We Apply A Private Equity Mindset To The Public Markets
As of September 30, 2019. Please note all returns are net of fees and expenses. Past performance does not indicate future performance.
RETURNS SINCE INCEPTION (CAD) AND PERFORMANCE SUMMARY*
This letter does not constitute an offer to sell or the solicitation of an offer to buy any interest in the Ewing Morris Small Cap Strategy. Such an offer may only be made by way of a definitive subscription agreement and are only available to investors who meet legal requirements for investor suitability and sophistication. The index returns above are provided for information only and comparisons to benchmark indices have limitations. The S&P/TSX Small Cap Index and the Russell 2000 Index are widely known equity indexes of Canadian and U.S. small-cap companies respectively. Investing in small cap Canadian and U.S. equities is the primary strategy for the Small Cap Strategy, but the strategy does not invest in all or necessarily any of the securities that compose the indices or the market indices. Reference to the indices does not imply that the Small Cap strategy will achieve similar returns. This information is provided for information purposes only and has inherent limitations. The Canadian Small Cap Mandate may not invest in all, or necessarily any, of the securities held by the other funds included in this research report, and the portfolio may differ significantly as the fund may hold a large proportion of U.S. listed equities as well. Benchmark source: Capital IQ. While all information prepared in this report is believed to be accurate, Ewing Morris & Co. Investment Partners Ltd. makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors, appearing in the report. This report is not intended for public use or distribution. Past performance does not guarantee future results. Returns may vary. Returns are unaudited.
We employ what we describe as an “Enterprising Approach”. We believe that there are multiple mental frameworks that, over time, can produce attractive absolute returns. Our process is to apply the appropriate framework demanded by the circumstance to maximize the return on a given investment idea. Dogmatic adherence to a single mental framework is not a value maximizing strategy. Instead, we restrict ourselves to investing in businesses that we can understand and where we can clearly formulate a thesis for attractive returns.
We don’t believe that popular descriptive statistics such as volatility or beta, are good representations of investment risk. Instead, we describe risk as the possibility of not meeting our minimum acceptable return hurdle over time. In today’s interest rate environment, we consider equity returns in the low-teens as the “minimum acceptable” threshold. More generally, we aim to grow the purchasing power of capital under our management over time. Safety of principal is the fundamental component to achieving our return objectives.
We believe that professional investment managers should be paid to add value and not gather assets. To that end, we have designed the incentives in our Long-Only Small Cap strategy to reinforce focus on performance. These incentives include an ETF-like management fee and a performance allocation reflective of the value we deliver relative to our partners’ opportunity cost.
We leave the choice of the benchmark that represents the opportunity cost of our partners capital to our clients. Too often the benchmark used to evaluate managers’ performance becomes her/his number one source of investment ideas as she/he starts to view any deviation from the benchmark as a risk factor. Our approach is different, we believe that over the long-term, if we can find investment ideas that will compound capital in the teens, we will outperform any reasonable benchmark for a North American mandate. As our approach usually translates to sizable active share, our investors should understand that over any time-period the performance of the fund can substantially deviate from that of the broader markets.
As a demonstration of our commitment to the long-term success of our investment strategy, we have put in place explicit restrictions on the amount of capital that we will accept in our investment strategy.
The goal of the partnership is to earn 5-8% annualized net returns, over a reasonable timeframe, while controlling volatility and minimizing the risk of permanent loss. We define a reasonable timeframe as five years, which translates into a cumulative return in the range of 30-40%. We think our goal of achieving stable, 5-8% net returns compares favorably to our two principal benchmarks – the iShares Canadian Investment Grade Corporate Bond Index ETF and the iShares US High Yield Bond Index (C$-hedged) ETF. These two benchmarks reflect well-known and accessible fixed income alternatives which can be regarded as our Limited Partners’ fixed income opportunity cost.
*Returns reflect Class P – Master Series. **Hedged to CAD.***Sharpe Ratio is a hypothetical measure of excess return. The Canada 3 month treasury bill rate as of September 30, 2019 as the risk-free rate of return in calculating Sharpe Ratio
MONTHLY NET RETURNS (%)*
This letter does not constitute an offer to sell or the solicitation of an offer to buy any interest in the Ewing Morris Flexible Fixed Income Fund LP. Such an offer to sell or solicitation of an offer to buy interests may only be made by way of a definitive subscription agreement and is only available to investors who meet legal requirements for investor suitability and sophistication. The Fund has a flexible investment mandate. Therefore, the Fund’s composition is materially different to major indices. We have listed the iShares U.S. High Yield Bond Index ETF and iShares Canada Corporate Bond Index ETF because they are representative of widely known and followed fixed income benchmarks. These benchmark indices are provided for information only and comparisons to benchmarks and indices have limitations. Investing in fixed income securities is the primary strategy for the Fund, however the Fund does not invest in all, or necessarily any, of the securities that compose the referenced benchmark indices, and the Fund’s portfolio may contain, among other things, options, short positions and other securities, concentrated levels of securities and may employ leverage not found in these indices. As a result, no market indices are directly comparable to the results of the Fund. While information prepared in this report is believed to be accurate, Ewing Morris & Co. Investment Partners Ltd. makes no warranty as to the completeness or accuracy nor can it accept responsibility for errors in the report. This report is not intended for public use or distribution. Past performance does not guarantee future results. The Sharpe Ratio is a form of hypothetical performance data. Unlike an actual performance record, simulated results do not represent actual performance and are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk. There are frequently differences between simulated performance results and the actual results subsequently achieved by the fund.
In the Flexible Fixed Income Fund, we believe that there are multiple mental frameworks that can produce attractive risk-adjusted returns. We have created an ‘Investment Playbook’ framework which articulates specific models of thinking used to evaluate fixed income investments. Our process is centered on evaluating individual investment opportunities using appropriate models of thinking demanded by the circumstance. Proper evaluation should enable us to identify investments that have low chance of permanent loss which also offer attractive absolute returns. Dogmatic adherence to a single mental framework is not a value maximizing strategy. Instead, we restrict ourselves to investing in businesses and capital structures that we can understand and where we can clearly formulate a thesis for attractive returns.
A critical part of our goal is to minimize the risk of permanent loss (what we consider to be true investment risk) and control volatility. We would posit that “permanent loss” also be considered “permanent loss of purchasing power,” a concept that takes into account the impact of inflation on capital. At current rates of inflation, one dollar today needs to grow by about 2% on an after-tax basis to avoid loss of purchasing power. From this perspective, it can be understood that long term allocations to cash effectively ensures permanent loss. Even at today’s low rates of inflation, a 5-year holding period would result in an approximate 10% impairment on cash relative to the future cost of living. Our view is that higher yielding fixed income investments are one of the few conservative means of minimizing loss of purchasing power while maintaining a liquid investment profile.
The Partners Fund allocates dynamically to each of our strategies with an average weighting of 60% Ewing Morris Opportunities Fund LP, 10% Broadview Dark Horse LP and 30% Ewing Morris Flexible Fixed Income Fund LP, over time. The Fund may invest in other funds or underlying securities from time to time, that complement these strategies. We may adjust the allocation to each of the funds as market conditions change and opportunities arise.
We describe our investment strategy using the analogy of a sport’s playbook. A team with only one play can often be stopped but a championship team will have perfected multiple plays so that they can score and defend regardless of the opposition’s strategy. In our Partners Fund, we classify each investment according to three plays:
The Offensive Playbook involves investing in units of the Ewing Morris Opportunities Fund LP which applies a private equity mindset to public company investing. The Opportunities Fund LP employs a long-term investment orientation and invests in a concentrated portfolio focusing on inefficient areas of the public markets. The Fund is geared towards capital preservation and targets a net return to LPs of 10% per annum over time, with lower volatility than the broad-based North American equity markets.
The Defensive Playbook is designed to preserve capital for investors through all market environments, particularly during periods of rising interest rates. This is achieved by investing into the Ewing Morris Flexible Fixed Income Fund LP, which has historically had lower volatility and low correlation with general markets and targets 5-8% net returns per annum over time.
The Neutral Zone Playbook is accessed via the Broadview Dark Horse LP, a low net exposure North American long-short fund focused on small cap companies. The strategy is capital structure agnostic and seeks “equity-like” returns. The investment approach is to look for structural, nuanced or temporal inefficiencies, conduct deep research and pursue company involvement as a back-up plan. Investment opportunities are reviewed through a private market value lens.
We view risk as the chance of permanent capital loss and believe that volatility represents a source of opportunity. We invest when security prices are trading at a significant discount to our estimate of true value. This is designed to provide a margin of safety to protect capital against unexpected events such as economic crises, natural disasters, political events and new technologies. Our goal is to protect and grow our clients’ purchasing power over time.