CBF Commentary – May & June 2016

Caldwell Balanced Fund Update June 2016

Portfolio Additions

Tricon Capital Group

About the Company: Tricon is an asset management firm focused on residential real estate. It currently manages $2.7B in assets with 90% of assets currently invested in the U.S., focused on the sun-belt states. The company has 4 business units that cover different areas of residential real estate: 1) they buy, develop and resell land to home builders; 2) they have a portfolio of single family houses that they rent, effectively institutionalizing the traditional ‘ma & pa’ home rental market; 3) they lease lots in manufactured housing communities; 4) they are developing luxury multi-family rentals. The different business units form a relatively unique structure versus a traditional reit. This includes the use of 3rd party capital ($1.2B of the $2.7B), and that Tricon ultimately looks to monetize its investments and recycle capital into better opportunities across the residential real estate space.

Investment Thesis: The stock has materially underperformed the market and its peer group since August 2015. The reasons for the under-performance (a failed spinoff of its land development business and the calling of a convertible debenture that created a sudden supply of shares) seem temporary and we therefore view this as an attractive entry point. The stock is trading at a significant discount to its net asset value (NAV); we believe the estimates underlying NAV are conservative and the discount does not reflect the growth opportunity across Tricon’s portfolio. As Tricon announces further investments and grows its portfolio, and the temporary affects of the failed IPO and conversion subside, we believe the shares re-rate higher.

CGI Group

About the Company: CGI Group provides consulting and technology implementation and outsourcing services to various different businesses. They compete with Cognizant (CTSH) and Accenture (ACN), two of the portfolio’s holdings.

Investment Thesis: We began to rotate out of ACN and into CGI Group. The trade will allow us to: 1) remain exposed to what we believe is a long term, secular trend of companies, across all industries around the world, using technology to transform every aspect of how they do business; 2) capture the relative discount in valuation – ACN has performed very strongly for our clients and now trades at a sizable premium to its peers, including CGI Group and Cognizant. By selling ACN, we are able to realize that premium and rotate into a more attractively valued name; 3) open up room to add another US name – CGI Group trades in Canada while ACN trades in the US. By shifting from US to Canada, we open up room to add another US name [see next month’s note] without increasing our currency exposure. CGI Group is a strong business with mid teens return on equity. Sixty percent of revenue is recurring in nature which provides stability during recessions. The stock offers a mid single digit free cash flow yield with opportunity to grow, driven by the secular trend noted above.

Market Commentary

What about Brexit?

A key driver of the market this year has been expectations for when, and how aggressively, the U.S. central bank (the Fed) will raise interest rates. The reason this is important is because interest rates serve as the baseline off of which all other assets are priced. Since macro (i.e. not company specific) factors are what shape central bank policies, markets tend to pay attention to, and respond to these events. This is especially true ever since The Fed adjusted its decision making process last year to include factors beyond its U.S. border.

Enter Brexit. While the market’s initial reaction to the June 23rd vote was to sell off, the U.S. market quickly reversed course and has subsequently gone on to reach new highs. It seems that the uncertainty created by the UK’s decision to leave the European Union has put a nail in the ‘2016 Fed rate hike’ coffin, meaning that interest rates are likely to remain low and accommodate higher asset prices. [If this all sounds a bit crazy, we would not disagree. We are certainly looking forward to the next several weeks as the market shifts focus back to companies as they report their 2nd quarter earnings.]

Forest from the Trees

Our job as professional investors is to identify the noise, see the forest from the trees, etc. When events create uncertainty and markets introduce negative emotion, which is often amplified by constant media attention, it is important to know your investment thesis – why am I invested the way I am? During the chaos of Brexit, we were able to fall back on our long-standing investment thesis: we think it is currently more attractive to own a company that creates value over time, generates a mid-single digit cash flow yield, and has the opportunity to grow that cash flow than to own bonds or cash. This gave us the confidence to buy into the weakness created by Brexit as we purchased some stocks for which we had been looking for an entry point.

What can individual investors learn from Brexit? First, we are by no means saying that this is all the world has seen of Brexit – this is going to be a long, drawn out process. However, we do think that the market is increasingly susceptible to this type of volatility and that this latest episode offers all investors the opportunity to improve the likelihood of successful investment outcomes going forward. Remember, while there is a high level of sophistication behind our investment process, which is continually improving and evolving, individual investors are the ones that make the decisions with the greatest impact on their investment outcomes: when to be invested and with whom to be invested. Here are some things we believe will help investors improve their outcomes:

1) We have observed a strong correlation between frequency of monitoring and anxiety levels. The more often an investor checks his or her account, the higher his or her level of anxiety when markets sell off. The heightened emotion increases the probability the investor will make a rash (and often bad) decision.

2) It is very hard to ‘time’ the market. If an event like Brexit fails to derail the market, how can one tell what will? There is not a single seasoned and successful manager I have heard of, or read about, whose strategy involved timing the market.

3) Know your investment thesis – why am I invested the way I am? This will provide muchneeded confidence during market sell offs. Your investment thesis includes the plan you created with your advisor and an understanding of what the manager’s investment strategy is. [Through these letters, you have good insight into our investment thesis and strategy. Can you say the same for other managers you may be working with?]

We appreciate your continued support.

Best Regards,
Portfolio Management Team