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. 

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%. 
 

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.   
 

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.
 

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.