is quite high given what I see out there). Too much of the portfolio is fixed income with limited opportunities for capital appreciation. The only reason why it is in fixed income is because I have nowhere else to put the cash.

My weighted average maturity for my debt portfolio is 2.5 years. A large holding is Teekay unsecured debt (January 2020 – just over 2 years to maturity) and I will not be surprised to see it get called as they now have a re-financing window of opportunity. I am content to hold onto this until they decide to do so as the 8.5% coupon is better than I can receive elsewhere.

I’ve been continually scanning the Canadian debenture market and find entities that are simply too risky to invest – there is an overabundance of optimism that companies that have suspicious balance sheets will find a source of reinvestment. This might be true today, but credit can vanish as quickly as you can say “Cryptocurrency”.

The biggest way to lose money is to force it to work – while I can find some reasonable safe opportunities to earn 4% relatively “risk-free”, it comes at a cost of liquidity and the ability to pounce when the market reaches some sort of crisis. It has been a long time since we have seen a true crisis affecting prices in the marketplace – the inverse can be argued for, we have never seen a period of stability like this.

There are storm clouds on the horizon.

The passage of the 2017 US Tax Cuts was one of President Donald Trump’s signature campaign promises and the lowering of the US Corporate tax rate from 35% to 21% will have significant implications to US domestic investment. Coupled with an increase in short-term interest rates, it should have the effect of increasing the demand for US dollars. My outlook on the Canadian dollar is moderately bearish.

Rising interest rates will also mean that there will be less dollars chasing asset prices, which should put a lid on the overall market. When the US Federal Reserve will continue to raise interest rates, this will also give room for other central banks to do the same – Canada will likely follow.

Rising interest rates generally does not mean good news for gold, but gold has been surprisingly non-volatile in the past few years and seems to be an increasingly non-correlated hedge against all of this financial distortion we are seeing. I believe the decoupling of gold to traditional metrics is rational.

I continue to remain bearish on the Canadian oil and gas market. Canadian governments continue to remain hostile to oil and gas investment and differentials for mined product continue to be at record highs (as pipeline and train capacity issues continue to plague deliveries). It is very difficult for capital to flow into an industry where it faces arbitrary hurdles everywhere. This oil and gas money will continue to flow down south, all capital choices remaining equal. This will also involve the continuation of the exportation of expertise from Canada to the USA. As such, I do not see the equity side of Canadian oil and gas to receive too much of a positive reception in 2018. The tide may change in 2019 and onwards (world demand for crude oil still continues to rise), however, but we will see then.

The rampant speculation of cryptocurrencies will undoubtedly resolve in 2018. Companies have been trying to raise money like mad and strike while the iron is hot. Eventually this craze will die down and investors will start to demand a return on investment. Likewise, the full economic reality of marijuana production in Canada will probably prove to be a bust once provincial governments implement legislation to govern the sale of it – I think one of the surprises will be projections of profitability being far less than expected for all players involved except for the government – confusing sales and profitability is a huge difference here.

Where to I see avenues for extraordinary returns?

Ironically, cash might be one of them.

I wish I had more to write, but with a market that is flush with speculative gains, I am finding it very difficult to find genuine opportunities. It’ll probably be easier to take the pickings from the wreckage than contribute to the mania.

Portfolio - Q4-2017 - 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)
12 Years (CAGR):+18.3%+6.6%+8.8%+3.1%+6.0%
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%
Q3-2017+4.3%+4.0%+4.5%+3.0%+3.5%
Q4-2017+5.6%+6.1%+6.6%+3.7%+4.3%

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%