Dear readers, followers, advisors, supporters and investors (which really means mom, dad and a couple of friends), we’ve had an amazing first full year running the Canadian Passive Alpha Fund and the JML Hedge Fund; we exceeded our most ambitious expectations and simultaneously achieved our goal of learning by doing.
If not by the vagaries and vicissitudes of the market itself, all of us at GIFM have been humbled by the astounding support and encouragement we have received from people in the industry (a special thank you to the very talented people at GCIC/DundeeWealth who took me in and mentored me in so many aspects of the business), journalists, bloggers, friends, classmates, and of course, families.
We engaged in transactions touching equities, bonds, exchange-traded funds, exchange-traded notes, commodities and currencies; though most of our trades (and exclusively in the CPA Fund) involved going long equities, we’ve gone short as well; On the derivatives side, we’ve had successful plays such as long-Brent/short-WTI and less successfully hedged (outright dangerous) plays such as short-Yen/long-Rupiah. We engaged in forward contracts, traded futures, negotiated an exotic swap, and bought and wrote a wide array of options.
All the while, we learned a tremendous amount about the markets and most importantly ourselves. Every day (and night) we spent on the Bloomy led to an exponential development of our own mental latticeworks of knowledge and experiences–and greater insights into the underpinning mechanics of markets and indeed the world at large. More introspectively, we learned about how to deal with each other in cases where there was discord and began to grasp the potential and limitations of our individual temperaments. Generally, I would say that we have used sound, well-informed judgment in making our calls.
Sandy Cay, Bahamas
The reason we started GIFM, the Canadian Passive Alpha Fund and this blog was for posterity and exposure. Since inception on the 24th of October 2011, the range of emotions we’ve gone through has been astounding—only to be amplified by the lens of an inexpugnable record for all to see. Moreover, I think working on the GIFM funds has allowed us to come of age and discover exactly what we want to do. In retrospect, I’ve also recently realized that during a very specific moment in the middle of an all-night Bloomy marathon, I went from dreaming about the nebulous end-goal of one day running my own shop in the Bahamas to actually being able to articulate the tangible steps and quantities of work, skill and luck I would need in order to get there.
Every single day working on GIFM funds really taught us something new about ourselves and our business. For one or two of us that ended undergrad not really knowing the difference between the sell-side, the buy-side and the glorious back-office, the few of us that really didn’t have a clue that being a 20-something year old investment banker didn’t mean looking like James Bond in Tomorrow Never Dies or going to crazy parties with coke-riddled hookers but rather (in the words of David Einhorn):
Having a job that required sitting in the office all day waiting for assignments that were generally passed out around dinner. Where work lasts into the wee hours and often overnight. Where you come to understand the concept of staying in the office until everyone senior [leaves]—even if you have nothing to do. Further, I did not understand that being an analyst was a rite of passage that required “sacrifice” for its own sake, even when it provided no benefit to the project at hand. But you do it anyway because that’s the culture: “If you aren’t coming in on Saturday, don’t even think about coming in on Sunday!”
On a more sobering note, we gained an appreciation for the difficulty and rigor involved in successfully running money; and as a corollary, we’ve been humbled by the unpredictable and irrational nature of markets and their participants. In retrospect we’ve also had our egos subdued–as far as the JML Hedge Fund is concerned, the reality is that its a coinflip between our having any reproducible results in the future and sheer luck; two trades out of eighty have accounted for roughly half of our total gains.
About eight months ago I wrote that:
I believe we continue to use derivatives in far too speculative a manner–we seriously need to enhance our risk-mitigation knowledge to avoid a catastrophe (that really means us at GIFM, not the markets in general –ed.) . Similarly I feel that markets are entering a new cycle of complacent carelessness combined with speculative over-buying and as such we have to be extra sensitive for the next set of unknown unknowns; I feel that a sub-perfect understanding of instruments such as ETNs (as opposed to ETFs) can have cataclysmic ramifications for the entire market (I am of the opinion that even sophisticated investors have perhaps been lulled into a false sense of security regarding these notes due to the widespread ascendance of ETFs–and that these instruments are significantly more dangerous than any CDS or CDO has ever been).
While I feel less animosity towards ETNs at this point, and feel that some of the ‘complacent carelessness’ has abated, I think its precisely in these moments of optimism that one must begin to be far more sensitive to the next set of ‘unknown unknowns’.
All of that aside, we’ve been tremendously lucky: We’re at a great program, live in a great country and have great mentors; As we’ve alluded to in past posts, if one were to offset some of our buys and sells by just a few days, we most probably wouldn’t have outperformed our benchmark by much—the rest really falls down to a confluence of factors which made our preferred strategy for a first fund (a common-sense Long-Only Equity Income Fund with a GARPish twist); pretty much the greatest decision since sliced bread and a Bloody Caesar by the pool at 10 AM on New Year’s day—and fiscal clusterfuck aside, I think 2012 will really be seen as one of those watershed years where North American equity markets turned the corner and began their recovery from a nasty hangover.
After a quiet first quarter we found our stride and did our first re-balancing, it was a fantastic time to pick up some great companies with attractive valuations like Dorel, as well as adding on to core holdings like K-Bro Linen and MTY. The next two quarters we had the chance to fine tune and step back and watch our picks finally get on a run and starting generating alpha for the CPA Fund.
While its nice to have winners such as Boyd Group Income Fund (58.9%), Liquor Stores (46.3%), MacDonald Dettwiler& Associates (44.1%), Badger Daylighting (38.2%), MorneauShepell (36.2%), Enbridge Income Fund (36.0%)—which we sold at full value last rebalancing, and others we continue to hold such as MTY (58.3%), K-Bro Linen (62.3%) and Acadian Timber (61.7%)—its difficult to learn much when you’re right (or lucky).
Looking back at some of the dogs we sold before the August rebalancing, there are definitely some lessons that we learned: With AGF Management (-17.8%), we learned about the importance of understanding industry metrics and the reasons behind relative over/underperformance; with Progressive Waste Solutions (-14.7%), a company I still believe in, we learned that sometimes the market just knows better—and seeing as the market can remain wrong far longer than we can remain solvent, we just had to cut our loss; with CAE (-5.0 %), we discovered the true meaning of dead money.
Some of the notable losers in the table below have in some way or another also paid huge dividends in terms of the lessons they’ve taught us: looking at Pengrowth Energy (-47.1%), we’ve learned the necessity of establishing temporal/loss limits on what are otherwise non-core investments; with Data Group (-49.5%), we’ve learned the vital need to differentiate between a stock that is good value and one that’s just cheap (usually there’s a reason for the latter); with Nordion (-36.0%) we learned the necessity of having the emotional intelligence and self-awareness requisite to be cognizant of the times when we honestly don’t understand what makes a business tick; with Southern Pacific Resources (-17.8%) and Pinecrest Energy (-20.1%) we’ve learned not to fuck with the ‘recipe’—We noted at the time of the last rebalance that among others, both of these buys were on the very fringes of the fund’s mandate (link). The truth is, this last rebalance has been underwhelming on a performance basis, yet very educational. I feel we made the right choice in taking profits from some of our early winners noted above, however as we mentioned in the article about that rebalance, we found it far more difficult at the time to find attractive valuations and therefore committed some cardinal sins: we messed with the recipe and pulled at straws with the likes of Nordion, Southern Pacific Resources and Pinecrest Energy which didn’t really fit the mandate of the fund (for starters, none of them even paid a dividend); we got greedy and added companies such as Data Group which paid what I would now define as an ‘unlikely yield’; and we displayed a measure of hubris by thinking our shit smells like roses by believing we could replace each of our sells with a new buy even though we were very aware that our timing was off and the values just weren’t there. Out of the top 13 winners currently in the CPA, two are from the most recent rebalancing. Out of the top 13 losers, 7 are from the most recent rebalancing. Suffice it to say, a valuable lesson we hope to never forget. For the upcoming year I believe that the main direction of our portfolio construction will shift away from purely seeking out sustainable yields (as valuations tend to be expensive in that space) to a construction that actively seeks to maximize beta convexity—i.e. finding the optimum balance between minimizing bear beta while maximizing bull beta.
The Bottom Line:
Since Inception Return (10/24/2011 – 01/04/2013) : 20.1%
SPTSX benchmark return: 6.9%
Beta: 0.51
Jensen Alpha: 12.8
FY Return (01/01/2012 – 12/31/2012): 12.4%
SPTSX benchmark return: 7.2%
Beta: 0.50
Jensen Alpha: 8.1
Once more, I would like to sincerely thank you for following along, supporting, mentoring or even just going for drinks. Doing this has been a blast and I look forward to another great year with GIFM.
For those that would like to see more specific data, please get in touch at max@lenarciak.net or give me call at (416) 315-0258. We are currently producing an MRFP-equivalent document which should be available shortly.
Sincerely,
Max Lenarciak
