- October was a roller coaster of a month for equity investors, one that saw both the sharpest correction and the strongest rally in over 3 years.
- We entered the month conservatively positioned and as a result were able to avoid much of the market’s losses.
- Third quarter earnings for our portfolio companies have generally exceeded expectations, but a key earnings miss late in the month cost us 80 basis points and the opportunity to post a positive return in October.
- Overall, in what was a very challenging environment for active managers, the ACE Fund was down 0.9%. Since inception we have made 2.1% after all fees for unit holders.
When we launched the ACE Fund earlier this year we were excited to incorporate some of the risk management strategies executed by our partner, Andrew Shortreid, in other areas of the firm. Andrew’s research primarily focuses on protecting capital and managing volatility during times of market stress through the use of options and other hedging techniques. For those of you who have not yet met Andrew, the October 3rd BNN appearance below is a great introduction to his views.
The past 2 months have served as a significant stress test for the Fund’s investment approach and we are happy to report that we have been able to outperform 70% of Canadian Equity managers and 85% of Small/Mid Cap Canadian Equity managers over the past 2 months, according to Morningstar. The foundation of this result is a process that delivers strong security selection, but we have also added value through active risk management and tactical trading.
The linkage between economic growth, commodity prices and the stock market (particularly in Canada) cannot be understated and recent weakness in the commodities complex seems to be pricing in slower growth ahead. The prime example is WTI Oil which has now fallen 28% since its recent peak in June. Headlines attribute much of this move to a supply glut, but weakening demand and a stronger US dollar are equally large factors. According to recent company reports this has not yet curtailed activity in the Canadian oil patch, but a new market equilibrium below $80 would have a very real impact on the Canadian economy. Stock markets are a discounting mechanism and the below chart illustrates how the potential drag from weak resource demand is being priced into both the Canadian stock market and the loonie. In the Fund we have only a very small allocation to resources and hold a 10% weight to US companies. In addition, many of our other Canadian companies generate a material proportion of their revenues in US dollars. Going forward this should continue to buffer us from some of the headwinds facing the Canadian market.
The Fund saw solid outperformance in October from two companies we have highlighted in the last few months. Clearwater Seafood (CLR-T, www.clearwater.ca, +7.5% in October) has benefitted from lower fuel costs, a weaker Canadian dollar and an upswing in market interest as investors have rotated towards Consumer Staples companies. Sandvine (SVC-T, www.sandvine.com, +1.1%) has recently perked up on the announcement of several new contract wins. Investors had overreacted to lighter than expected revenues last quarter and with the recent positive news flow, sentiment now appears to have turned strongly for the better.
We got additional colour on Sandvine earlier this week when we met with management, and we came away believing that the company has a very bright future. We particularly liked CEO David Caputo’s description of how sponsored usage by major corporations is opening up entirely new avenues for growth. Companies already know when we access their web content from our mobile devices and have web pages designed specifically for tablets and smart phones, however these pages are generally stripped down versions designed to be light on mobile data usage. As mobile spending becomes an increasingly large share of total consumption, corporations targeting a larger wallet share of mobile are looking to enrich the customer experience. This means pushing out video and other high data usage formats to mobile devices. Historically this would have been a cost to the customer but now savvy companies are actually paying for the bandwidth consumed by mobile customers surfing their web content. Sandvine is a market leader in the technology that enables wireless carriers and companies to seamlessly manage this “sponsored” type of web activity.
Our experience with Canam Group (CAM.TO) this month is a different type of story that resulted in a costly lesson. We had previously written that we like Canam for its attractive valuation, ability to win new business and a record backlog, but noted that their internal operating performance in the early part of the year was sub-par. When we spoke with management about a month ago, our read through was to expect sequential improvement in the second half of the year, however Canam reported disappointing earnings at the end of October which sent the company’s share price sharply lower. The poor results were mostly driven by weaker margins as the company’s recent contract wins had come at the expense of profitability. With actual performance weakening instead of strengthening, Canam’s leadership has now failed to manage market expectations effectively for several consecutive quarters and their credibility is shot. We no longer believe in management’s ability to deliver on the backlog profitably and as a result we are not interested in being shareholders of this company.