DECEMBER 2017

CAPITAL INVESTMENT FUND

  • +0.04% (Class A)
  • +0.13% (Class F)

OPPORTUNITIES FUND

  • +0.08% (Class A)
  • +0.16% (Class F)

CRYPTOCURRENCY FUND

  • +40.54% (Class A)
  • +40.66% (Class F)

Capital Investment Fund

RSIF units were flat in the month of December and declined -1.5% for 2017.  Trailing annual volatility for the Investment Fund was 1.7% and its correlation to the S&P/TSX Composite Index was -0.9.  


The Investment Fund made 2 new investments during the month, including 1 structured product arbitrage and 1 volatility arbitrage investment, while exiting 11 investments.  At the end of the year, we were monitoring 111 redeemable structured products with total market value of $8.7bn ($78mm average size).  The Investment Fund ended the year with 26 structured product investments.


Gross exposure (long + shorts) of RSIF was 179% as at year end, with approximately 35% of the portfolio invested in the structured products arbitrage strategy, 23% in multifactor, 21% in relative value and 21% in volatility arbitrage.


The structured product arbitrage strategy gained 0.5% in December and the volatility arbitrage strategy gained 0.3%.  The relative value and multifactor both declined -0.3%.  


Typically, RSIF thrives off high volatility and historically, its best relative performance has occurred in bear markets.  Throughout 2017, markets did not suffer from even the mildest of drawdowns and the VIX averaged 11, which is near record low volatility.  Any potential future increase in volatility and reversal of the growth over value outperformance would bode well for future performance of RSIF.       

Opportunities Fund

RSOF units gained 0.08% in the month of December and declined -1.5% for 2017.  Trailing annual volatility for the Opportunities Fund was 6.4% and its correlation to the S&P/TSX Composite Index was 0.07.  


The Opportunities Fund made 8 new investments during the month, all of which were merger arbitrage allocations.  At the end of the year, we were monitoring 105 risk arbitrage situations globally with total market value of over $1.02 trillion.


Gross exposure (long + shorts) of RSOF was 131% at year end with 58% invested in Canada and the remainder invested in the US.  44% of the portfolio was allocated to the merger strategy, 35% to special situations, 11% to relative value, 6% to liquidations and 4% to high yield.
December Fund performance was driven by the special situations portfolio with a 0.7% return, followed by the high yield debt strategy, which added 0.2%.  The merger, liquidation and relative value strategies declined -0.5%,  -0.3% and -0.1%, respectively.


The Fund’s best performing strategy in 2017 was the merger arbitrage portfolio, which contributed 6.2% to the Fund’s annual return. We were able to generate significant alpha in the merger arbitrage market, while only allocating around one-half of our portfolio to the strategy.  Unfortunately, this outperformance was offset by a decline in the special situations portfolio, led by spin-offs, sum of parts discounts and share repurchasers that underperformed.  Not to suffer from thesis drift, we have divested underperforming special situations securities from our portfolios and de-emphasized the strategy on a go-forward basis. As the evidence mounts, it appears that the days of spin-off outperformance are behind us.  


Our favorite merger securities are those whose peer set multiples have expanded over the deal cycle, especially if certain deal-related turbulence has held back the merger security’s market performance.  We have seen this effect in two of the Fund’s current merger securities with perceived market risks, being Time Warner and Cannimed Therapeutics.  While the market has been overly focused on deal-related noise (in the case of Time Warner, a questionable anti-trust case, and in the case of Cannimed, an outstanding hostile bid with a novel capped consideration mechanism), the market has missed the fact that these companies’ peers have had large share price rallies, lifting their valuation multiples.  This has had the effect of reducing the merger securities’ downside deal-break prices, which in turn improves the risk / return profile of a merger arbitrage investment.  These asymmetric risk / reward opportunities are the ideal investments for the Fund.

Cryptocurrency Investment Fund

RSCF units gained 40.5% for the month of December and 203.3% for the year.  As at year end, the Cryptocurrency Fund holds 98.93% bitcoin and 1.07% bitcoin gold.


We continue our effort to invest in a diversified basket of crypto assets.  While we maintain the view that most ICOs and altcoins are of dubious value, we have a keen interest in coins with value-added use cases, such as ethereum (smart contracts), bitcoin cash (low-cost transactions) and monero (enhanced privacy).  The ability of RSCF to hold additional crypto assets requires regulatory approval from the securities commission and we have been working tirelessly on attainting the necessary approvals for this growth initiative for many months.

Outlook

It was a mixed bag of results for RSAM funds in 2017.  The Cryptocurrency Fund outperformed our expectations by a long shot by rising over 203%, making it a top performing fund in the country.  While the Opportunities Fund and Investment Fund were both up slightly on a gross basis, both hedge funds fell on a net basis, which was disappointing. It is our goal to provide positive absolute returns with low volatility in our hedge funds, and unfortunately our hedged strategies underperformed our expectations in 2017.


Global markets are in the midst of a “market melt-up” as stock market indices continue to grind higher and higher on a daily basis with low volatility and a lack of material draw-downs.  While top-decile market index valuations are concerning, they have little effect on our investment process as we focus solely on mispriced securities and asset classes.  All of our funds have exhibited low correlation to the market indices and we expect this to continue on a go-forward basis, given our vastly differentiated investment approach.  In early 2018, the clear consensus trade is to be long the stock market irrespective of record valuations. And this will continue, until it doesn’t of course. While portfolio hedging has appeared to be ill-advised over the past number of years, it’ll prove to be evidence of prudent stewardship of capital once the market melt-up ends. 


Cryptocurrencies, once considered a fringe asset for libertarians and cryptographers, are now beginning to become accepted as a legitimate asset class.  Early signs of this legitimization include the advent of bitcoin futures contracts traded on the CBOE and CME.  In addition, there have been over a dozen filings to bring a bitcoin ETF to the market.  Every day crypto assets gain credibility and this momentum is snowballing.  As each drawdown is met with future new highs, more market participants become less skeptical and begin allocating capital to the asset class.  As the size of the networks utilizing crypto grows, the network values grow.  We believe that it is only a matter of time until a large pension fund or central bank begins purchasing cryptocurrency, and by that time, the price is likely to be significantly higher. 


Our modus operandi continues to be to bring differentiated investment strategies with attractive risk / reward characteristics to our clients.  We continue to be bullish on our current suite of investment strategies and look forward to updating you on our new initiatives. 

Julian Klymochko, CFA 

Trout Taylor