ACE Fund: February 2016 Manager Letter

February 29, 2016

29 February 2016

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Aventine Canadian Equity Fund

Monthly Fund Manager Update – February 2016

Executive Summary


The Aventine Canadian Equity Fund (“ACE Fund”) returned +1.4% in February.  While the volatility in February was intense at times we maintained our discipline and added to our highest conviction names at incredibly low valuations.  The price-to-earnings multiple on our portfolio is at one of the lowest levels since inception (10.4x vs 16.9x for the TSX).

Despite a tough start to 2016, Morningstar has ranked the ACE Fund as the top performing Canadian Equity fund in the category over the past 12 months. 

Fund Documents

Purchase Documents


Media Appearances

Performance Overview

Current Year Performance

1 Month 6 Months Year to Date
Aventine Canadian Equity – Class F +1.4% +2.0% -5.6%


Historical Performance

1 Year 3 Years* Inception*
Aventine Canadian Equity – Class F +1.8% n/a +6.6%
* Performance for periods >1 year are annualized.

Top Holdings

Concordia Healthcare (CXR-T) 7.4%
Clearwater Seafood (CLR-T) 6.4%
Goeasy (GSY-T) 6.0%
New Flyer Industries (NFI-T) 4.9%
Aercap Holdings (AER-US) 4.7%

Metrics of Average Company

Market Capitalization ($B) $3.1B
Expected EPS Growth 22%
Forward Price-to-Earnings 10.4x
Dividend Yield 1.4%
Return on Equity 14%

Fund Commentary

The heightened market volatility that began on the first trading day of 2016 continued through February. Extreme movements in stock prices over the past few months are reminiscent of the period in late 2014 which saw tremendous intra-month whipsaws, but that resulted in little change to the month-over-month closing price.  In this respect, February’s monthly performance looked almost perfectly “average” on the surface, with the S&P/TSX Composite Total Return Index (“TSX”) closing up 0.5%.  A peek under the hood, however, reveals that the engine has many more miles on it than one might expect.  To illustrate, over the past 3 months the TSX index has had an average monthly trading range of 1,153 points, meaning the average intra-month swing of this index since December 1st has been in excess of 9%.  This is truly stunning volatility and highlights the impact of illiquidity and uncertainty on markets in the post QE era.

In contrast to January, where our holdings seemed to catch all of the monthly downside and none of its mid-month rebound, we were much more pleased with both the path and the results in February.  We were much better positioned going into the month and we were able to take actions that first dampened our volatility on the way down and then clawed back some of January’s losses on the rapid rebound.  As the dust settled we were satisfied to close the month with a positive return of 1.4%. 

News Vacuum

While we have made some opportunistic changes to the portfolio recently, the biggest contributor to the Fund’s performance in February versus January was the end of our “news vacuum”.  In January, our portfolio companies distributed no press releases, earnings guidance, or other material news, so they were left to float, unanchored in the sea of negativity.   As in physics, markets abhor a vacuum and absent management reassurances, investors in several of our portfolio companies invented negative narratives to justify selling.  In these instances calculators and spreadsheets can be the value investor’s best friend, helping to separate a valuation that is based on emotion from one that is based on cash flows and assets.  Armed with our trusty tools of reason we just couldn’t sensibly construct a scenario where the most negative of these valuations became reality, so we added exposure to the more compelling opportunities.  Considering that our future returns are going to be partly determined by the valuation at which we enter a position, we believe that unitholders will be able to enjoy the benefits of these additions in the coming year.  Case in point, February brought visibility into the continued strong operating performance of several portfolio companies we recently added to, such as Goeasy, AerCap and Cott:
  • Goeasy (GSY-T, +12% in Feb) – Q4 earnings beat expectations with solid operating leverage from easyfinancial.  Their outlook remained very strong although credit metrics slightly deteriorated (as we expected). Management guided that average credit quality of their portfolio continues to improve and said defaults should tick down next quarter, which we will be monitoring closely.  The recent credit deterioration is mostly a result of migrating to an online loan application model, which dramatically lowers customer acquisition costs, but at the expense of initially higher credit charges.  Overall however, the net result is an expanded profit margin in the lending business, as management demonstrated in Q4.   
  • AerCap Holdings (AER-US, +16% in Feb) – AerCap management provided very strong guidance on the leasing market on its recent earnings call, which was also consistent with commentary we saw from some of their competitors.  Fears about Chinese growth and global air travel trends had been weighing on the stock but shareholders were treated to a solid EPS beat and a newly announced $400m stock buyback.  Looking forward, Aercap trades at 6x 2016 earnings with confirmed guidance for 7-9% core earnings growth this year. 
  • Cott (BCB-T, +15% in Feb) – Very strong quarter with free cash flow coming in ahead of expectations, both ours and the consensus.  Cott has undergone a significant transformation in recent years, moving away from its declining legacy business of branded carbonated drinks and diversifying more broadly into contracted manufacturing and a water/coffee delivery vertical.  They recently acquired DS Services which is in the direct-to-consumer bottled water and office coffee delivery business, and have since used it as the central vehicle to pursue a roll up of this fragmented industry.  We believe that Cott will recycle its excess cash flow into additional acquisitions that will provide added diversification away from the traditional carbonated businesses. 

Discipline & Conviction

Successfully navigating these markets has required a delicate balance of discipline and conviction.  By discipline we mean following the process that we know works – focusing on companies and sectors that are performing well operationally, have market support and remain undervalued.  This part of our process prevents us from trying to call bottoms in stocks or sectors and also keeps us focused on what is working well in the portfolio – which in the last few months has shifted towards utilities, gold and other “defensive” industries.  By conviction we mean taking large weights in portfolio companies when we believe that the business fundamentals, economics and industry dynamics are being materially underpriced as a result of twitchy sentiment or news vacuums, for instance.  This part of our investment process mostly uncorrelates the portfolio from the broad market index, giving the Fund an opportunity to produce long term returns that are both different and better than the average.

We never wish for the type of market volatility we have seen so far in 2016, but we have tried to use it to our advantage.  We believe that we’ve been able to put a portion of our cash reserve to good work, adding weight to a number of portfolio companies at levels significantly below our calculation of intrinsic value.  These moves benefitted unitholders in the latter part of February and thus far in early March as well.  Unfortunately it’s just not possible to generate consistent outperformance with a concentrated portfolio of stocks that also always experiences lower levels of volatility than the market.  However, we are confident that the increased volatility of our unit price over the last nine months has been largely the result of an exceptionally dramatic period in global capital markets, and that through this difficult period we have steered the ship well. 

On a closing note with respect to the portfolio, we wanted to highlight to unitholders that Concordia Healthcare, one of our largest – and somewhat controversial – positions reports earnings later this month.  Regular readers will recall that Concordia Healthcare has been at various times over the past year both our biggest winner and our biggest loser.  As a growth-by-acquisition story in the pharmaceutical sector it has suffered greatly from guilt by association during the very public and very political targeting of Valeant (a large competitor).  The upcoming earnings release contains Concordia’s first couple months of consolidated results with its most recent acquisition, a large UK firm.  We believe that the new more diversified Concordia is going to present some very encouraging results and we look forward to updating our unit holders when those results are made public.   


From a market exposure standpoint, we rely on the weight of evidence presented by our risk models which continue to suggest defense over offense.  The read we are getting is that both Canadian and US markets remain in fragile condition and that although there have been improvements in equity, volatility and credit trends, we don’t believe that the bear market has retreated into hibernation indefinitely.  Our net exposure at the time of writing, excluding options, is just under 75% which we view as appropriate given the current balance of risks.  As always, however we reserve the right to change our mind and adjust accordingly.

We noted last month that when sentiment is universally negative even slight improvements in economic data can help to establish a floor under asset prices.  Often during economic decelerations, such as we have experienced the past few quarters, economic forecasts get progressively more pessimistic until they hit an inflection point beyond which the actual data starts to look good by comparison.  This, along with some stability in commodity prices, particularly oil, is what has been drawing buyers back to equity markets.  It’s a bit counter-intuitive, but cutting forecasts is an essential part of the market bottoming process and the Citi Economic Surprise Index (“CESI”) is how we observe this relationship between expectations and actual performance in regards to the economy1.

The CESI has been negative for 14 months now, meaning that actual economic data at the aggregate level, has been consistently coming in below expectations.  This is the longest such streak of economic underperformance since the index was created.  In the past few weeks however, as the consensus US GDP growth forecast for 2016 has fallen from 2.50% to 2.15%, the CESI data has started to improve versus the lowered bar, rising to its highest level this year.  Perhaps economists have lowered the bar enough to break the string of negative surprises.  While 2% growth is underwhelming from a historical context, it rebuffs the rising US recessionary fears, is consistent with mid-single digit EPS growth, and would be generally supportive of the stock market.

When we look out towards the remainder of the year, we remain particularly encouraged by the commentary coming from our portfolio companies in the leasing, consumer products, and alternative lending industries.  As noted above, another surge in volatility is entirely possible but considering that the Fund’s holdings are trading at an average of 10.4x 2016 earnings with strong growth prospects, we are pretty comfortable with the “margin of safety” implicit in our portfolio.  In our judgement, the current allocation of capital amongst long stockholdings, cash reserves, short positions and options overlays, provides us with the ability to benefit from the ongoing operational success of our portfolio companies while dampening the impact of external risks from broad market volatility.  We look forward to keeping you updated throughout the year as the portfolio evolves based on our discovery of undervalued businesses with superior return potential.

Investors who are familiar with us know that we have substantially all of our investment capital invested in the ACE Fund and we believe the prospects for superior long term returns in this strategy are excellent.  We are thankful to those friends and investors who have shown us support in our endeavours and we look to build on the ACE Fund’s early success.  The Fund remains open to new capital and we are always happy to chat about the portfolio and our approach with any investors, old or new.

Performance Presentation

Fund Inception: March 31, 2014

This email communication is intended to provide you with information about the Aventine Canadian Equity Fund managed by Aventine Management Group Inc. This Fund is distributed by prospectus exemption exclusively to qualified investors in the provinces of Alberta, British Columbia and Ontario. Important information about the Fund is contained in its Offering Memorandum which should be read carefully before investing and may be obtained from Aventine Management Group upon request, or by clicking on the link at the top of this email. The Offering Memorandum of the Aventine Canadian Equity (“ACE”) Fund does not constitute an offer or solicitation to anyone in any jurisdiction in which such an offer or solicitation is not authorized, or to any person to whom it is unlawful to make such an offer or solicitation. All investors should fully understand their risk tolerances and the suitability of this Fund prior to making any investment. Rates of return presented for all periods greater than one year are the historical annualized compound total returns for the period indicated. For periods less than one year the rates of returns are a simple period total return. Rates of return do not take into account income taxes payable that would have reduced net returns. The performance presented for Class A and Class F Units of the ACE Fund is the performance of the target series of each class and the NAV Per Unit presented for Class A, Class F and Class I Units is the current NAV Per Unit of the target series of each class. The value of the Fund is not guaranteed and will change frequently. Past performance may not be repeated. All credited third party information contained herein has been obtained from sources believed to be reliable at the time of writing but Aventine Management Group Inc makes no representations as to its accuracy. 
Copyright  © *|CURRENT_YEAR|* AVENTINE MANAGEMENT GROUP INC., All rights reserved.

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