ACE Fund: October 2016 Manager Letter

October 31, 2016



31 October 2016

Aventine Canadian Equity Fund

Monthly Fund Manager Update – October 2016

Executive Summary


The Aventine Canadian Equity Fund “ACE Fund” finished the month of October down 0.8%, bringing our one year return to +11.8%.

While the U.S. Presidential Election came as a shock to many, our team was prepared for a surprise victory and positioned the ACE Fund accordingly.  We also explain the concept of ‘Emerging Managers’ and the relationship between outperformance and size.

Fund Information

Purchase Documents

Performance Overview

Current Performance

1 Month 6 Months Year to Date
Aventine Canadian Equity – Class F -0.8% +2.7% +1.5%


Historical Performance

1 Year 3 Years* Inception*
Aventine Canadian Equity – Class F +11.8% n/a +7.9%
* Performance for periods >1 year are annualized.

Metrics of Average Company

Market Capitalization ($B) $2.7B
Expected EPS Growth 22%
Forward Price-to-Earnings 10.7x
Dividend Yield 1.6%
Return on Equity 12%

Performance Statistics

Annualized Standard Deviation 12.3%
Beta vs TSX Composite 0.69
Correlation vs TSX Composite 0.52
Sharpe Ratio 0.69
Annualized Alpha vs TSX Composite 6.4%

Fund Commentary

The ACE Fund closed the month of October down 0.8%. The biggest upside performance drivers were from our anchor stocks in the consumer packaging and aerospace sectors, which saw investor demand as the rotation into cyclicals continues. Energy names hurt the portfolio as skepticism grew regarding OPEC’s willingness to implement (and enforce) the production cap announced in Algiers recently.  However it was the U.S. election and Q3 earnings scorecard that held the market’s focus as the month wound down.

On the earnings front, we were encouraged with the broad tone of reports out of U.S. companies (Canada is currently in the thick of earnings season).  Per share earnings for the aggregate S&P 500 in Q3 has come in at +2.5% growth year over year, which brings the “earnings recession” of the past 18 months to a close and relaxes a major headwind for the equity markets.

Much has already been said about the U.S. election, so instead of rehashing the why or how of Trump’s victory, we thought that perhaps we could offer readers more value by seeking to add some insight or a new perspective on what it all means.  First and foremost, there is clear evidence that a global populist movement is underfoot and it has tremendous momentum.  No longer contained to fringe markets like Hungary, Boliva and the Philippines, recent outcomes in Britain and America lend credibility to the surge of support for anti-establishment parties across Europe.  This is particularly acute in Italy where an emboldened “5 Star Movement” – already the official opposition party – is seeking to increase its influence in a constitutional referendum on December 4th.  Outside of Italy, the next 12 months will see general elections in France, Germany and the Netherlands, during which the polarization over issues like globalization and immigration is sure to expand already deep social divisions.

It may feel as though America took a sharp right turn last week, but the reality is that the White House was the last, sole liberal holdout in what has become a dominantly conservative U.S. legislative landscape.  Come January, Republicans will hold the oval office, majorities in the Senate and House of Representatives, 32 of the 50 state Governorships, and control a majority of the state legislatures. This is a historically one-sided tilting of the map and its ripples are likely to be felt far into the future as the GOP will also appoint the next Fed Chair, at least one and perhaps as many as three Supreme Court Justices, and be well set up for the next Congressional redistricting in 2020.  So much for those shifting demographics sweeping a wave of blue across the electoral map.

Election night itself felt eerily similar to the UK referendum back in June and the overnight trading session saw “limit-down” moves in several currency, bond and equity markets.  In investor meetings over the past few weeks we had been highlighting our view that a surprise Trump victory would likely create a buyable correction.  Going into election night we had scaled our risk exposure down to 80% and as the outcome took shape, our team corresponded throughout the evening.  The plan was to buy stocks at the open, unfortunately by the time the market opened for trading, futures had regained nearly all of the overnight nosedive and we didn’t get a chance to do as much buying as we would have liked.  Still, we eliminated a majority of our shorts (based on the reduced uncertainty), and added to specific longs that reflected (1) our views on the improved earnings trends and (2) expectations for reduced taxes and regulation under the Republicans.

The Importance of  Emerging Managers

In the investment management business the term “Emerging Manager” relates to adolescent funds or asset managers that have graduated from the start-up phase but that are not yet so large as to have become institutionally complex.  Large enough to survive but small enough to perform, Emerging Managers are at a developmental point in their corporate life cycle where the demands of running the business (e.g. complexity) have not yet subjugated the goals of the profession (performance). Put another way, the investment approach of an Emerging Manager is not yet constrained by market capitalization limitations or by the group-think mentality that occurs when investment decisions are made by a committee whose members are individually divorced from the risks of their actions.  By contrast, the Operating Partners or Portfolio Managers of an Emerging Manager will almost always have the entirety of their capital concentrated in their own strategies or funds.

Why is this important? The significance of Emerging Managers is simple: there is a discernible correlation in asset managers between outperformance and size.  Taking this a bit further, the optimal window to be invested with a young and performing asset manager tends to be between roughly years 3 and 8, when total assets under management are above $100 million, but below $500 million.  Several factors align during this window, some organizational, some structural, which helps to make it a more reliable predictor of success.

Organizationally, the compensation structure of an Emerging Manager is much more conducive to alpha generation than at a mature fund company.  For starters, a Portfolio Manager on a billion-dollar fund is making a pretty good living, almost certainly seven figures.  This individual is not very likely to risk their career for a few extra basis points of performance and their employer, probably a public company, is tolerant of failure so long as it is conventional.  A big decision for a manager like this is whether to have a 6% weight in Royal Bank or a 7% weight.  By contrast, the Emerging Manager builds its business on the back of superior performance and risk control, and is hungry to identify exploitable discrepancies in securities prices.  The Emerging Manager seeks compelling opportunities across all sectors and market caps, irrespective of benchmarks, and views being different as a necessary precursor, not a career risk.

Over time, a successful Emerging Manager will grow in scale through a combination of performance and new investors, until such time as its activities become constrained by its shrinking investable universe.  The chart below illustrates this nicely.  If a Canadian Equity Fund manager is restricted from buying more than 10% of a company (the threshold to become an insider), the chart below shows how quickly one’s investable universe in Canadian Equities drops off as fund size grows.  Up to this point, a key asset of the Emerging Manager has been its ability to buy and sell securities with minimal price impact, and to take meaningful weights in small companies doing big things.  As the manager grows, these advantages diminish and the ability to capitalize on market inefficiencies in smaller market cap companies erodes.

The simple math of asset managers is that larger you get, the harder it is to become statistically different (and therefore have a chance at being consistently better) than your peer group.  When the law of large numbers is combined with the lack of incentive to take “active” risk by mature asset managers, it leaves only a small residual opportunity for outperformance, and more often than not, you are left with negative returns on a relative basis.  The trend towards ETFs for an average investor who lacks exposure to a selection of top tier Emerging Managers makes perfect sense in this context.

The below chart comes from Eurekahedge, a Singapore-based manager research firm which tracks monthly performance on a database of over 22,000 global funds for institutional clients.  This specific chart looks at 16,000 managers in its US-focused database, plotting their annualized 5 year trailing returns against their average assets under management.  While there is a lot going on in this chart, the quality that stands out to us is the positively skewed dispersion of returns for managers with between $100mm and $500mm in assets under management, and how the median manager performance peaks around the high end of this range.

From Eurekahedge: “while some of that dispersion is on the downside, we see rich potential in the thousands of funds in the northwest corner of the chart.  Specifically, there are more than 2500 funds under $200m with annualized returns over 10%, and only 186 funds over $1 billion with comparable returns.”

A Final Thought on the Difference Between Emerging Versus Mature Managers

Emerging managers tend to have a single focus – generating investment performance. This is partly because they aren’t yet burdened by the administrative complexity that comes with managing scale, and partly because performing is far more important to smaller firms than large ones.  In our roles at Aventine we have occasion to interact with all manner of investors and we generally find that if an investor has had a really good long-term experience, it is often because they identified a great manager at an early stage in their life cycle, had the temerity to allocate a significant portion of their capital and then the wisdom to let it compound over many years.

Investment consultants often focus on trying to identify if a manager has an “edge” before greenlighting their allocation to any new strategy.  If the best degree of edge is one that is tangible, explainable and repeatable then a true edge is extremely difficult to find, because if it is tangible and explainable then it’s rarely repeatable (due to market forces exploiting it).  However investors and capital allocators can rely on the Emerging Manager performance edge as a phenomenon that replays over and over with consistency, within the parameters outlined above.

If you have any questions about Emerging Manager performance trends or would be interested in learning more about the implementation of such a strategy in your broader asset portfolio, we’d be happy to speak with you.

Thanks as always for your interest in the ACE Fund. We deeply appreciate your continued support and hope you will remain satisfied investors for years to come.

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 in various jurisdictions across Canada, please contact Aventine Management Group Inc to discuss if you may be eligible to invest.  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 the ACE Fund is the performance of the target series of F Class units. 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 © 2016 AVENTINE MANAGEMENT GROUP INC., All rights reserved.

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