The Canyon Value Realization Fund closed a difficult third quarter by noting how central bank “policy experimentation” was causing it to be more conservative.
The value oriented credit hedge fund shaved -1.51 percent off performance to end the third quarter, but is still higher +3.68 percent year to date, an investor letter reviewed by ValueWalk notes. Coming into a volatile October, the fund was relatively unlevered with 19 percent of the portfolio in cash, which was a posture they believe to be appropriate for a slow growth world.
Canyon’s goal of keeping a high level of cash
The goal of keeping such a high level of cash is so the fund can benefit from bouts of volatility, as witnessed in October, when the VIX experienced a five-day 74 percent rise, among the sharpest moves in recent history. The fall sell off “somewhat predictably” created a market environment characterized by capitulation and forced selling, which punished highly concentrated and leveraged portfolios most, the letter stated.
While Canyon “took some lumps in October,” with the fund down -0.66 on the month alone, it did take the opportunity to do some bottom fishing, putting $400 million of cash to work, with over 80 percent of the purchases made in the first half of the month when volatility spiked.
During the October volatility spike, Canyon took advantage of “disrupted” situations. This included purchases in airline stocks, which had fallen significantly due in part to Ebola fears and despite plunging fuel prices.
In this regard it appears as though Canyon disregarded emotion and embraced hard math. The Ebola fears could have been emotionally driven and overblown, at least based on early data which doesn’t support mass panic, while the lower fuel prices are hard statistics that are known to improve an airlines bottom line.
Canyon was also active in certain relative value, risk arbitrage deals. This is where the spread between the price of two stocks significantly reverted past statistical means that determine the fund’s perception of value. One example is how spreads “blew out” to a statistically obtuse level after the AbbVie Inc (NYSE:ABBV)/Shire PLC (NASDAQ:SHPG) (LON:SHP) deal was announced dead. Another example where relative value opportunity was found occurred with energy stocks, which had plummeted after forced liquidation by damaged energy funds provided a value investing opportunity.
Canyon’s Q3 letter
Below are some select highlights from the fund’s Q3 letter:
Select highlights:
- The Canyon Value Realization Fund (Cayman), Ltd. (Class A shares) (“CVRF” or the “Fund”) returned an estimated -1.51% in the third quarter, bringing year-to-date returns through September 30 to an estimated +3.68% (in both cases net of fees and expenses).
- The portfolio is unlevered (with 19% cash), a posture we believe to be conservative and appropriate for a slow growth world undergoing various forms of policy experimentation. In a market where interest rates have remained low and stock market indices have hovered at or near record levels, it has seemed prudent to maintain a healthy level of cash to take advantage of bouts of volatility.
- We got a preview of higher levels of volatility at the end of the third quarter across the FX, commodity, equity, and credit markets. However, this was rapidly overshadowed by the events of early October, which included a 5-day 74% rise in the VIX. This was among the sharpest moves in recent history (not quite as bad as August 2011, but comparable to the 2008 financial crisis and worse than September 11, 2001).
- Somewhat predictably, this kind of disorder created a market environment characterized by capitulation and forced selling. Levered and/or overly concentrated positioning, hallmarks of bull markets, were swiftly and severely punished. Such volatility spikes are usually accompanied by idiosyncratic damage as well, and the October experience was true to this pattern. In particular, the acute decline in Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) preferred and common stock and the collapse of the AbbVie/Shire deal put significant pressure on the largest holders (hedge funds), leading to rapid and pervasive de-risking. Canyon had no exposure to either of these investments, though we certainly have had a few notable missteps this year. Fortunately, none of them has been fatal from a sizing standpoint (no position has cost CVRF more than 75 basis points of gross performance).
- While we took some lumps in October (CVRF was down -0.66% month-to-date through October 24), our 19% cash position afforded us the flexibility to do some bottom fishing in particularly disrupted situations and sectors.
- CVRF made over $400M of purchases (amounting to over 6% of NAV) during October. Over 80% of these purchases occurred during the first half of the month, when volatility peaked.
- Our October purchases included airline stocks (which had fallen precipitously due in part to Ebola fears and in spite of vastly improved fuel prices), certain risk arbitrage deals (where spreads blew out after the AbbVie/Shire deal break), energy stocks (which had plummeted after forced selling by badly hurt energy-focused funds), and existing special situation (credit and other) positions that had weakened in sympathy with the broader markets. As markets stabilized in the latter half of October, these purchases rebounded and contributed positively to performance, and we have already taken profits on some of these investments.
