Manager Letter

2019 Q4 Manager Letter

December 31, 2019

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Quarterly Manager Letter
Current News and Updates

Q4 2019

December 31, 2019 Commentary

As we close out another year and look forward to 2020 many of the key themes that have been in place since early 2019 are still present; low interest rates, a sluggish global economy and accommodative central banks. We believe these inputs should continue to result in positive equity returns in the near term and will keep traditional fixed income allocations muted. Interestingly, almost every major equity market closed 2019 at all time highs while global interest rates closed near their lows. This unique environment favoured our clients’ asset allocation as we were overweight interest rate sensitive sectors such as REITs, utilities, and other defensive sectors that appreciate as rates fall. After a slowdown in the summer months and as geopolitical and trade risks subsided, we rotated into more cyclical areas of the market, deployed additional capital and gained exposure to names that had a measurable catalyst.

Global Equity Market Returns

Our strongest return in 2019 came from the US Dividend Growth strategy (+29%). This is a direct reflection of the relative strength of the US economy and the difficulty in finding stable yield. Where do investors (pensions/individuals/institutions) go for a reliable income stream to offset a liability or to provide cash flow? We continue to believe that equities, and dividend growth equities specifically, remain attractive as they help solve this key challenge and they remain a large part of our clients’ allocations in 2020.

As we manage clients’ capital and partners’ capital alongside, we always focus on risk management and capital preservation. 2020 will be no different. There will be geopolitical challenges, elections, central bank surprises, and as a result there will be changes to our investment forecast. If we could highlight one important lesson, however, for investors and clients from 2019 it is that making decisions based on headlines is not a process. It often felt like the global economy was going to unravel at times. From Brexit, to Trade Wars, to Recession Risks – the market shrugged them all off and managed to post one of its best returns since 2013. It is more important than ever to keep focused on your long-term financial goals and resist the day to day noise in equity markets. Predicting short term market movements is something that allows pundits to sound authoritative on factors that are almost impossible to foresee.

Market Outlook

One of the key drivers of our general market outlook and positioning for 2020 at this point is that the risk of inflation seems mispriced, which should result in above trend returns for certain asset classes. Demographics and productivity have shifted global growth lower, however fiscal stimulus and easy monetary policies have provided a positive backdrop for risk assets and equities. Central banks are trying to communicate to the market that they are willing to let inflation run above target. Technological advances and globalization have clearly brought the prices of goods down, however the service economy is arguably more influential, which we believe has much higher inflationary characteristics. The cost of housing, healthcare, and education have been increasing steadily and are essential for the middle class. As a result, we have been taking steps to protect against unexpected rises in inflation by increasing exposure to Treasury Inflation-Protected Securities (“TIPS”) as well as a modest allocation to Gold in certain client accounts.

One of the main drivers of Q4 returns was that the US Federal Reserve significantly ramped up the expansion of their balance sheet by purchasing as many short-term bonds as they could get their hands on, thereby adding significant liquidity to the market. Make no mistake, this type of behaviour is a tailwind for equity markets and if you couple that with the fact that central banks have recently turned much more accommodative and supportive, we believe that risk assets will remain in demand.

With this backdrop we remain well invested in equities, with a focus on companies with stable free cash flow, organic and inorganic growth opportunities, high returns on capital, and dividend growth. Our fixed income allocations continue to focus on special situations in the perpetual preferred share and convertible bond market, high yield bond opportunities and inflation protected securities. We continue to manage our cash level in the 5-10% range depending on clients’ risk profiles.

Implications of the Iran Crisis

Aventine’s neighbour at 2 Bloor Street West in Toronto is the Mosaic Institute, a Canadian charitable institution that advances pluralism in societies and peace amongst nations. For the past year, Mosaic has been incubating work with the Iranian-Canadian diaspora and with regional experts to develop measures to protect human rights within Iran and to reduce the risk of conflict spiralling out of the country.

We spoke with Mosaic’s CEO, Akaash Maharaj, on the implications of the current crisis in Iran:

“The Iranian military’s shooting down of flight 752 has been deeply traumatic, especially to Canadians, who lost 57 of our fellow citizens,” he said. “The shock appears to have caused a pause in escalations between Iran and the US, because it has demonstrated that, in a febrile atmosphere, it is easy for states to trip into catastrophic consequences.”

“Iran has now agreed to allow staff from the UN’s International Civil Aviation Organization to inspect the crash site and debris. European governments have activated the dispute mechanism in the Iran nuclear treaty. The British government has called for a new anti-nuclear agreement between Iran and the United States.”

“None of these diplomatic measures will bear immediate fruit. However, the willingness of states to rush to the pen instead of the sword is an indication that they have made the political decision to step away from, rather than towards, the abyss.”

Having listened to Akaash, our sense is that the spikes in unrest in parts of the world will continue, however our view remains that the longer-term trend continues to be positive.

US Dividend Growth

The Aventine Dividend Fund is off to a solid start since inception (August 31, 2019) rising 8% in USD after all fees. During the quarter we consolidated our exposure to the US healthcare sector and added two new positions; Bristol Myers Squibb (BMY-US) and UnitedHealth Group (UNH-US). Both companies have strong dividend yields at 2.8% and 1.5% and have grown their dividend by 3% and 24% over the last five years, respectively. While the historical dividend growth of Bristol Myers has been low, they recently closed the acquisition of Celgene, and we expect increased news flow and positive FDA results in the coming year. We also believe the 10x P/E multiple, improving balance sheet metrics and significant free cash flow growth should help the shares and provide an opportunity for further dividend growth.

Two of our key themes in the Fund worked well in 2019 as we look to own companies with a wide competitive moat and a long runway for growing free cash flow, and therefore the dividend. First, we wanted exposure to the accelerating trend of subscription services and streaming. Valuations of many software or service providers had reached extremes, however we were able to participate in this theme through Disney (DIS-US). Their recent launch of Disney+ helped the shares reach all-time highs in 2019. It was recently reported that Disney+ has managed to acquire over 35 million subscribers in just two months of operations.

Another important theme we wanted to participate in is gaming (not gambling, but electronic games) – the second fastest growing form of entertainment next to streaming. The industry is estimated to grow at a 9% CAGR (Compound Annual Growth Rate) for the next five years. There are now subscription models, tournaments and streaming opportunities (watching other people play online). Gaming companies are innovative, have a recurring revenue stream and generate a lot of free cash flow. There is only one company that fits the bill for a dividend growth portfolio and that is Activision Blizzard (ATVI-US), the owners of popular titles such as World of Warcraft, Call of Duty and Candy Crush.

Canadian Equities

Our Canadian Equity strategies performed very well in the final quarter of 2019 highlighted by a 7.2% gain within the ACE Fund (our All-Cap Canadian Equity strategy) after all fees. Interestingly, the TSX was one of the top performing indices globally in Q4 as the Energy sector’s 8.0% return and the Materials sector’s 7.8% return drove a great deal of the broad market’s overall 3.2% Q4 return. In our Canadian Dividend Growth strategy, we added a handful of new names including Empire Company Limited (EMP/A-TO, the owner of Sobey’s) after a significant sell off post earnings in December. We believe they are the Canadian grocer that still offers the best upside on margin expansion and, given their defensive qualities, we trust that they are a great addition to long-term focused portfolios.

We also added CAE Inc. (CAE-TO) after recognizing the significance of their market leading position in aviation simulators and the positive trends in pilot training globally. Two factors are helping solidify demand for their products and services. First, the recent tragedy with the Boeing 737 MAX will increase the demand for pilot training. CAE recognized this and has increased production accordingly. Secondly, there have been some regulatory changes on the mandatory training hours for pilots which will increase the number of rookie pilots hired and result in a dramatic demand increase for CAE training services.

The ACE Funds overall return in 2019 was solid at +16.3%. Essential to this performance was that we avoided any major underperformers (i.e. had very few losing positions) and in fact we hold five positions which returned more than 40% in 2019, including Kinaxis (KXS-TO), Brookfield Asset Management (BAM/A-TO), Heroux-Devtek (HRX-TO), ATS Automation (ATA-TO) and People Corp (PEO-TO). We continue to hold each of these names and believe that 2020 will be an exciting year as they all have top notch management teams, robust strategies and improving outlooks.

In case you missed it, James Telfser was recently on BNN Bloomberg’s Market Call making the case for the mentioned above, CAE and Heroux-Devtek, as well as FirstService (FSV-TO)

Click above image to view video (5:14 mins)

In summary, 2019 was a successful year for Aventine clients and we believe 2020 will be equally rewarding. The key to this is the fact that Central Banks are currently committed to maintaining nominal interest rates below GDP, thereby supporting risk assets. We are positioned to benefit from the significant value that can be found in all-cap equities and high dividend growth companies. Our security selection remains focused on firms that are cash flow compounders with high barriers to entry while we avoid those with extreme valuations or structural macro headwinds. While inflation could be a risk to the overall narrative we are taking steps to protect against such a threat.

We encourage you to come speak with us anytime and we appreciate the confidence you have in allowing us to manage your savings for you.

Best wishes as always,
James, Jim, David and Shannon

Aventine Performance Update
December 31, 2019

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Aventine’s Partners and their families are among the largest investors across each of our strategies. You can be assured in our focus and commitment to performance.

Aventine Balanced Composite
Inception: June 1, 2009

Aventine Balanced is our core portfolio for separately managed accounts following a “balanced” mandate. It is an actively managed, endowment-style portfolio that offers investors diversified exposure to a broad variety of markets and asset classes. This diverse portfolio produces below average volatility and high income generation as we include asset classes such as private debt, mortgages, traditional and non-traditional fixed income, all-cap equities, alternatives and portfolio protection through prudent risk management strategies.

CURRENT PERFORMANCE SUMMARY


	Q4	YTD 2019
Aventine Balanced Composite	3.7%	11.6%

Annualized	3 Year	5 Year	Inception
	3.7%	5.0%	7.2%

Statistics	Risk	Sharpe
	6.5%	0.95