NEWS & RESOURCES

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March 31, 2016

COVENANT CAPITAL MANAGEMENT NEWSLETTER - MARCH 2016

Newsletters

Editorial

This quarter has been filled with ‘ground-breaking news’ (at least that is how the media referred to it). Most recently, Brussels became the latest victim of ISIL with bombings at the Brussels Airport and another at a metro station, leaving 35 dead and hundreds injured. In the earlier part of the year, we saw 29 people killed in Burkina Faso.

On February 27th , a ceasefire was declared in Syria in an attempt to reduce the bloodshed, but will this be enough? As these heinous acts hit closer to home both literally and figuratively speaking, it is in our human nature to fear. But fear is the goal of these terrorists so that their opponents can be manipulated. And although a natural response, fear is a thief of joy.

As we celebrated Easter, we recall Jesus’ time on Earth. Yet even when Jesus told His disciples that He was leaving them for a little while, they were fearful. Here was His response:

“Peace I leave with you; my peace I give to you; not as the world gives do I give to you. Do not let your heart be troubled, nor let it be afraid.”

John 14:27 (ESV)

It was on the cross that Christ conquered death and along with it, fear. In these troubled times, let us transform fear, anger, and hate into the fruit of the spirit: love, joy, and peace.

“So also you have sorrow now, but I will see you again, and your hearts will rejoice, and no one will take your joy from you."

John 16:22 (ESV)

Market Update

What happens when things get overheated? You blow a circuit. At least that is what happened to China’s stock markets at the start of this year after a newly integrated circuit breaker suspended trade several days in a row when the market fell a whopping 5%. Indeed, a system designed to temper volatility in the market had the opposite effect. This display accurately paintsthe larger picture of market jitters and the risk-off sentiment that is prevailing after a 7-year bull run. Over this past quarter, the Canadian stock market is up 4.5% and the US stock market is at -5.6% (C$). However, those numbers don’t tell the full story, as it was only a couple months ago that the Canadian stock market was down 10% over a six-month period. This theme of volatility has played out in a long downturn over the past year (with the peak to trough being -22%) followed by a perhaps overly peppy recovery for the past month and a half, which is where we stand as of March 31, 2016.

Nationally speaking, energy and specifically oil have continued to weigh heavily on Canada’s economy, which could result in continued lacklustre growth now predicted at 1.7% for 2016 by the International Monetary Fund (IMF). While we may have seen the worst in terms of oil prices, until there is a meaningful discussion and subsequent action on an output freeze, it is unlikely that we will see an oil price recovery any time soon.

Amid this backdrop, The Bank of Canada’s Stephen Poloz held its key rate steady at 0.5% this past January, as was expected. We have witnessed similarly dovish movements across the border as Janet Yellen, Chairman of the Federal Reserve, announced that they are now forecasting two further rate hikes this year, down from four at its December forecast. All this to say that we are very much in a lower for longer environment.

On January 29th , the Bank of Japan joined the NIRP club. What’s all the fuss about this exclusive club? Japan is the latest country to join a handful of others that have delved into this aggressive form of monetary policy initially pioneered by the European Central Bank (ECB). The Negative Interest Rate Policy (NIRP) applies to banks who will now be charged for holding excess reserves with Central Banks. The goal is that the banks will instead choose to lend more capital to potential borrowers, which could in turn stimulate an economy which is faced with the continued threat of deflation. Quantitative easing and controlling interest rates as mentioned above are forms of monetary policy.

Fiscal policy is a tool used by the government whereby spending levels and tax rates are used as means to influence the economy. To that end, the Federal Budget was released on March 22 with the bottom line figure almost $30 billion in deficit spending with a heavy focus on infrastructure. It is the hope of the Liberal government that through their Budget, they can jumpstart the Canadian economy. Is there a possibility that Canada and/or the US will join the NIRP club? Following the theme of a global slowdown, could 111111 slower growth become the new normal? With the world’s largest economies combatting either slow growth (China, North America) or stagnation (Europe, Japan) despite many attempts at resuscitation via monetary and fiscal policy, we will have to wait and see to find out the answers to these questions.

Portfolio Update

Given the whipsaw effects recently seen in the traditional equity markets, we would like to use this opportunity to highlight an arena where we have been able to find value: Real Estate. Texas, specifically, is one area that we have been a proponent of for a while now.

Although still considered to be the nation's largest energy producing state, Texas has broadly diversified its economy since the 1980’s oil bust. Its diverse labour market has largely been fueled through a combination of affordable housing, a lack of state income tax and a corporate-friendly tax structure, which has brought in several large names including JP Morgan Chase, IBM, and Toyota Motor Co. This Lone Star State leads the US in population growth as well as job creation with its unemployment rate lower than the national average. Within Texas, Houston lays claim to being the busiest port in the United States in terms of foreign tonnage and is the thirteenth-busiest in the world. If the state of Texas were a nation, it would be ranked as 13th largest in the world!

It was the conviction that Texas is indeed a land of opportunities that lead us to partner with Rockspring Capital, a real estate investment firm who sources, manages and oversees strategies on behalf of their investors. In conjunction with Rockspring Capital, we are looking to find opportunistic plays where either land or existing buildings can be repurposed and sold to developers with particular attention paid to “up and coming” areas in and around the Texas Triangle (defined as Houston, San Antonio, Austin and Dallas/Fort Worth). Given that Texas is a nondisclosure state, our partnership is one that allows us to have boots on the ground by those who have grown up in and around those areas. This local, intimate knowledge of the industry has allowed us the strategic advantage of accessing opportunities well before properties hit the public market.

Our latest acquisition and subsequent sale was of a 4- acre property in Houston. This covered land play was purchased late last year in a growing residential area and was picked up a mere seven months later by Whole Foods. As a partner in this syndicated deal, our net return was just over 45%. The proceeds from the sale were then used to redeploy into new opportunities.

Covenant’s Non-Traditional Equity Pool currently has 5 properties located in Houston, Austin and San Antonio, making up approximately 20% of the Pool as of March 31st. Each of these properties have differing disposition timelines, and these are generally staggered to be realized within 1-5 years. Our priority is on cash-only deals, as they reduce the risk by not having to employ leverage.

Investing in Texas provides value through the acquisition of tangible assets in a broader market outside of Canada. As we face continued instability in the traditional equity markets, direct exposure to real estate in multiple geographic regions adds excellent diversification to a balanced portfolio, thereby reducing overall risk.

Meet the Team

The Investment Management Team, frequently referred to as the “IMT,” is comprised of Glenn Murray, Victor Whang, and Micah Neely. Glenn and Victor, both Portfolio Managers, hold the Chartered Financial Analyst (CFA) designation, while Micah’s background in mathematics, programming and probability makes him an excellent Research Analyst. This team is responsible for monitoring current investments and deciding which opportunities meet the strict criteria set out by the mandate of each of our pooled funds. Once the IMT has completed their due diligence on an investment opportunity, they present a proposal to the Investment Committee for consideration.

While often hidden from the spotlight, these three work tirelessly in the background on research, analysis and the ongoing study of investment trends. Armed with up-to-date news items, the IMT members are always ready to share interesting observations about factors that influence market cycles.

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