ACE Fund: December 2016 Manager Letter

The Aventine Canadian Equity Fund (“ACE Fund”) finished the month of December up 1.6% and ended 2016 up 5.9%.  

2016 was a challenging year for us overall, however, since inception (March 31, 2014) we have generated net returns after all fees that have almost doubled the S&P/TSX TR Index at 9.1% versus 5.5%.

While December was a solid month for the ACE Fund it capped off what had been a rather disappointing 2016 for us overall.  Let’s just get it out there right off the top:  We were dead wrong on Concordia Healthcare, which ended up being one of the worst performing stocks of 2016, and we mostly missed a major rally in the resource sector.

Now before getting too apologetic, it’s important to remind readers that our investment process tends to lag when sharp market rotations occur and also underemphasizes commodity companies.  In short, 2016 was not our ideal environment but we ended the year well, rising 3.5% in the fourth quarter and 5.9% in 2016 overall.  Further, since inception (2 years, 9 months) we have generated net returns to investors after all fees and expenses of 27% versus 16% for the S&P/TSX Total Return Index.  In terms of risk/reward, ACE has generated an “Annualized Alpha” (risk-adjusted excess returns per year) of 5.5% and we believe that such performance likely places us among the top 10% of all Canadian Equity funds since inception.

2016 brought both challenges and growth for us professionally and there were many opportunities to remind ourselves that managing a top fund is like running a marathon.  There is your game plan – developing an overall strategy that gives you a long term advantage or edge; there is your physical pacing – consistently delivering a positive return on investment to maximize the benefits of compounding over time; and there is your mental execution – the discipline required to keep to your strengths and style when the going gets tough, while still being observant of the changing conditions around you. We see opportunities ahead in 2017 and have learned from the mistakes of 2016 – notably in terms of the red flags we missed (chief among them: questionable management character and over-levered balance sheets).  Great investing is a path not a point and we become better asset managers as we learn, grow and evolve.  Now with that perspective in mind, let’s consider the state of the markets.

Even if your knowledge of the financial markets is minor, you probably noticed that this was a volatile year for investing and that the volatility was felt across most asset classes.  Stocks, bonds, commodities and currencies all fell under periods of intense stress at various times during the year as several significant political and market events played out.  Few fund managers will forget this year, with the non-consensus outcomes of BREXIT and the US election and the market moves that followed, not to mention OPEC’s year-long roller coaster game of will they/won’t they cut production.  While we spend most of our time analyzing individual companies, 2016 was a year where “macro” flexed its muscle in unexpected ways.  It will be interesting to see if the rising socio-political trends of populism, protectionism and anti-globalization continue to divide the developed world and if so, how it impacts markets and our holdings.  At this point it’s too early to know for sure, but if you were to simply focus on the current economic data, financial conditions and market trends as a guide (usually not a bad place to look for an unbiased point of view) we are encouraged by what we see. 

As we closed out 2016, most major indices were at or near their all-time highs.  This is a pretty impressive situation considering that it looked as though we were headed for a full-fledged bear market back in February.  From a technical standpoint, the market looked very “broken” in mid-February, similar to how it broke down in advance of the 2000 and 2008 corrections.  Financial conditions were bad and worsening, credit spreads were high and widening, recession risks were spiking and realized volatility was near record highs.  Conditions such as these typically appear concurrent with market selloffs of 25% or greater, but the reversal off the February bottom was so significant it has only happened two other times in the past 100 years.   If we look at the chart below of the S&P 500 you can see that we actually broke below the 2015 low in February, a very bearish sign, but managed to close the year near an all-time-high and above last year’s high, a very bullish sign.  The only two other times that this pattern (called a “bullish outside year”) has occurred, 1982 and 1933, marked the end of big recessions and signalled the start of new multi-year bull markets for stocks.  The following years (1983, 1934) saw stocks rise 28% and 18%, respectively.

This would be encouraging enough on its own but the closing of the year was even more significant in that it pushed the S&P 500 to break out of a three-year consolidation which is shown in the chart below (thank you Ciovacco Capital). This suggests that the continuation of the recent upward trend is likely.

Maybe you are thinking, OK great, but what about the Canadian stock market?  Well, it wasn’t a wildly different story in Canada as the TSX has rebounded enormously since February.  As you can see from the table below the resurgence in Materials, Energy and Financial stocks powered the TSX to its biggest gain since 2009.  For Materials, it was all gold in the first half before base metals took the lead on the back of improving global economic data and the return of a heartbeat to inflation indicators.  As readers know, the vast majority of our Fund is invested in the non-commodity / resource / extraction sectors as the future cash flows of these companies just isn’t something that can be predictably forecasted. While this natural sector tilt benefited us in 2015, it unfortunately also meant that we weren’t invited to the rebound party in 2016. 

While the ACE Fund has been at the forefront of Aventine from a marketing perspective, we are very excited to let our readers know that we officially launched the Aventine Stable Income Fund in early January.  This is a multi-strategy income fund that offers fixed income exposure to bonds and preferred shares, generates enhanced yield from a covered-call dividend equity strategy and provides exposure to diversified income sources such as convertibles, closed end funds and equity linked notes.  We think that big changes are underway for income investors and the passive strategies which worked so well in the falling rate regime will disappoint in the future.  This is far less complicated than it might sound at first – we are simply taking a slightly different approach to generating income, one that focuses on assets classes which perform well an inflationary environment and strategies that offer high income predictability.  The Fund’s objectives include annualized net returns of between 7% and 10%, annual portfolio yield of between 3% and 6%, and low to medium volatility risk.  This Fund will pay out 5% per year monthly.

Stable Income is an excellent complement to the ACE Fund with virtually no overlap in holdings.  There is a significant lack of nimble income investors in Canada and we look forward to uncovering the many opportunities this market will afford us as we meet our clients’ financial goals for stable income.  If you are interested in rounding out your portfolio with the Aventine Stable Income Fund, please give any of us a call anytime, we would be happy to walk you through the strategy and structure of our new Fund.