Lions Bay Q3 2025 Commentary – Navigating Euphoria, Positioning for Alpha
For the third quarter of 2025, the Lions Bay Fund declined by -0.88%. On a year-to-date basis, Lions Bay is up +7.85%, relative to the S&P 500 which is now up 14.81% on the year. Since inception, Lions Bay has generated an annualized return of +16.34% and a total return of +195.82%, relative to the S&P 500 with a total return of 164.16%.
This commentary is longer and more technical than we typically write. We recognize that following a period of strong outperformance in the first half of the year, Lions Bay is undergoing a period of underperformance that is understandably frustrating. We hope that this commentary conveys two things to our readers. First, the positioning that drove our recent performance. And second, that our conviction at the prospect of alpha generation in the quarters ahead is higher than it has been in years. We’ll review the quarter, what is concerning us in the market, and wrap up with a review of our philosophy and process.
For reasons we will outline in the following commentary, we feel the risk-reward for equities is unattractive at the index level in general, and alarmingly so in specific sectors. While there are still pockets of the market where we are finding attractively valued investment opportunities, these stocks do not represent a large portion of the index. Many of the extremely overvalued ones however, do. This is one of the reasons we’re excited given our discipline of managing downside risk at the index level.
Who’s Buying?
A veteran portfolio manager once told us that two of the most important questions to ask when looking at a stock are “who owns it?” and “who is buying it?”. Learning that a stock is owned and being bought by investors with a track record of long-term success usually means it’s a compelling opportunity and provides a sense that the stock is in ‘strong hands’ who step up to support a stock with buying on bad news. Conversely, a stock that is being bought by retail investors, or rules-based trading strategies may be thought to be in ‘weak hands’ as these investors tend to head for the exits very quickly, creating the risk of a sharp reversal at the arrival of bad news. You want to avoid weak hands.
Applying this analysis to the broader market rather than a specific stock, we see a market as a whole that is being held in weak hands.
Retail Investors:
CITI RETAIL FAVOURITES BASKET
The chart above shows that markets have now entered a stage in the cycle that is characterized by brazen speculation. A basket of stocks favoured by retail investors has gone vertical in recent weeks, and past parabolic moves proved to be excellent times to hedge downside risk at the index level. We believe it is a good time to subscribe to Warren Buffets famous wisdom to “be greedy when others are fearful, and fearful when others are greedy”.
Data from Citadel Securities on retail trading activity reveals that retail investors have been net buyers of bullish call options for 23 straight weeks, tied for the second largest streak ever, one week shy of the all time record.
RETAIL NET BUYERS OF BULLISH CALL OPTIONS
We think it’s interesting to observe in the chart above that the first week of April (which marked the lows of the year) and the third week of April (which was a retest the lows) marked the two weeks with the most bearish retail activity of the year – consistent with the typical pattern to sell the lows and buy the highs.
When we see a market driven in part by a record streak of speculative activity by retail investors, we get nervous, and believe it is more important than ever to stay disciplined with downside protection.
VALUE OF U.S. EQUTIES HELD BY BOTTOM 50% OF HOUSEHOLD NET WORTH
While equities are now back to the dot-com level records as a percentage of household financial assets, as is common at all-time highs for the market, the above chart shows something unique to this cycle. The value of equities owned by individuals comprising the bottom 50% of household net worth has gone parabolic since 2020. This a product of the democratization of investing, and the explosion in the popularity of self-directed trading platforms. A longer-term concern for us is that in the next prolonged sell-off, the stock market may become the economy to the extent that such a large portion of the U.S. economy is exposed to equity risk.
Systematic and Rules-Based Investors
The longer the market continues its unabated rally, and the more overvalued stocks get, the more cautious we become. This is only logical to us, and this thinking has helped protect our clients from some of the scariest moments for investors over the 7 years that we’ve had the privilege of managing their money.
Oddly enough, a tremendous amount of investment capital is managed in the opposite fashion, by rules-based, systematic investors. In stark opposite to Lions Bay, these investors mechanically increase their exposure to equities the higher the market goes and the lower volatility declines.
ESTIMATED GLOBAL EQUITY POSITION OF SYSTEMATIC MACRO
The chart above from Goldman Sachs shows the current exposure level of a composite of these different systematic investors. As you can see, the behaviour of these investors is to sell into falling markets and buy into rising markets, up to a point where their exposure gets close to zero at the lows and is at its fullest near the highs. Just as it’s a green light to buy stocks when their exposure levels hit the floor they did in 2020 and April this year, it is a reason for caution when these exposures get back to the maximum level. Many of these funds adjust their exposure level based on the recent level of market volatility, and with VIX close to YTD lows as we enter the most volatile month of the year, a small move higher in VIX could spark a self-fulfilling sell-off in the near term. Leaving aside our thoughts on the wisdom of an investing strategy predicated on selling low and buying high, the incremental behaviour from this set of investors going forward is what’s most alarming to us. It is one of the reasons we’ve been disciplined with our hedges all quarter, and why we’re so excited about the prospect for downside alpha in the quarters ahead.
GLOBAL EQUITY SYSTEMATIC MACRO $BN
The chart above shows the simulated flows from systematic investors in the event of a flat market, up market or down market. The lines showing buying flows that would accompany a flat, up 1 standard deviation, or up 2 standard deviation market are pretty much the same. Given how low volatility currently is and how full their exposure levels are, the market would see minimal buying from these investors regardless of whether the market is flat or moves sharply higher.
Much more interesting are the gold and yellow bars, which show flows expected from a -1 standard deviation and -2 standard deviation market move. These funds would turn into massive sellers of equities the next time the market has a pullback, and the more volatility increases, the more their rules-based models will force them to sell. We believe the potential for a small pullback to turn into a vicious one is high because of this dynamic, and as such, we have remained disciplined with our hedges and are willing to give up some upside to protect our clients from the pain of such an unwind.
Over the life of Lions Bay, this dynamic is something we have tracked closely. We remember how painful it was during the late 2019/Jan 2020 retail-driven melt up, as well as the Q4 2021, July 2024 and February 2025 melt ups when we observed similar levels of record systematic exposure.
The spark that sets off the reversal doesn’t matter to us. Of those four episodes we mentioned, we only saw the trigger for the reversal coming once – as we correctly identified the hawkish pivot in monetary policy following Powell’s re-nomination in November and over the following quarters enjoyed the best relative performance in the life of the Fund. We did not forecast a global health crisis in February 2020, a Japanese Yen carry trade unwind in August 2024 or the magnitude of the protectionist policies from Washington in this spring. What mattered to us was then, as today, is that we recognized the fragility in the current market structure, hedged appropriately, and were able to protect our clients from the selloffs. Too often in this business, investors wait to hedge risk until the risks are obvious. At that point, it is often usually too late to avoid losses.
Trouble Brewing in Private Credit
As we outlined above, the market is in an incredibly fragile state given the euphoric sentiment and magnitude of forced selling that will accompany even a shallow sell-off or corresponding spike in volatility. We don’t know what that spark will be, but it may come from some of the risk unfolding in private credit markets that we’ve observed in recent weeks. When there are problems in the economy, the first signs will typically emerge in lending businesses, particularly to the extent that they employ leverage to do so.
The chart above shows the share prices of a group of publicly-traded companies in the private credit space: Blue Owl (OWL), Future Standard KKR Capital (FSK) and Blackstone Secured Lending (BXSL). These are just a small sample of the cracks we’re starting to see emerge, and our experience working at Wealhouse through the global financial crisis instilled in us that you never know how interconnected these risks may be until after the dust settles.
Despite one of the strongest tech bull markets in history, it’s a software company that has been causing headaches for Blackstone Secured Lending and FS KKR. Private credit funds enjoy a unique flexibility in how they mark their positions at quarter end. As of June 30th, BXSL marked their loan to Medallia Inc., the largest loan in their portfolio, at 87 cents on the dollar down from 89 cents at Q1. FSK meanwhile, marked the same loan down to 91 cents for June 30th, down from 95 cents in Q1.
Given that BSXL and FSK are BDCs that distribute most of their earnings, it is a bit misleading to just look at the share price performance alone. However, even considering their distributions, shares are massively underperforming the market, with BXSL -11.7% YTD and FSK -23.1% on a total return basis.
The woes for the private credit space picked up steam in early September, with the sudden bankruptcy of Texas-based subprime auto lender Tricolor Auto on September 10th. Tricolor tapped financial markets for over $2 billion in loans over the past few years, according to Bloomberg, who observed that roughly 40% of their loans which were used for asset-backed securitizations contained identical VIN numbers to vehicles on at least one other loan, suggesting widespread fraud.
Most recently, on September 29th, again in Texas and again in the auto sector, First Brands Group filed for Chapter 11 bankruptcy. First Brands Group is an auto parts company that abruptly filed for bankruptcy after third-party advisors discovered “irregularities”. The details of the situation are still emerging, but the Chapter 11 filing cited “geopolitical headwinds from newly imposed tariffs” as a reason for their difficulties. The company engaged in extensive off-balance sheet financing with private credit firms, estimated at $2.3 billion by Bloomberg, in addition to having $800 million in supply chain financing liabilities and $6.1 billion in on-balance sheet liabilities.
Perhaps all these bad credits are unrelated and idiosyncratic. Perhaps all these losses are marked fairly and consistently in all the portfolios that are exposed to the loans, and any forthcoming redemptions will be managed smoothly. We are certainly grateful that we have the tools to protect our portfolio if contagion does emerge and that the market is willing to sell protection to us so cheaply right now.
Q3 Review
During the third quarter, our active trading portfolio was a positive contributor to returns through realized gains in some of the housing related investments we outlined in our previous commentary, along with our positions in gold. The strong returns of the market during the quarter and the complete absence of any meaningful volatility led to our systematic hedges being a drag for Q3.
Core Portfolio and Active Trading Portfolio Q3 Review
Our core portfolio lagged the market during the third quarter, as index returns were increasingly narrow as the quarter progressed driven by stocks leveraged to the AI boom. Google alone was responsible for close to 20% of the S&P 500 returns for the month of September. Google was a core portfolio position entering the quarter, and we sold it into the parabolic move late in the quarter. Our other large cap technology investments such as AMZN, MSFT and META underperformed the market in September, and we have been adding on the recent weakness. Positive returns for the portfolio were led by our long-term core holding, Altius Minerals (ALS), which benefitted from strong appreciation in commodity prices.
Houlihan Lokey, our largest investment, slightly underperformed the market during the quarter as it was caught up in the weakness related to private credit. We feel this is an opportunity, as given its position as the leading bankruptcy advisor in the world, any shock to the credit markets would be a boon to their restructuring practice. The company takes no balance sheet risk and doesn’t engage in any lending. We had the opportunity to meet with the CEO and CFO in Toronto in early October, which re-affirmed our conviction in the long and resilient runway of growth ahead for their franchise.
Lastly, our investments in the lumber sector hurt our performance during Q3, with West Fraser Timber (WFG) declining by 1.2% for Q3, while Canfor Lumber declined by 9.7%. While other housing related sectors rallied on the rate cuts this quarter (such as DR Horton, which we took profits in) Canadian lumber stocks continued to be weighed down by fears of U.S. soft lumber tariffs, with the final announcement expected to come before November.
The announcement of a 10% incremental tariff came on September 29th, effective October 14th, which is better than feared figure based on our what we heard from conversations with industry analysts before the announcement. As such, we believe a meaningful overhang has been lifted from this sector, and as we enter a period of seasonal strength following the cyclical de-stocking that takes place in the fall as buyers ‘Get Lean into Halloween’. We think the risk reward for these stocks in highly compelling, particularly so if the Fed decide to let the economy run hot and continues to cut rates into the Spring. Following the announcement, we realized hedging profits on our November West Fraser put options and are adding to shares of both stocks.
As we wrote earlier, despite a market that is overvalued at the index level, we continue to find compelling investment opportunities in smaller companies.
New Core Portfolio Investment: Vail Resorts
VAIL RESORTS – 5 YEAR PRICE CHART
Ski resort operator Vail Resorts (MTN) was a new addition to our core portfolio during the quarter. The stock has languished in recent years due to a mix of issues, some out of the company’s control (several consecutive seasons of bad snowfall in the Rockies, ski patrol strikes in Park City), as well some pricing challenges from competitors. We owned shares of MTN early in the life of the Fund, as it boasts some truly unique assets as an owner of the 5 most visited ski resorts in North America, including Whistler here in Canada. For an investment to be considered for our core portfolio it needs to have a unique aspect to their business model that will provide them a durable competitive advantage, and the reality that there is a finite supply of high-quality ski resorts and mountains in the world checks that box. We also like the recurring revenue model of the business through their sale of season passes.
We became interested in the stock again in late Spring when we saw former CEO Rob Katz rejoin the company as full-time CEO. Rob Katz was a highly-celebrated executive, heading the company from 2006 through late 2021, a period which saw the stock enjoy a 1,110% total shareholder return, or 17.3% annualized return over a fifteen year span that included a global financial crisis and a pandemic. From his departure in November 2021 through his return announcement in late May, the stock declined by 51%. We don’t believe a high calibre CEO like this would return to run the company if he didn’t see an opportunity for meaningful value creation ahead, setting up a compelling turnaround story. Katz’s early priorities include revitalizing the marketing process which still relied on email rather than an AI driven campaigns and social media presence and reigniting season pass sales through innovation and pricing strategy refinement.
The company boasts strong margins, with resort adjusted EBITDA margins of 28.8%, and trades at 22x forward earnings, a rare a discount to the S&P 500 at the moment and a large discount to its 20-year average P/E multiple of 29x. The company has an active stock buyback program and repurchased approximately $200 million in stock during the last quarter at an average of $156 per share. Lastly the stock boasts an attractive dividend yield of 5.64% with a 5-year dividend growth rate of 20%.
Q3 Review – Hedging Portfolio
The challenges we faced from our hedging portfolio during the third quarter were not so much from the degree of the rally in stocks, but the unabated nature of the rally. Given how actively we trade these instruments, we are usually able to take advantage of small spikes in volatility within a quarter to roll hedges profitably and help ease the cost burden of these instruments.
PNL OF BUYING SPXW 1-WEEK ATM PUTS FOR PAST 52 WEEKS (IN BPS)
The chart above shows the profit and loss of buying 1 week at the money S&P 500 puts over the past year. As the chart shows, this strategy would have lost money in every week but two since April, with only one profitable week in all of Q3. This is a particularly challenging market for us, but it is an anomalous one that increases our opportunities ahead. Much like a forest that hasn’t experienced a wildfire in a long time, the longer it takes for one to arrive, the more devastating it will be.
The early months of this chart show what a more typical period looks like, when from September 2024 through February, we were still able to generate positive net returns through actively trading shallow pullbacks present in less euphoric markets.
CORRELATIONS AT EXTREME LOW LEVELS THAT PRECEDED PAST SELL OFFS
One of the ways to visually look at the level of risk appetite in the market is to examine the correlation of the returns amongst various sectors. During a panic, correlations go to 1 as everything trades the same way – everything gets sold. Swings in correlation such as we saw in 2021, or persistently elevated ones that we saw in 2022, were both great environments for our strategy.
With the caveat that past performance is not indicative of future returns, we note that in the past, when correlation has fallen to the levels it is at now, such as in July of 2023, summer 2024 and February of this year, Lions Bay has enjoyed a considerable stretch of outperformance in the following months.
Philosophy and Process Review
To close, we wish to quickly summarize our process and philosophy at Lions Bay.
Our low correlation to the market is a double-edged sword. It serves us extremely well in times of market distress, protecting clients from large drawdowns, while it also results in short-term underperformance in times of extreme complacency. As was outlined in our Q3 hedging review, comparable historical periods have preceded considerable money-making opportunities for the Lions Bay Fund.
Our long-time clients know that it is not in our nature to be promotional, but we are committed to highlighting when we see a uniquely compelling environment for our strategy. We are in one right now and firmly believe it is an attractive entry point for new capital to the Fund, particularly for those who have enjoyed a recent stretch of strong performance from a rising market.
Lions Bay celebrated its 7-year anniversary this quarter. Over the past seven years, we have been able to generate strong risk-adjusted returns while protecting our investors during periods of market turmoil. We have achieved this by staying disciplined with our strategy, and following a process that we deeply believe in.
Our process is straightforward:
We build a portfolio of long-term investments in high-quality businesses that are resilient enough to grow through the ups and downs of a business cycle, run by great management teams. We buy more of these stocks whenever they sell off on macro turbulence.
We scour the market for tactical opportunities to deploy capital in areas of the market that are out of favour and discounting a more negative economic outlook than the broader market, presenting an outsized risk/reward scenario. When our thesis plays out and our evaluation of the risk-reward returns to a more balanced one, we monetize the trade and hunt for the next one.
We hedge our portfolio against both known and unknown risks to the market, to protect our client’s capital when bad things inevitably happen. When the market enters periods of extreme risk mispricing, resulting rampant speculation, overvaluation and complacency to downside (such as today), or a condition of abject panic (early April), we will dial these hedges up or down, respectively. Beyond those extremes, we are disciplined about taking advantage of idiosyncratic spikes in volatility within a bull or bear market to actively roll and take profits in our hedges, to help minimize the cost of this protection.
Lastly, we are guided by an overarching philosophy of asking what could go right in some of the most unloved and hated stocks and sectors, while avoiding (and always being mindful of what may go wrong in) crowded, highly speculative, and overvalued sectors. Unlike most of the investment capital in the world, which moves in a herd and takes comfort from consensus, we are deeply uncomfortable with a one-sided narrative.
That last point, in addition to making us bad party guests, means we will have stretches like the past few months where the Fund underperforms relative to an euphoric market. That same philosophy is what has allowed us to protect, and often profit, from sharp reversals in sentiment.
We remain committed to the process and discipline that have been responsible for our long-term track record of successful risk management. We look forward to writing to you again at the conclusion of the year. As always, please do not hesitate to reach out with questions, comments or ideas.
Sincerely,
Justin Anis, CFA
Disclaimer:
This Commentary expresses the views of the author as of the date indicated and such views are subject to change without notice. Wealhouse has no duty or obligation to update the information contained herein. This Commentary is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Wealhouse believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based.
