Amplus Fund April Update
The hottest product on the market is…lumber? Increase in home reno projects due to COVID has caused lumber prices to soar. But latest CPI numbers show that lumber isn’t the only price that went way up during the pandemic. Is this the first sign of the dreaded inflation? Amplus PM Andrew Labbad discusses in his latest commentary.
Known as the greatest magician of all time, one of Harry Houdini’s most celebrated tricks was his ability to sustain powerful punches to his abdomen. It was not so much a trick as it was practice. Houdini exercised his abdomen diligently everyday and prepared his muscles before each performance. In 1926, while Houdini was in his dressing room, a group of students from my alma mater, McGill University, visited him there. Without warning they began striking him to the abdomen. The next day Houdini complained of abdominal pain, his appendix ruptured, and he died. His inability to prepare for such unexpected blows led to his demise.
The most dangerous outcomes can occur without warning and are often due to unforeseen risks. Houdini, who managed to escape a straight jacket buried six feet underground, learned this the hard way. This is an important reminder when assessing financial markets and our investments. In hindsight, we know the risks and impact a novel highly contagious virus can have. At the onset, the global life-altering damage went mostly unforeseen.
These lessons remind us to constantly account for unforeseen risks. Amplus Credit Income Fund specializes in hedging out unwanted interest rate and currency risk. We spend significant resources and foresight on a diverse tool chest of hedges to protect our investors from unforeseen risk. My colleague Justin often says: “you do not want to be shopping for home insurance when your house is on fire.”
Our strategy continues to reward investors despite the volatility showcased this year in fixed income. Amplus Credit Income Fund closed up +1.41% in April. After launching the fund on July 2nd, 2020, cumulative returns are +24.28% after costs. During that same time frame, major fixed income indices are showing negative returns, the two major Canadian fixed-income indices are still down -4%. Most of these negative returns can be attributed to a rise in interest rates.
We have repeatedly discussed the warning signs and impacts of rising inflation. We are becoming increasingly concerned with the divergence between the U.S. Bureau of Labor Statistics (BLS) data and personal experience at our most exciting weekly outing, the grocery store. The CPI tracks the price increases of a basket of goods over time and is used as the gold-standard for measuring inflation. You can see from the chart below, according to CPI, inflation is hovering around two percent and it’s “business as usual”. Meanwhile, the largest and most successful companies in the U.S., who have decades of experience both locally and abroad managing the costs of goods and services, have reported an 800% increase in inflationary concerns.
The conflictual information presented in this chart is staggering. Anyone trying to build a fence these days knows it is harder and more expensive to get your hands on lumber than it is on cocaine!
Tailwinds in credit remain strong. Monetary and fiscal policies continue to be extremely accommodating, robust inflows in U.S. fixed income ($84 billion YTD) and a rising rate environment are all positive for credit spreads. We are investing in companies that should see an increase in asset growth and earnings power from either rising interest rates or inflation including banks, commodities, and real estate. For example, our deep-dive credit analysis and scouting uncovered a huge and unobvious inflation-led opportunity in AutoCanada bonds.
The Trade: In the last year, used car prices have increased by 12.4% in the U.S., new cars by 7%. On April 14th, AutoCanada announced changes to its capital stack, positive Q1 sales guidance, and the issuance of $125 million of senior debt. The rating agencies upgraded their existing senior debt by two notches to B. This bond offering would mature in as little as 1 year, yielding 5.59% representing a discount of 100 basis points to existing debt without factoring in all the positive data and credit rating upgrades that day. With consumer disposable income reaching 30-year highs, AutoCanada was an ideal risk-adjusted investment for Amplus. Three weeks later on May 5th, earnings blew out expectations on profitability. Same store new car sales increased by 30%, used car sales by 44%, with higher margins. As a result, our bonds have traded substantially higher. Some skeptics may show concern with the auto chip shortage slowing future car sales but the 80/20 rule in business applies well here. Simply put, non-car sale revenues represent about 20% and make up 70% AutoCanada’s gross profit. We think that these revenues coming from parts, service, collision repair, finance and extended warranties should continue to do well and act as a counterbalance for consumers extending the life of their cars.
