ACE Fund: March 2016 Manager Letter

March 31, 2016

31 March 2016

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Aventine Canadian Equity Fund

Monthly Fund Manager Update – March 2016

Executive Summary


The Aventine Canadian Equity Fund (“ACE Fund”) celebrated its two year anniversary on March 31, 2016. 

The ACE Fund has been ranked in the top 1% (second highest return) of all Canadian Equity Funds in the category over this two year period with a return of +8.5% compared to the S&P/TSX Composite return -0.1%. 

Fund Documents

Purchase Documents


Media Appearances

Performance Overview

Current Performance

1 Month 6 Months Year to Date
Aventine Canadian Equity – Class F +4.1% +13.2% -1.7%


Historical Performance

1 Year 3 Years* Inception*
Aventine Canadian Equity – Class F +3.0% n/a +8.5%
* Performance for periods >1 year are annualized.

Top Holdings

Clearwater Seafood (CLR-T) 6.6%
New Flyer Industries (NFI-T) 6.0%
Concordia Healthcare (CXR-T) 5.9%
Goeasy (GSY-T) 5.5%
Winpak (WPK-T) 5.3%

Metrics of Average Company

Market Capitalization ($B) $3.2B
Expected EPS Growth 22%
Forward Price-to-Earnings 10.8x
Dividend Yield 1.4%
Return on Equity 14%

Fund Commentary

The recovery in global equity markets that began in mid February continued to steam ahead through March.  While this rally may have sprung from technical factors like short covering, the past few weeks have seen enough “good” economic news to drive material improvements in commodity prices and risk appetite.  We saw a bit of normalcy return to markets and several of our portfolio companies were rewarded for superior earnings results.  Trends across a range of global macroeconomic indicators – equities, credit, commodities and currencies – improved and for the first time this year our risk model turned from red to green.  The ACE Fund finished the month of March well, returning +4.1%, leaving our year to date (January to March 2016) performance at -1.7%.   

The biggest contributions in March came from New Flyer (NFI-T, +29%) and ZCL Composites (ZCL-T, +20%).  New Flyer reported an excellent quarter and earnings came in above the highest estimate on the street.  Management comments focused on their strong margin performance and they noted accelerating growth in Motor Coach Industries, acquired last year.  Markets cheered ZCL’s decision to return some capital to shareholders as management of this steady business announced a 66% dividend increase and a $0.50 per share special dividend (representing 7% of the stock price). 

Our biggest disappointment in March was Concordia Healthcare (CXR-T) whose 16% decline during the month cost the Fund over 100 bps (i.e. 1.0%) of performance.  We were happy with Concordia’s Q4 earnings and cash flow performance, which was ahead of what most analysts were expecting, but apparently the results were not good enough to spark buying interest in the stock.  As we all know, the negative press around Valeant, particularly with respect to drug pricing and their delayed annual report, has hurt the entire specialty pharmaceutical industry. The result is that Concordia is trading today at a valuation multiple of less than 4x our expected 2016 earnings.  We strongly believe the balance sheet concerns are overblown and that Concordia currently represents one of the top investment opportunities in Canada.

Our Two Year Anniversary

The past two years have been extremely fulfilling for us both personally and professionally.  We knew when we launched the ACE Fund that it would be deeply challenging and deeply rewarding, and this has certainly been the case to date.  We started out as colleagues with shared values and complementary skills and through the ups and downs of the past 8 quarters have really grown together as partners. 

ACE is more to us than just an investment fund within a growing wealth management organization.  It is about expanding our knowledge, working with amazing mentors and daring to be excellent over a long period of time.  We believe that we have the opportunity to build something truly exceptional with our team here, focusing on finding value investments which will reward our investors and ourselves. 

Our investment process has benefited from the input of these new influences, and we have incorporated several subtle refinements over the two years to further strengthen our ability to generate superior risk-adjusted returns.  While we are proud of our results to date, we don’t sit around patting ourselves on the back – we are always looking ahead, searching for our next great investment.  But on this 2nd anniversary we feel it’s appropriate to take a moment and thank our investors, partners and mentors for their continued support, encouragement and guidance.

Performance Since Inception

Since launching the ACE Fund we have provided an annualized return of +8.5%, net of all fees and expenses, soundly outperforming the TSX Composite annualized performance of -0.5% on a total return basis.  Perhaps most impressive is that we accomplished this feat during a period in which the average stock (and average investor) in Canada has experienced bear market-like conditions.   Regular readers will recall that ACE was the #1 performing Canadian Equity fund in calendar 2015, but Morningstar also recently ranked us as the second best performing Canadian Equity fund – with the seventh best Sharpe Ratio (risk-adjusted return) – over the trailing 2 years as at March 31st, 2016.  The chart below shows 131 major funds from the Morningstar Canadian Equity category plotted in terms of risk and reward.  While our standard deviation is higher than many of our peers (+9% months like November 2015 will skew this measure), we have taken risk well and more than compensated our investors for the higher volatility. The following sections highlight 4 factors that we attribute a lot of our early success to.

Success Factor #1: Active Value

The primary focus of our investment activities continues to be the identification of undervalued or underappreciated companies with a high probability of realizing significant, value-creating catalysts in the intermediate term.  We invest in strength, meaning we want to own companies with improving operating or financial performance, gaining market share in growing or protected markets, and whose share prices are undergoing multiple expansion.  We call this hybrid style of value investing with catalyst characteristics “Active Value” and prefer it to traditional (passive) value investing where the cheapness of an asset is often its sole or dominant virtue.  Our Active Value approach acknowledges that while cheapness is attractive, it frequently needs help to achieve truly superior returns.  Active Value is about finding cheapness in the right hands.

This philosophy of investing in strength so long as a quantum of value is present has led us to be shareholders in some tremendous Canadian companies over the past two years.  We took meaningful positions in several of these names long before they were on the radar of the investing public or financial journalists.  Being early can come with some special risks, such as illiquidity or volatility, but these are more than offset by the margin of safety that comes from being able to acquire shares at cycle-low valuation multiples.  The best part is that when we get it right, those risks diminish as the companies grow into industry leaders and begin to develop widespread appeal.  The following three charts show examples of companies that represented “cheapness in the right hands” when we acquired them and that have since comprised a significant portion of the gains that we have all shared in as unitholders of the ACE Fund:

Success Factor #2: Selling Right


While the three companies noted above shared our ideal investment characteristics at the time of initial purchase – undervalued, underfollowed, catalyst rich – these merits are not likely to be held in perpetuity.  We only seek to own companies in ACE so long as they maintain those qualities.   If we become frustrated with management’s lack of progress towards our expected catalysts, observe a fundamental breakdown in particular business plans, or have the stock hit our valuation target, we’ll sell.  Over the past two years we have experienced all of the above and more, and have stuck to our discipline on the sell side throughout.  More to the point, there have been several instances whereby our disciplined approach to closing out positions has allowed us to avoid a significant loss.  Limiting the number big losses in the portfolio has allowed our big winners to have a much more meaningful impact to the positive overall. 

To illustrate, since launching ACE we have held seven stocks in which have netted the Fund gains in excess of $400k each, while holding only two stocks which have cost us that same amount.  Looking back at our trading ledger over the past two years, it’s clear that the most significant impact our sell discipline has had on the portfolio was getting us out of the Energy sector early. While we never held anything near a TSX-like weight in this sector, avoiding 50% further downside on the companies we did own in late 2014 saved us perhaps 5% at the Fund level.  The below graph shows how shares of Newalta, an oilfield service company, have fallen over 85% since we exited the position at a 30% loss back in December of 2014. Selling Right in 2014 kept our losses reasonable, and Active Value kept us from trying to call a bottom in the commodity sector throughout 2015. 

Success Factor #3: Dimensional Risk Management

Turnover in the Fund has been right around 100% per year since inception, which aligns with our target horizon on an average position of between 6 and 12 months.  This would be high for a traditional value manager, but it fits perfectly within our philosophies of active value and selling right.  We are strong believers that if we charge an active management fee, we had better earn it for our investors.  We aren’t going to sit on dead money companies waiting for a turnaround or “closet index” and hope to eke out a benchmark by 0.2%. We make concentrated allocations until a catalyst is realized, a valuation discount is closed, a better opportunity arises, or our models tell us that the balance of risks against our positioning has changed. 

On this final point above, we believe that dimensional risk management – bottom-up, top-down, and cross-asset – is important because most risk is managed through the rear view mirror by investors trying to avoid the last crisis.  

  • Bottom-up risk is controlled by our fundamental views on sectors and industries within the broad market.  With a portfolio limited to 20 positions our allocations are a scarce resource and we are sensitive to changes in sector leadership, both positively and negatively (eg. oil stocks in late 2014).  We utilize proprietary tools and resources along with our own analysis and judgments to rotate the portfolio towards pockets of relative value on an opportunistic basis. 
  • Top-down risk management relates to the Fund’s overall equity market exposure as viewed along an “aggressive versus defensive” spectrum.  While longer term forecasting is almost entirely useless, we still need to have a primary big picture outlook that supports our broader risk allocation, because we are not just content with riding the market’s ups and downs.  We have developed a set of real-time tools and models that we believe improves our timing with respect to determining the appropriate levels of cash, shorts and hedging within the portfolio. 
  • Cross-asset hedges are more tactical in nature and focus on alpha generation by exploiting vulnerabilities or mispricings across correlated markets and assets.  The goal with these hedges is to ensure we have multiple ways to win – we don’t necessarily need our base case scenario to occur. 
Having a successful risk management program is somewhat bittersweet, as it usually means there are losses in other areas of the Fund.  We would prefer to think of these hedges as insurance we never need to use, but that’s just not the case.  We have had pretty great success with this part of our strategy in our first two years adding value both in pure alpha terms (roughly +1.5%) as well as by reducing volatility.  

Success Factor #4: Portfolio Downside Protection

While we have clearly shown that we have the tools to manage risk in the portfolio, one of the key aspects of our success over the past couple years has been our thought process around downside protection.  This goes well beyond systematic tools and comes with an attitude or willingness to spend capital on insurance policies and raise cash in the good times to ensure that our investors capital is protected in bad times.   Capital preservation is a major motivation of ours for the ACE fund and for all Aventine mandates, which we believe is a fundamental objective of all our investors.

One way to measure this is through a figure know as downside capture ratio which is the percentage of the downside your fund has captured.  For example, if the TSX is down 10% and your fund is down 5%, your downside capture is 50%.  The ACE Fund has a ratio of only 15% (as a point of reference, 85% is considered a strong  ratio), so over the last two years we have only captured 15% of the markets downside.  Our partners have added an incredible amount of strength to our process in this regard and we consider it to be one of our best assets as we navigate these increasingly challenging markets. 

Looking Ahead

When we look at our portfolio of businesses, we couldn’t be more excited about their prospects.  The portfolio is expected to grow earnings greater than 20% in 2016 and we are only paying 11x earnings for this growth.  Given the expected catalysts that we see on the horizon coupled with the multiple expansion opportunity for many of our holdings it should be easy to see why we are excited.  In addition, for the first time in a long while our stock specific excitement is being complemented by our macro outlook. 

Notwithstanding that valuation concerns exist at the market level, trends across most asset classes have turned positive on the exceptionally strong rebound in prices since mid February.  Indeed, nearly every major category we track across equities, credit, FX and commodities, has showed an incredible level of resilience.  Flow of funds data also suggests long positioning remains light and that the recent rally was missed by the majority of investors which is often a precursor for the continuation of a trend.

In both Canada and the US, our risk models turned positive in early March, recovering the sharp deterioration that began in early January. As a result, our confidence in the sustainability of the recent market surge off the lows has risen.  Accordingly our investment exposure has risen as well, and much of our dry powder has now been back to work.

We deeply appreciate all of our friends, family and investor support over the past two years and hope that you will continue to enjoy many more years as satisfied investors in the ACE Fund alongside us.

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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