2023 January CAD

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-3.42% MTD
-3.42% YTD

Something's Gotta Give...

...And the Fed never does

Dear Partners,

For the month of January, the Caravel Capital Fund returned -3.42%.

While the SPAC book contributed materially to the fund’s positive returns in 2020 and 2021, it has been a source of pain both in 2022 and again in January, constituting approximately half the month’s loss. We have no more exposure to SPACs and do not foresee re-entering them. The remainder of the loss came from a widening of merger arbitrage spreads, and market hedges as stocks broadly ripped over the course of the month. The fund’s fixed income portfolio contributed positively to returns but has given up some of those gains at the time of writing on the heels of the latest strong economic data, hotter-than-expected inflation, and subsequent shift upwards in the treasury curve.

When the facts change, we change our opinion. However, one of the difficulties of this business is trying to identify whether a surprise outcome represents a sea change or merely a bump in the road of the broader trend. Given the strength of the labour market and slower-than-expected disinflation in the US, we have placed hedges on our corporate bond portfolio, which consists of issuers in both the US and Canada, but is heavily US-dollar weighted. These hedges protect against short-term pain in the bond market, but we remain confident in our thesis that bonds offer a better risk-adjusted return outlook than the stock market over the medium term. We have long and short exposures to equities, but these exposures are mostly in market-neutral and event-driven strategies.

Two things we’d like to touch on (briefly, at the risk of repeating ourselves) that underly our thinking:

Firstly, the US is the most attractive part of the fixed-income market to us for a number of reasons. Investors will likely flock to safe-haven assets like US treasury bonds if the global economy cannot avoid a recession. This would keep a bid under their government debt and the investment-grade bonds that are priced relative to it. Emerging and frontier markets are conversely less attractive. While US credit spreads could widen under a recessionary scenario, we are confident that the high quality of the issuers whose debt we hold will insulate them from significant deterioration in their credit profiles. US interest rates also remain higher than Canada’s despite having, in our view, a less vulnerable economy and general consumer. We remain skeptical, for example, that Canadian consumers holding (very popular) resetting mortgages will be resilient as they are forced to pay much higher mortgage rates when their contracts reset at higher levels. This is to say nothing of people holding variable-rate mortgages who have already been affected by rising rates. We believe this dynamic, coupled with bloated housing prices in many urban areas, is not being appropriately priced by the Canadian fixed-income market. We also view the US and its economy favourably compared to Europe and Asia Pacific in terms of geopolitical risks and demographic headwinds.

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 5006.28%6.28%16.77%0.781.140.112.82%-12.35%12.32%

Growth of $1000 since inception

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