Vantage Protected Performance Fund commentary for the year ended December 31, 2016.
2016 Hedge Fund Letters
The Vantage Protected Performance Fund is managed for risk?adjusted performance. The objective of the fund is to generate double?digit returns with significantly lower risk and volatility as compared to the Canadian equity market. The historical success of the investment strategy is the result of effective stock selection (long and short) and a commitment to maintaining a hedged (protected) portfolio. The fund’s investment process is based on extensive, fundamental, bottom?up research with a focus on companies where operational or strategic catalysts can unlock significant value for shareholders.
Vantage Protected Performance Fund – Manager Commentary: December 2016
The Vantage Protected Performance Fund was up +1.1% (net) in December, resulting in a full?year return of +29.5% (net). As an investment team, we were pleased with the fund’s performance, but we are not looking backward. Rather, the Vantage team is focused on ensuring 2017 will be another productive year for investors and all of the firm’s resources are dedicated to achieving this outcome.
We have two important messages for investors as we enter 2017:
1. The Risk Profile and Investment Strategy Remain Unchanged: Despite the fund’s +29.5% (net) return last year, it is important to emphasize the portfolio remained well?protected with an exposure and risk profile consistent with historical metrics. More specifically, the fund averaged 28% net long in 2016 – below the 32% historical average of the investment strategy. Effective stock selection was the primary driver of returns with 12 different investments generating in excess of +100 basis points of attribution. As we look toward 2017, we have no intention of increasing the fund’s risk profile or making any changes to the investment process.
2. Fund Closure Expected in 2017: Vantage’s assets under management (AUM) grew significantly last year. We entered 2016 with $115 million in AUM and are currently sitting at $240 million, up $125 million over the 12?month period. The increase in AUM was driven by a combination of the fund’s organic return and subscriptions from new and existing investors. Importantly, we are committed to ensuring AUM remains appropriately sized relative to Vantage’s investment opportunities. Historically, our market cap “sweet spot” has been companies in the $500 million to $3.0 billion range – which means we need to be disciplined regarding the ultimate size of the fund given the liquidity considerations associated with this segment of the market. As a result, we intend to soft close the fund to new investors once AUM exceeds $350 million. For those investors not familiar with the term soft close, it means the fund will only be available to existing investors from that point onward. Given the fund added $125 million in AUM over the past year, the current pace of growth implies the investment strategy will be closed to external investors in Q4 of 2017.
A number of core investments generated positive attribution in December with four different positions contributing +50 basis points to performance. A brief commentary on some of the larger contributors is provided below:
Mettrum Health (TSXV: MT): Mettrum was the fund’s largest investment when the company was acquired on December 1st by Canopy Growth (TSX:CGC). In October, Vantage became actively engaged in a formal process with Mettrum’s board regarding the company’s strategic position within Canada’s medical cannabis industry. As the company’s largest investor, we secured support from 19% of their shareholders – positioning Vantage to play an instrumental role in applying “firm but friendly” influence over Mettrum’s decision to consider strategic alternatives. The senior management team and board deserve credit for creating significant shareholder value over the past three years and for the leadership they showed by engaging in strategic discussions to sell the company. We applaud the board for their responsiveness and initiative – particularly Michael Haines (CEO) and Don Wright (Chairman). In aggregate, Mettrum contributed +110 basis points in December and was the fund’s #1 driver of performance in 2016.
Boralex Inc. (TSX: BLX): Boralex was another key driver of attribution in December. The company owns and operates power generating assets in Canada, the northeastern United States and France. Most of the assets operate under long?term contracts with an average life of ~16 years – providing Boralex (and investors) excellent cash flow visibility. During the research process we met with Boralex’s CEO (Patrick Lemaire) and CFO (Jean?Francois Thibodeau) and engaged in numerous discussions with the management team. We were impressed with Patrick and Jean?Francois’ commitment to creating shareholder value and their prudent approach to pursuing new growth opportunities. On December 8th, we added Boralex to the portfolio when the company announced a strategic acquisition and equity financing – an event which presented an opportunity to buy a larger and more diversified company at a 3% discount to the previous valuation.
The December 8th acquisition was a binding agreement to acquire 100% of the 230 megawatt Niagara Region Wind Farm (NRWF) from Enercon. The purchase price was $238 million and included 77 Enercon turbines which provide power under a 20?year Power Purchase Agreement (PPA) to the Ontario Independent Electricity System Operator (Ontario IESO). The acquisition increased Boralex’s power generating capacity by ~21% and the deal was +10% accretive to the company’s free cash flow per share – after adjusting for the increased share count. The company recently increased its 2020 contracted capacity target from 1,650 megawatts to 2,000 megawatts – reflecting confidence in the company’s pipeline beyond the recent addition of the Niagara Region Wind Farm.
Looking beyond the recent transaction, we expect Boralex to execute on a number of growth opportunities in the coming years. Larger competitors in the power market are often inclined to pass on smaller projects which cannot add sufficient economics to an already large production footprint. However, these smaller projects can be material for a $1.5 billion market cap like Boralex. The company already has a strong and expanding footprint in France’s alternative energy market with a visible development pipeline. Additional growth opportunities beyond France exist in Denmark, Scotland and Canada – particularly in Alberta given the recently issued 400 megawatt renewable power RFP and the province’s commitment to increase its overall alternative energy production. With Boralex’s stock trading at 11x 2017 EBITDA with a 6.5% free cash flow yield and 50% payout ratio, we believe the company is attractively priced. As managers who prefer investments which offer “multiple ways to win”, we would not be surprised if Boralex was eventually acquired at a sizeable premium. In the current interest rate environment, there are many market participants and strategic investors clamouring for long?term secure cash flow generating businesses.
* * * * * * * *
Included below is additional information regarding the fund’s exposures, beta, ideas and liquidity at December 31st:
- Portfolio Exposures: The portfolio was 36% net long and 148% gross at the end of December. The net and gross exposure was comprised of 92% long vs. 56% short. For context, the fund’s historical averages have been 32% net long and 136% gross.
- Portfolio Beta: The portfolio’s beta averaged 0.12 in December, modestly below the historical average since we began actively monitoring beta in early 2013.
- Number of Investments: The portfolio entered December with 25 investments (longs + shorts) and exited the month with 25. This is in line with the historical average.
- Cash Position & Liquidity: The portfolio was holding 8% net cash entering January and ~83% of the portfolio could be liquidated to cash within 10 days based on 15% of the average daily trading volume (90?day trailing). We are comfortable with the fund’s liquidity profile and remind investors that Vantage only holds publicly?listed securities. Private company investments are not permissible under the Offering Memorandum.
As always, thank you for your continued support and confidence. 2016 was a productive year for the fund, but Vantage’s team is focused on delivering another successful year in 2017.
We look forward to updating you next month.
Vantage Protected Performance Fund See the full PDF below.