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Financial Statements

July was an extremely volatile month for investors as Greece once again stared into financial abyss, the Chinese stock market continued its historic meltdown, and commodity prices plunged to new lows.   Several times in the past year now we have seen negative “macro” developments trigger sharp selloffs in Canadian equites (October 2014, December 2014, March 2015) only to see those declines reverse suddenly and stock prices shoot back higher.  July followed this established pattern, and despite falling 5.5% intra-month, the TSX Composite Index rebounded in the final few trading days to finish the month down just 0.3%.

By comparison, the ACE Fund had an exceptionally steady month.  We started July strong and our positions held their value well during the broad market swoon.  We dipped into negative territory on the month only briefly and finished July up with a positive return of +1.4%.  This brings our year to date performance for F-Class units to 10.0% which puts us in the top 1% of our peer universe over that time period (430 funds).  Additionally, as the two tables below present, we are exceeding every absolute performance metric we have formally set for the ACE Fund while soundly outperforming on a relative basis as well:

Metric	ACE Fund Target	ACE Fund Actual
Annualized Return	10-12%	12.5%
Annualized Volatility	High Single Digit	6.9%
Beta	0.80 or Lower	0.4
Correlation	0.75 or Lower	0.5
Sharpe Ratio	Better than 1.0	1.8

 

“Relative” Performance Update

 

Time Period	ACE Fund Performance
	Vs TSX Index	Vs Category	Rank in Category
3 Month	+7.5%	+6.5%	Top 1%
6 Month	+10.6%	+9.9%	Top 1%
Year to Date	+9.4%	+9.6%	Top 1%
12 Month	+14.2%	+13.0%	Top 2%
Since Inception	+12.2%	+12.3%	n/a

As hardworking Portfolio Managers and full time students of the market we are continually learning from the great minds in our field who choose to share their knowledge.  One such influencer whom we hold in high esteem is Howard Marks, Founder and Chairman of Oaktree Capital, an alternative asset manager based in Los Angeles.  Mr. Marks has written at length on the virtues of being different from the pack and the particular lesson that springs to mind as we reflect on the last twelve months is this: “You can’t take the same actions as everyone else and expect to outperform.”    This has been a principal conviction of the ACE Fund since launch and it remains a firm belief of ours that consistently superior returns (versus a broad market index) will only come from investing in a concentrated basket of undervalued and underfollowed equities, combined with a complete disregard for benchmark sector weights.

Considering the devastation that has hit the resource sectors of the Canadian stock market over the past year, the value in having discretion to tactically avoid heavily weighted sectors when they are not at all in favor should be clear to investors.  By taking steps to limit the potential for large losses, investors can provide themselves with significantly more capital to compound over future years.

Being Small

Another conviction of the ACE Fund is to accept that being different from the average requires us to stay smaller and more nimble than the most prominent managers in our peer universe.  We view our profession as relatively rare, in that a dramatic increase in size can actually bring with it pretty meaningful diseconomies of scale.  Put another way, the business success of an investment firm (generating large profits for its shareholders) will often come at the cost of professional success (generating superior investment performance for its clients). While a critical mass in terms of assets under management is necessary in order to remain viable, once you pass the optimal size for your mandate, further growth in capital starts to work against you.  Being very large places real constraints upon a management team in terms of both concentration and liquidity, and typically results in strategy dilution as managers wrestle with the challenge of staying concentrated in their best ideas, while still being liquid enough to move between investment positions if needed.

Within the pure “Canadian Equity” category the ACE Fund competes against many behemoth funds (defined by us as managing over $2 billion) which we consider simply too large to offer investors enough “active share” to justify the fees they charge.  (Recall from prior letters that active share is a statistic which quantifies how different a portfolio is relative to its benchmark.  The rationale behind active share says that if an investor is going to pay active management fees then they should be receiving active investment management, not a closet index fund whose returns parallel lower cost ETF strategies!)

The table below presents a sample of behemoth funds, each of which are among the 10 largest Canadian Equity Funds in Canada, and their returns over the trailing twelve months.  Frankly, performance in these very widely held strategies has been uninspiring to say the least.  Only one of the five funds has managed to outperform the broad TSX index after fees, while not a single one has been able to buck the market’s negative return over the period.  By way of comparison we have included the returns and current size of the ACE fund at the bottom of this chart.

Fund	Assets	12 Month Return	Return vs TSX
Beutel Goodman Cdn Equity	$5.4 billion	-2.4%	+0.5%
RBC Canadian Equity	$3.0 billion	-4.6%	-1.5%
Franklin Bissett Canadian Equity	$3.0 billion	-5.6%	-2.7%
TD Canadian Equity	$2.9 billion	-7.3%	-4.4%
RBC Canadian Equity	$2.6 billion	-5.3%	-2.4%
Aventine Canadian Equity	$18.5 million	+11.3%	+14.2%

Speaking of meaningful positions, we had very strong results from the global leader in labels, CCL Industries (CCL.b-TSX, +19% in July), as they reported results significantly above analysts’ expectations on continued margin strength within their Avery division.  We remain impressed with CCL’s execution and strong balance sheet and look forward to participating in the next phase of their growth-by-acquisition business model.  We also had a strong month from Concordia Healthcare (CXR-TSX, +15% in July) as investors cheered the company’s filing of a $3 billion shelf prospectus.  Another growth-by-acquisition story, the shelf filing means that Concordia has paperwork in place which would allow it to raise $3 billion of capital (debt or equity) should a large acquisition opportunity present itself.  Considering that the market capitalization of Concordia is only $3.6 billion today, this would be a potentially game-changing deal and effectively double the size of the company.

We have spent a lot of time talking about Easyhome (EH-T, -8.5% in July) over the past few months and as our largest position we were greatly anticipating the quarterly results released on July 29th. We were looking for clarity on a few key operational items during the quarter, particularly (1) the loan growth, credit trends and cash flows related to 45 new store openings; (2) the “high grading” of their existing consumer loan book; and (3) the long awaited announcement of an expanded debt facility to fund future growth.   Each of these items came in line with our expectations and we believe this sets up Easyhome (soon to be renamed Goeasy) for an excellent second half as continued growth in the consumer loan book drives margin improvement through operational leverage.  We continue to view Easyhome as one of the most compelling value/organic growth opportunities in Canada and note that the company is trading at 7x our conservative 2016 EPS estimate.  Additionally we see revenue and earnings growth at 20% and 54% respectively, and expect growing return on equity as overall operations de-risk.

Market Update

Our posture towards this market has not changed much over last month.  We continue to conservatively manage the portfolio and at the time of writing the Fund’s long exposure, net of cash and short positions is approximately 73%.  Taking into account our options positions (all of which are either “in the money” or within a couple percent of being so), our net exposure falls to just 54%.  While this is no guarantee that we will be completely insulated from any market volatility that may occur in the coming weeks or months, it is certainly indicative of our intent to manage downside risk to the extent possible, and these hedges nicely complement the long investment positions we hold in high quality, undervalued Canadian companies.

We appreciate your time and support and hope that you will continue to follow our progress.  Should you consider joining us as investors in Aventine Canadian Equity Fund, your savings and capital will receive great care and attention, as it is invested right alongside our own.