June 2018 – Commentary & Outlook

Sell in May?

Despite the old adage “sell in May and go away”, North American markets continue to climb a wall of worry with technology leading the charge.

Market volatility remains a consideration as headlines on trade, interest rates and political unrest and instability in Europe cause short-term swings.

These short-term swings have been an opportunity for us to capitalize on more expensive options premiums and to position our funds in companies we want to own trading at prices that we would consider to be a discount based on the underlying fundamentals. This approach of creating new positions on the lows and harvesting profits as stocks near short term highs has so far been productive for our portfolios.

Fund Performance

TCG 531 Equity Growth

May was a strong month for our Equity Growth fund putting in a positive return of 2.67% which was a little under the TSX Total Return bench mark. However, the year to date return comes in at 4.54%, well above the benchmark which sits at 0.25%.

When asked about how market conditions influenced the Equity growth fund, lead manager Alex Brandolini, confirms that market volatility during the month was inconsistent with underlying economic fundamentals. Market pullbacks in a strong economic environment normally indicate a buying opportunity. As such, one notable trade executed was a bullish put credit spread on SPY based on technical indicators suggesting the ETF that tracks the S&P 500 was oversold and ready for a bounce. This strategy generates cash flow as the ETF moves higher but has another option position built in as a hedge. The objective was to enhance the funds returns, but in a risk-managed way.
Alex added that with the market cycle continuing to mature, it was also decided to shift the funds exposure to companies with higher profitability and strong balance sheets. An example of our continued active management was the sale of our Disney position as the shares moved higher on the heels of its studio success, with the funds being allocated to the purchase of shares of Canadian Tire.  Alex notes that both companies operate in the consumer discretionary sector and share similar characteristics of high return on equity, low leverage and low earnings variability.

In general, and in line with the firms overall positioning, the fund remained overweight in the tech sector while trimming positions which had moved higher to harvest profits.

 TCG 534 Income

The Income Share class closed the month of May with a gain of 2.12% beating the Real-World Income Index benchmark which came in at 1.59%.  This brings the year to date return to 1.52% compared to the benchmark at 0.08%.

Consistent with our expectations and our overall approach, lead manager Mark McAdam notes that we continued to put cash in the Income fund to work on market pullbacks. We have been actively using a put writing strategy to take positions in companies that have been on our radar.

This approach was most recently used in May to take positions in BLK, MMC and STX at depressed prices while capitalizing on the high implied volatility of the options market. This strategy generates cash flow for the fund and lowers the cost basis of the shares as we take positions in the underlying stock.

In addition, part of an ongoing hedging strategy has been the purchase of put options on the S&P 500 ETF SPY as it approached short term highs.  Puts increase in value as the underlying security sells of and as implied volatility increases.  This helps offset some of the risk to the fund’s holdings associated with a broader market decline. This position was closed out profitably on a market pullback driven by headlines around Italy. A new position was reestablished as the S&P 500 approached it’s recent high.

The fund continues to be overweight equities with a covered call strategy overlay.  This is another approach used to generate cash flow as option premiums are attractive due to day to day volatility.

TCG 539 Option Writing Fund

The Option Writing Fund is managed to produce above- average cashflow through the selling of option contracts. Both bullish and bearish strategies may be deployed depending on market conditions

Not to be outdone, The Option Writing Share Class added 3.18%, ahead of its benchmark, the MX Covered Call Writers Index at 0.48%.

Year-to-date, the fund sits at 1.09% ahead of its benchmark which remains negative 0.14% for the year. To help offset some of the market volatility at the time, lead manager Richard Croft had been focused on selling longer dated options back in February to capitalize on the significant increase in implied volatility and to bring in more upfront cash.

With Option premiums having contracted in recent, Richard has been taking shorter term positions in the portfolio, especially in weekly close-to-the-money options. The typical approach as of late has been to sell close-to-the-money put options (options with strike prices close to where the stock is trading) and, if assigned to buy the stock, a one-week close-to-the-money covered call written on the purchased shares. This active strategy has been working well under current market conditions in helping to achieve the funds objective which is optimal cash flow.

Regarding sector concentration, for the past month the fund has been overweight in the tech sector mainly the FAANG stocks. The premiums are good, the option market is liquid, and the sector has been on firm ground as of late. The fund is underweighted the banks but may move back into that sector as the latest rate hike works its way through the economy.

Expectations

Our general market expectations remain intact for the month of June.  Headlines continue to drive short-term market volatility, but this is seen more as an opportunity based on underlying fundamentals.  We will continue to build in hedges to offset a portion of the market risk.  We feel increasing interest rates are already factored in as a headwind to the markets and, overall, the economy is doing well. The wild card has been the imposition of tariffs and the risk of a trade war,  which has had the markets on it’s heels. The challenge is no one really knows how far this will go and how significant the impact may be. It is possible that this is another Trump bargaining tactic and we don’t believe that this will escalate to significant levels. That said, we will continue evaluate and adjust as market conditions change.