Real Fund Semi-Annual
June 30, 2020
The Real Fund invests in assets exhibiting specific qualities that allow for long-term growth beyond inflation.
For the six-month period ending June 30th, 2020, our fund delivered a net return of -12.4%; inflation was -3.3% as measured by our custom cost of living index; and -1.2% as measured by the Canadian Consumer Price Index (CPI).
In early 2020, the world was blindsided by a global pandemic; a health crisis that hasn’t occurred since the Spanish Flu in 1918. To slow the spread of the virus the world coordinated a global economic shutdown, which is an event we have never seen. This created tremendous economic uncertainty and record financial market volatility, with many equity indices dropping >35% at one point.
During a time like this it is important to keep our emotions in check, maintain our reason, and stick to our investment process. Our process is to analyze what we think an asset is worth and to compare that value to what we can buy that asset for. So, the question became how does the pandemic impact what a particular asset is worth?
In our view the pandemic impairs the value of many businesses, including some we own (highlighted in asset allocation section below), which impacted returns. However, other businesses are resilient or even positively impacted by the Pandemic, including some we own and some we aggressively added too in March. We believe there were tremendous investment opportunities in March/April and we were quite active during that time. We also highlight some of those new investments in the asset allocation section below.
COMPANIES: 90% WEIGHT
In our view the pandemic negatively impacts the value of many businesses, including some we own:
- Banks will see narrower profit spreads as a result of lower interest rates and higher loan losses as a result of financially impaired clients. This negatively impacts JP Morgan Chase & Co. (-29% ytd), Bank of America Corp. (-30% ytd), and TD Bank (-14 ytd) although we believe all three banks will be able to weather the storm and gain market share during this time.
- We believe there are structural negative shifts in global travel and physical cash use. This negatively impacts Heroux-Devtek Inc. (-47% ytd) a leading supplier of landing-gear for new aircrafts, and Currency Exchange International Inc. (-35% ytd) a leading provider of physical cash for foreign travellers.
- We believe there could be lasting regulations and capacity restrictions in hospitality. This negatively impacts Gamehost Inc. (-24% ytd) an owner of hotels and casinos in Alberta.
Some businesses are resilient or even positively impacted by the Pandemic, yet their share prices still plummeted in March. This created tremendous investment opportunities and we were quite active in March/April:
- We believe the Pandemic significantly accelerates prior trends in digitalization. This positively impacts Visa Inc. (+4% ytd; +33% since Mar 23 add) a leading processor in digital payments, and Microsoft Corp. (+48% since Mar 23 initiating buy) a leading enabler of business digitalization through its varying IP.
- We believe the Pandemic has driven a material shift in consumer spending: away from travel and towards home improvement. This is a tailwind to FirstService Corp. (+31% since Apr 1 initiating buy) a leading property manager who also owns many businesses tilted to home improvement, and Sleep Country Canada Inc. (-19% ytd; +76% since Mar 23 add) the leading Canadian retailer of beds and mattresses.
- Despite causing short-term store closures, we believe the Pandemic will accelerate long-term demand for strong casual clothing brands that can sell directly to consumers through online and instore channels. This positively impacts Nike Inc. (-2% ytd; +46% since Mar 23 add) a leader in athletic apparel and e-commerce, and Aritzia Inc. (0% ytd; +81% since Mar 23 add) a leader in female fashion and e-commerce.
HARD ASSETS: 4% REAL ESTATE +2% INFRASTRUCTURE +2% COMMODITIES
We believe real estate and infrastructure remain expensive overall and our focus is on idiosyncratic opportunities. For commodities, we initiated an investment in natural gas in March.
CURRENCIES/CREDIT: 2% CASH +0% BONDS
After tax and inflation, we believe cash and most bonds are priced for losses.
HOW DO WE INVEST INTELLIGENTLY IN AN UNKNOWN ENVIRONMENT?
As we wrote in our introduction, the world has been blindsided by a health crisis we haven’t seen in over 100 years and to combat this crisis the world coordinated a global economic shutdown we have never seen. The key phrase above is “we have never seen”. It is difficult to make financial forecasts and thus financial decisions when we are operating in an environment we have never seen before. How do we invest intelligently during this time?
Cash is likely not the long-term answer. The default decision is selling everything, going to cash, and reinvesting when there is more certainty in the world. Most often this is a grave error as you are doing so at the exact time many others are and that combined selling pressure means you are selling at severely discounted prices. We will use March as the perfect example: highest uncertainty = highest rush to cash = highest amount of selling errors. Equally important, governments have responded to the Pandemic by devaluing money at an unprecedented rate. We believe money is an asset whose value is amongst the most impaired by this crisis.
Focus on what you can know. Financial TV is fixated on trying to forecast GDP, unemployment rates, interest rates, virus spread rates, second waves, vaccines, and short-term equity market direction. While important, NO ONE knows how these will play out and, unlike financial TV, we do not try and forecast these things. Instead, there are structural shifts that will arise from this crisis that can be studied and known with some type of conviction. We highlighted some of these shifts in the asset allocation section above: digitalization, large shifts in consumer preferences, work from home. These are examples of large structural shifts that impact varying assets in significant ways, both positive and negative. More importantly, they are meaningful trends we can study and know with conviction. By focusing on what we can know, we can make some confident decisions in an unknown environment.
Focus on businesses that will survive. The question we most often get is: when? When will the economy come back? When will there be a vaccine? When will the market bottom? Despite what you hear on TV, NO ONE knows when any of these will occur. Instead, we focus on owning companies that can survive a downturn for an extended amount of time. When the crisis hit, we studied all our positions to analyze how long they could survive this crisis. A company’s balance sheet is most important, and we continue to focus on companies with no or manageable debt levels. For these companies, “when” is not a significant question as, barring the end of the world, they will live to see the brighter day.
When you’re experiencing something that has never happened before, you can’t know how it will turn out. Our response to most questions we’re asked during this Pandemic is “we don’t know”. However, there are a few things we do know: cash is likely not the long-term answer, many are basing decisions on things that can’t be known, we should focus on the identifiable structural shifts that are happening, and we should focus on businesses that can survive a prolonged downturn. Through this playbook we believe we have been able to make some intelligent investments in a highly uncertain time.
Over the last two “Final Remarks”, we spoke of euphoria and the dangerous emotion of greed. We provided a list of assets that faced extreme euphoria followed by an inevitable severe correction in price. We believe that by studying euphoric behaviour and focusing on fundamental value you can avoid investing in assets that face an inevitable decline in price. In other words, through research you can avoid some investment losses.
However, the recent Pandemic teaches us another thing: you can’t always see it coming. Sometimes a meteor hits the earth and destroys what it impacts: this is how I would describe the Pandemic. This is not your typical economic cycle driven recession, where a period of greedy and unsustainable behaviour leads to a period of correcting that behaviour. This is a meteor hitting the earth and making an impact. If this meteor had hit during the bottom of the natural economic cycle in 2008, we wouldn’t be saying “the bottom of 2008”, it would be something like “the bottom of 2010”.
Well, we’ll find out how long this will take, no one knows.
Thank-you for investing!
“What good poker players and good decision-makers have in common is their comfort with the world being an uncertain and unpredictable place. They understand that they can almost never know exactly how something will turn out. They embrace that uncertainty and, instead of focusing on being sure, they try to figure out how unsure they are, making their best guess at the chances that different outcomes will occur.” – Thinking in Bets
National Instrument 31-103 requires registered firms to disclose information that a reasonable investor would expect to know, including any material conflicts with the firm or its representatives. Doug Johnson and/or Pathfinder Asset Management Limited are an insider of companies periodically mentioned in this report. Please visit www.paml.ca for full disclosures.
*All returns are time weighted and net of fees. Performance returns from the Real Fund are presented based on the Class C Master series. Inception and 2013 returns include the 10 months from inception in March 2013. Returns greater than one year are annualized. The custom cost of living and CPI provide general information and should not be interpreted as a benchmark for your own portfolio return. The custom cost of living represents an equally weighted (at inception) basket of Teranet-National Bank National Composite House Price Index™, UBS E-TRACS CMCI Food Total Return ETN ETF (FUD:NYSE), United States Gasoline ETF (UGA:NYSE) and Canadian import prices from Statistics Canada in Canadian dollars. We created the custom cost of living index to give investors another way to measure their cost of living. It has some differences versus CPI; for example, CPI measures shelter costs as the cost of renting a home versus the custom index which measures it as at the cost of purchasing a home. A bachelor may view renting as an accurate gauge of shelter costs. On the other hand, a mother and father who want to raise their family under the security of the same roof without the risk of forced relocation likely views home ownership as a more accurate gauge of shelter costs.
Pathfinder Asset Management Limited (PAML) and its affiliates may collectively beneficially own in excess of 10% of one or more classes of the issued and outstanding equity securities mentioned in this newsletter. This publication is intended only to convey information. It is not to be construed as an investment guide or as an offer or solicitation of an offer to buy or sell any of the securities mentioned in it. The author has taken all usual and reasonable precautions to determine that the information contained in this publication has been obtained from sources believed to be reliable and that the procedures used to summarize and analyze such information are based on approved practices and principles in the investment industry. However, the market forces underlying investment value are subject to sudden and dramatic changes and data availability varies from one moment to the next. Consequently, neither the author nor PAML can make any warranty as to the accuracy or completeness of information, analysis or views contained in this publication or their usefulness or suitability in any particular circumstance. You should not undertake any investment or portfolio assessment or other transaction on the basis of this publication, but should first consult your portfolio manager, who can assess all relevant particulars of any proposed investment or transaction. PAML and the author accept no liability of any kind whatsoever or any damages or losses incurred by you as a result of reliance upon or use of this publication.