Decade of Daddy Mirror Fund goes to cash

It has been more than seven years, and the strategy of the Decade of Daddy Mirror Fund has served us very well (see prior post “Decade of Daddy Mirror Fund Q4 Report” Jan. 16-14). Starting with $40 million of play money on July 1, 2008, the fund has more than doubled to date. That’s right: a gain of 100%. Unlike the original O’Leary Global Equity Income Fund, which has generated a return of barely more than 4% since inception (including its successor funds the O’Leary Global Equity Yield Fund and the O’Leary Global Dividend Fund). That’s not an annual return figure — that’s the entire gain, including distributions.

The Yahoo Finance account I used began making errors in the cash balances starting around March, and I’ve been unable to accurately track dividends and cash levels ever since. That’s why I’ve not done updates for the first, second or third quarters of 2014. The Mirror Fund’s positions have done just fine, mind you, just the same.

As of the last trade, here’s where they stood:

Berkshire Hathaway (+48%), BCE (+37%), BMO (+44%), BNS (+38%), Bristol Myers (+122%), Constellation Software (+126%), Goldman Sachs 2037 Subdebt (+67%), Duke Energy (+46%), JP Morgan (+40%), Merck (+60%), Royal Bank (+42%), Spectra Energy (+67%), TD Bank (+48%), Thomson Reuters (+11%).

As I reported in February, we exited our two Venezuelan bond positions when things looked tough there. The BOLIVARIAN REPUBLIC VENEZUELA AMORTIZING BD REG S 2022-08-23 12.7500% went out for US$81, while the PETROLEOS DE VENEZU NOTE 2014-10-28 4.9000% realized US$89 — including accrued interest. In the end, we earned 5.6% on the face value of the Republic one ($95k), and 50.5% on the Petroleos version ($859k).

Since the fund began we’ve locked in our gains on BMO ($775k and $1.133MM but we are back in again), BNS ($136k but are back in again), CIBC ($242k plus dividends), JP Morgan ($1MM but are back in again), Merrill Lynch ($799k), MKS ($3.19MM plus dividends), Royal Bank ($566k but are back in again) and Teranet ($307k plus distributions) as you’ve read in prior reports. We’ve also realized losses on Canadian Oilsands, Discovery Air bonds and Eli Lilly.

We hold nothing in the portfolio that’s currently in the red column. Not that I see a 50% sell-off over the coming weeks and months, but since I went to 50% cash in my own RRSP on Oct. 3rd., I figured that I should take the ultimate step with our Daddy funds.

After all, as KO reminds us, money is the “only thing” that matters. And if you don’t have it, you can’t spend it.

Having never made such a move on the personal side during 2007 or 2008, I’m not sure what you should take from it. The Decade of Daddy Mirror Fund definitely traded during that time (sold one Canadian bank in the high $40s and bought back at $30), but I didn’t lift a finger on the personal side; never got scared, even as we blogged away about the Armageddon that was underway. Rode it right down and then right back up again.

The futures are up this morning, and I remember some nice market tops (ie. head fakes) in April and August 2008. too. It’s not just economic challenges in Europe, the inexplicable drop in oil prices, or the potential black swan represented by Ebola; it’s all of the above, demonstrated by the pounding 250-300 point down days that usually foreshadow a tough time.

MRM
(disclosure: this post, like all blogs is an Opinion Piece; it is not meant to represent investment advice and should not be taken as such)

 
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How did experimental Canadian Ebola vaccine wind up in Iowa?

News report: Canadian Ebola vaccine to be shipped to Geneva next week

Along with the rest of our planet, I dearly hope that the researchers at Winnipeg’s National Microbiology Laboratory have discovered the 21st century’s version of Major Sir Frederick Banting, MC’s insulin discovery (and then some).

What will come as a surprise, perhaps, is the news that the Public Health Agency of Canada has exclusively licenced the intellectual property, and not to a Canadian biotech firm. As reported by The Globe and Mail:

Canada holds the intellectual property rights to the vaccine but has licensed the rights to a small American biotech company, NewLink Genetics. Based in Ames, Iowa, the company’s primary focus — until recently — has been the development of cancer vaccines. It does not have its own vaccine production facility and has never brought a product through the expensive and onerous process of gaining regulatory approval.

But because it holds the licence to one of a very few experimental Ebola vaccines — and one of only two ready for human safety trials — NewLink has found itself at the centre of a storm.

While the company has been getting assistance from a U.S. government agency — the Biomedical Advanced Research and Development Authority, or BARDA — frustrated scientists and others have questioned whether the company has the resources, finances and clout to push the vaccine forward.

NewLink Genetics (NLNK:Q) listed on the NASDAQ three years ago on the back of work its researchers had done to use immunotherapies to treat cancer. Like most early stage biotechs, the company is still looking for meaningful revenue from that research. To date, NewLink has burned more than US$150 million, and had cash on hand of about US$78 million as of Q2 (or 8 quarters of cash at current burn rates).

For the past few years, the Conservative government has tried to stimulate Canada’s innovation economy in a variety of ways. You’ve read about them here (see representative prior post “Feds on right path with Innovation ecosystem consultations” July 2-12). Direct investments, fund investments, commercial offset programs, policy directives and so forth. It took the CVCA a few years of effort (see prior post “CVCA letters to Messers Flaherty, Clement and Ignatief” Dec. 26-08), but we are now in a better place.

How is it possible, then, that not a single Canadian biotech company is involved in what could be the most important clinical trial of this generation?

Billions of tax dollars are spent annually in Canada on research and development. Much of it within university campuses and in federal medical labs. For reasons that I’ve never understood, little of this R&D is ever successfully commercialized. This commercialization step is a core ingredient for a thriving angel and venture capital ecosystem, as traction on that front eventually leads to outsized financial gains for institutional investors (which in turn fund Canadian pensions and retirement funds). Which allow VCs to raise another fund, and start all over again with a new group of researchers and entrepreneurs.

Our poor record of commercialization has always been an element of why Canada’s VC industry punches below its weight as compared to our American or Israeli counterparts. And yet, when one of the greatest potential discoveries comes along, a firm in Iowa, with no reported experience in bringing a drug to market, is given the chance to harvest the fruits of Canadian research labours. What’s the point of having an Economic Action Plan geared to the sector, if this kind of thing can happen? It would have made sense if NewLink had the bonafides to bring this product to market faster than anyone else in the world; humanity’s needs trump all. But, according to the Globe, that doesn’t appear to be the case.

And an exclusive licence? What were they thinking?

Hopefully, someone in Winnipeg has a clear answer as to how that happened; not that a “clear answer” will help soothe anyone in the Canadian biotech industry. But it might give us a window into what’s broken in the research/commercialization world, and a sense of how to fix it once and for all.

MRM

 
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CPPIB draws more critical attention, but to what end?

I hate to be the one to break it to the very influential pairing of The Fraser Institute and Andrew Coyne, but they are wasting their time on the CPP Investment Board. As someone who has been blogging about the agency’s activities since July 2007, at some personal cost, I dearly understand why the topic gets their attention. It is our $200+ billion, after all.

After years of playful prodding (see prior representative post “Why so uninquisitive about the CPP Investment Board, ROBers?” Mar. 3-13), the mainstream media’s critical interest in CPP’s performance and inner workings finally came to a head thanks to Tim Kiladze last summer. Over the past month, the CPPIB has drawn further high profile criticism; and not from the Left. The Fraser Institute released a well-researched report pointing out that the relative cost of managing CPPIB has grown dramatically over the past decade. As I wrote over 18 months ago, the CPPIB’s management expense ratio is out of line with other large Canadian pension plans (see prior post “Why is CPPIB’s MER higher than its peers?” Jan. 9-13):

Last time I checked (see prior post “Does Ontario really need five Pension Plans?” Nov 24-11), Ontario Teachers’ MER was a modest 0.20%-0.21%, and the HOOPP was getting by with 0.18%-0.22% of their gross assets under management. On a gross asset basis, CPPIB’s MER drops to about 0.25% from 0.28%, which means it still would cost the CPPIB $60-70 million more internally than the Teachers to manage the same asset pool.

The new Fraser Report includes all of CPPIB’s external management fees in its analysis, along with the federal government costs of collecting the payroll tax. I never went so far as to include Ottawa’s piece of the equation, but I understand The Fraser’s position:

The CPPIB needs to be more transparent about the expense of designing and implementing its investment strategy; every dollar spent on behalf of the CPP is one less dollar available to beneficiaries. As well, a full accounting of all CPP costs, including those incurred by the Government of Canada, is necessary.

On the transparency front, I sympathize with The Fraser team. After my years of back-and-forth with the CPPIB Board and management, one can only conclude that true transparency isn’t the goal. If it were, CPPIB would follow the steps taken by such pension plans as Oregon, WSIB, CalSTRS, CalPERS and so forth to mirror their clarity around IRRs within the CPP $35 billion externally-managed private equity allocation (see prior post “CPPIB’s new website fails to improve opaque disclosure” Aug. 8-13). Nor would the agency have an unpublished “Broadcast Policy” that apparently shields its managers from appearing on Canada’s Business News Network when tough questions arise (see prior post “12 questions CPP Investment Board won’t be answering on BNN today” Jan. 17-13).

For Mr. Coyne, he is also focused on the cost of managing our money, with a particular affinity for CPPIB’s executive compensation and its relationship with CPP’s performance:

More striking still has been the growth in compensation for senior managers: from $220,000, on average, in 2000, to $1.56-million in 2007, to $3.3-million in 2014.

Has this extraordinary executive bounty been associated with a similar increase in returns to the fund? Hardly. Even looking at the simple rate of return (net of costs), the fund earned slightly less on average after 2007 than before.

Maybe the fund’s bet on private equity, and the high-priced investment talent that goes with it, will pay off. As the board likes to explain, interminably (another measure of bloat: the CPPIB’s annual reports are now five times longer than they were a decade ago), as a public pension fund it can afford to invest on much longer time horizons than other investors; the returns to private equity are hard to measure in the short term; etc., etc. So it’s always possible we’ll find, decades from now, that it was all worth it. Or perhaps we won’t. But by then the managers will have made off with their millions, either way.

I get it. Trust me, I do. But I can assure these new CPPIB hawks that after seven years of tracking MER, IRR, net versus published gross returns, and so forth, the effort amounts to little more than, perhaps, career suicide for any Bay Street money manager. A journalist the likes of Mr. Coyne will surely agree that the following topics are each worthy of answers from the CPPIB Board:

- CPP owned $21 million of Sino-Forest shares as of March 31/11, This investment exceeded the CPPIB’s stakes in several other more established Canadian companies, including BCE, Bombardier, Brookfield, CIBC, Canadian Tire, Imperial Oil, National Bank, Onex, Power Corp., Shoppers Drug Mark, SNC, Telus, Thomson Reuters, TMX and TransCanada. What independent due diligence did CPPIB conduct to give it the confidence to go very over-weight into what the OSC says turned out to be a corporate fraud?

- According to the CPPIB 2012 “Report on Responsible Investing”, the agency says that it “adheres to the highest standards of transparency and accountability”. The CPP refuses to disclose the individual IRRs of our 135+ private equity fund investments, while the state pensions of such places as California, Oregon, Texas and Washington all disclose the individual internal rates of returns on their entire private equity, debt and venture capital funds, such as Apollo, Blackstone, Carlyle, KKR, Silver Lake, etc. The “IRR” calculation is a widely-recognized metric to determine the true performance of an investment over time. CPPIB has invested in dozens of these same funds, and yet refuses to disclose the IRR calculation, preferring to report nominal performance based upon dollars in and dollars out in the home currency of the fund in questions (CAD, Euros, USD, etc.).

- Over the past 10 years, the Canadian dollar has strengthened appreciably. The CPPIB has substantial investments in assets that are denominated in foreign currencies, and has a policy of not hedging our risk to changes in the relative valuation of these currencies against the Canadian dollar. What is the true individual performance of our 135 private equity fund investments when you take into account the huge swings in the currencies we’ve invested in? CalPERS, CalSTRS, Oregon, WSIB and UTIMCO all report the individual fund level return data on the basis of their own invested currency (being U.S. dollars), rather than the currency of the private equity vehicle in question (whether it be denominated in Canadian dollars, Euros or Renminbi, for example).

- CPPIB has committed over $30 billion to external private funds over the past decade. What IRR has CPPIB earned on its investment via the entire asset class of its external LBO managers, since the inception? Weighted by dollar invested / realized.

- CPPIB has disclosed to the media that it made hundreds of millions via its co-investment in Skype when it was acquired by Microsoft in 2011. At the same time, CPPIB refuses to disclose to the media how much we’ve lost on other mega private equity LBO co-investment deals that went south, such as EMI (went bankrupt in 2011), Freescale, SunGuard, TXU…. Why does CPPIB only disclose the details of the PE wins and not the losses?

- When I last checked, CPPIB owned $233 million of stock in four U.S. tobacco companies. As a founding signatory to the United Nations’ Principles for Responsible Investing, CPPIB has agreed to define responsible investing as “excluding companies from the investment universe on the basis of criteria relating to their products, activities, policies, or performance. This includes sector-based screening (where entire sectors are excluded)….” According to the CBC, CPPIB advises that “The CPPIB is mandated by law to evaluate companies only by their investment potential; morals and politics generally don’t enter the picture.” How does the CPPIB explain investing in tobacco firms, unlike CalPERS for example, while at the same time adhering to its duties to the United Nations?

- One of CPPIB’s stated PRI tests is “anti-corruption practices”. As of its most recent financial statements, CPPIB owned $175 million of HSBC stock and $74 million of UBS shares. Together, these banks recently paid US$3.5 billion in fines after admitting they were engaged in illegal activity over an extended period of time. In HSBC’s case, the fine was for multi-billion dollar drug money laundering. These firms have broken the “anti-corruption” requirement of the CPPIB’s Policy for Responsible Investing. Did CPPIB sell these shares once the banks have plead guilty? If not, why not?

- In February 2010, CPPIB announced that it was making a new $400 million allocation to Canadian venture capital and private equity managers via an external manager (Northleaf). At the time, CPPIB CEO Mark Weisman told the Globe and Mail’s Boyd Erman that he was excited about the opportunity presented by the Canadian venture landscape. As of Dec. 2103, $135 million of the $400 million had been drawn by fund managers. And yet, a raft of Canadian innovation-related funds have closed, including Vanedge, Georgian, iNovia, Lumira, Merck Lumira, Rho, Celtic, TVM and Wellington Financial. According to industry sources, none of the CPPIB’s $400 million was committed to these nine funds. Is this true? If not, how much of CPPIB’s 2010 $400 million vehicle has been committed to date to Canadian-based venture funds, in keeping with Mr. Wiseman’s excitement?

- In October 2012, CPPIB announced that it had loaned $400 million to the company that puts on the Formula One car races. CPPIB exec Andre Bourbonnais told the Globe and Mail that the CPPIB’s analysis was simple: “For us is was really an analysis of who was the counter-party, and in F1 if your counter-party is the principality of Monaco you’re pretty sure they’re going to be good on their commitment”. Since the Formula One is owned by CVC Capital Partners, Waddell & Reed Financial and Bernie Ecclestone (who recently paid $100M to settle bribery charges in Germany), what role does Monaco have in guaranteeing our $400 million 7-year loan?

You see, Andrew. There’s plenty of gruel to go around the Press Gallery. You’d think Canadians could get to the bottom of these topics, but we can’t. Unlike a public company, CPPIB has no real shareholders; the agency doesn’t even hold its “Annual General Meeting” annually. Unlike a traditional pension plan, we beneficiaries have no direct nominations to the Board overseeing our retirement savings. Unlike the Abu Dhabi Investment Authority, there is no supreme stakeholder who can weigh in if he/she is unhappy.

What we have is an agency which is a force entirely onto itself. If the plan delivers on the “75 year promise”, our grandchildren will be grateful and the unusually high MER and wall of silence will have been worth it. If the plan does poorly — have no fear — they’ll just increase your payroll taxes, as CPPIB CEO Mark Wiseman told ROB’s Doug Steiner two years ago:

And what happens if the CPPIB team turn out to be the worst investors the world has ever seen, and lose most or all of the money? Notwithstanding all of the checks and balances in place, Wiseman cracks a smile and says, “If they raise the amount taken off your paycheque by 50%, in less than five years we’re right back where we are now.”

That’s why your efforts are pointless. It’s a case of “Heads they win, tails you lose.” Do the smart thing and throw the towel in now; you’ll thank me seven years hence.

MRM
(disclosure: this post, like all blogs, is an Opinion Piece)

 
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Almost 50% of 2014 U.S. private-equity deals breached bank regulators’ leverage guidance

News report: Federal Reserve Demands Bank to Address Problems With Leveraged Lending

It was only a few months ago that I pointed you to a tongue-lashing doled out to the U.S. banking industry by a Federal Reserve supervisor (see prior post “Bloomberg: Regulators stand by while U.S. bank lenders get footloose” May 14-14). Things have gotten worse since then, and the Fed is now making examples of banks in writing, such as Credit Suisse, as reported by Gillian Tan and Ryan Tracy in the WSJ last week:

The Swiss bank in recent weeks received a letter from the Federal Reserve demanding the bank immediately address problems with its underwriting and sale of leveraged loans, or high-interest-rate loans used by private-equity firms and others to finance purchases of companies, among other uses.

The letter to Credit Suisse, known as a Matters Requiring Immediate Attention, found problems with the bank’s adherence to guidance issued last year, warning banks to avoid deals that included too much debt or too few protections for the lenders in case of a default, according to the person familiar with the matter.

These topics are of great interest to anyone in the specialty finance space, since banks are granted a host of benefits by the government that aren’t available to the rest of the private sector. The luxury of deposit insurance means that many U.S. banks have a cost of funding of less than 0.25%, versus the 6-10% cost of capital that the rest of the market lives with. There’s also the matter of balance sheet leverage. Many banks carry loan books which approach 18x their equity capital, versus the zero to two times leverage of the non-bank sector.

Those two luxuries make for a very nice business model indeed, and since the taxpayer is on the hook, society requires that bank regulators do their jobs. According to the WSJ, banks are pushing back:

Banks dispute the risk levels attached to leveraged lending and said they are taking steps to ensure strong underwriting standards are applied to such loans.

They said Washington’s efforts are driving more financing into unregulated sectors of the financial system, putting banks at a competitive disadvantage to other lenders.

Now, if the bank managers don’t like the fact that regulators are mandating that they should require covenants on every commercial loans, and must abide by certain leverage limits, they should be forced to read every NYT or Wall Street Journal edition from 1928, 1929, 2007, 2008 and early 2009. If that refresher isn’t sufficient, bank regulators need to outline for management the steps a bank can take to shed itself of deposit insurance, de-lever the balance sheet, and live with the consequences just as every other private lender that doesn’t benefit from the inherent government guarantee that keeps them in business.

Banks have a structural competitive advantage over the rest of the lending space, which is why their market share is so overwhelmingly high. It is disingenuous to complain about the apparent luxuries of the non-bank lending space, and Regulators shouldn’t duck from doing their jobs.

MRM

 
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Wellington Financial portfolio co. FolioDynamix being acquired for $200M

We got some great news earlier today for our limited partners. New York-based FolioDynamix is being acquired by NASDAQ-listed Actua (ACTA:Q) for ~US$200 million. It was only the Spring of 2012 when we joined VCs ABS Capital and Edison Partners in the Folio Dynamics Inc. syndicate. What Folio Chairman and CEO Joe Mrak and his team have built clearly drew attention in a relatively short timeframe. And Actua, which calls itself the multi-vertical cloud company, had to have it.

FolioDynamix supplies a cloud-based technology platform to manage the full wealth management lifecycle for wealth service providers and investment advisors. It works across all account types including unified managed accounts and unified managed household programs. The company’s technology is complemented with institutional-quality research, content and consulting expertise delivered by its subsidiary, FDx Advisors, a registered investment advisor. FDx provides clients with due diligence and discretionary investment solutions regarding managers / models used to support separately managed account unified managed accounts, mutual fund wrap and exchange traded fund programs.

In operation since 2007, Folio’s clients include banks, money management firms, brokers and so forth. Examples include Cambridge Investment Research, LPL, Raymond James and Wedbush.

The management team has been very efficient with its investment capital over the years. Which is code for: this is a big win for the Folio team and their VC partners. ABS and Edison came did their round in late 2010, are were very much committed to the deal when the opportunity arose for a venture debt tranche. The role and benefits of venture debt was clear: provide capital at an important time without the meaningful dilution to the management team that would result from a VC follow-on. For the VCs, they got to keep their powder dry and improve their own multiple of capital on an exit.

From its vantagepoint, Actua gets “a current net revenue run rate of over $30 million (approximately $50 million on a gross revenue basis), with positive earnings and cash flow. [Folio] grew over 40% in 2013, and growth is expected to continue at that rate in 2014.”

Congrats to Joe, CFO Mark Herman, CTO Mark Davis, the Folio family and the teams at ABS (Cal Wheaton) and Edison Ventures (Chris Sugden).

MRM

 
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