2022 May CAD

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-1.61% MTD
1.58% YTD

We take small losses to avoid big ones.

Dear Partners,

For the month of May, the Caravel Capital Fund returned -1.61%, bringing the total net return for 2022 to +1.58%.

The most challenging times for an asset manager are the moments just before a strategy begins working and just after it stops. During May, we responded to macro elements and flinched in the moments just before one of our strategies was about to take effect. This reaction was compounded by a material widening of spreads in the merger arbitrage book, specifically where our largest position dropped 10% in value over concerns regarding delays due to regulatory challenges. We had been reducing our exposure before this, as we often trade around core positions, but it was not enough to insulate the fund from a loss. After continued extensive due diligence on this merger, we added back some of the exposure as we strongly believe the deal will close.

In a month where markets did everything to shake the conviction of both bulls and bears, we could not escape the combination of increased systematic risk and a vicious bear market rally. We are very proud of the 25 consecutive profitable months the fund has produced since April 2020, but the most critical work is still in front of us in this environment.

From this point forward, we want our partners to have the comfort that we have not modified the fund's medium-term profile. We are well-positioned to remain profitable while markets adjust the valuations of fixed income, equities, and commodities. We continue to believe that current inflationary pressures will cause nominal interest rates to rise upward through 3.5% and likely through 4% this year. As interest rates increase, investors pay a lower multiple for every dollar of a company's earnings.  

 As we have stated numerous times, we believe earnings in North America will not meet the elevated expectations of 17+% growth for 2022. Specifically, we believe the following exogenous factors will materially impact earnings growth:

  • +64% increase in energy cost in 2022
  • +125% increase in financing costs (interest) in 2022
  • +5.2% increase in hourly labor costs over the past 12 months
  • +16.2% increase in the US dollar value over the past 12 months.

Without diving too deeply into the income statements of the S&P 500 or TSX companies, it is clear that the above factors will have a negative (NOT positive) impact on 2022 earnings. Incredibly, Wall Street's estimated 2022 earnings for S&P500 and SPTSX reflect a 15% and 24% earnings INCREASE.

We firmly believe these projections must be revised downwards and may continue to drop into 2023. We are seeing our prediction play out now through lower market values. At the time of writing, the S&P 500 is down 21% year to date, and interestingly, the TSX has only dropped 7.5%. This distortion is primarily a result of the heavy concentration of the big six banks and the larger energy/resource complex in Canada.

We see more problems than solutions at current market values. In past letters, we have highlighted a risk that is now entering the realm. The Japanese Yen has fallen 23% against the US Dollar since September, and the 10-year Japanese bond yield has risen 5-fold from 0.05% to 0.25% during the same period. The further the Yen weakens, the greater the risk for yields to rise, which is unsustainable. We will be watching this development closely going forward. We have positioned the fund to take advantage of the current economic and earnings uncertainty.

On a closing note, Jeff redeemed $679,000 to pay the remaining building costs of his house. Jeff and Michelle have moved into the house and could not be more pleased. 

In that same vein, after six years of reinvesting 100% of his performance fees while he rented an apartment on the island, Glen has finally purchased a home in the Bahamas. Glen redeemed $2.6mm from his $10 million US holdings in the fund. Glen does not take possession of the property until October and will be financing the purchase balance with a conventional mortgage. Combined, the founding partners continue to be the largest holders of units.

If you want to discuss anything or just say hi, we love catching up with our partners at any time.

We thank you for your continued confidence and capital,

Jeff and Glen.

Monthly Performance (net of all fees)

JanFebMarAprMayJunJulAugSepOctNovDec YTD

Risk vs. Return Comparisons Across Indexes

Month Return YTD Return Volatility Sharpe Sortino Beta Best Month Worst Month Annualized
S&P 500.18%-14.76%15.44%0.7610.112.82%-12.35%13.89%

Growth of $1000 since inception

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