2023 November CAD

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2.21% MTD

-0.85% YTD

Dear Partners, 

For the month of November, the Caravel Capital Fund was up 2.21%, the S&P500 was up 9.13%, and the TSX was up 7.49%. In our last letter, we pointed out how the North American indexes had performed since July.   

"From Jul 31 to Oct 31, 2023, the SP 500 fell 8.25%, and the Toronto index was down 7.72%, while the Caravel Fund was up 1.3% net of fees."  

Far be it for us to take a cheap shot like that and not follow up after the monster run by North American indices in November. So how would you have done over the past five months while biting your nails and losing sleep? We think a picture is worth 1,000 words, and we respect your time.   

We believe a hedge fund's performance chart should look like the one above.   
We try to make that clear on our website. Our Mantra from day one has been:

We let others who are more qualified than us judge our performance. Caravel Awards. For 35 years, I have taken great pride in generating above-market returns with below-market risk. That is exactly what we do at Caravel, and we are very proud of it. 

So what happened in November? 

Anyone who visited our office in Nassau has seen the large 4' x 3' whiteboard hanging near the front entrance. There, you will find a handwritten list crafted over the past seven-plus years. The list contains lessons we have learned over our careers that tend not to be taught in schools. These rules are sacrosanct, and we never break them. They are hung at the front door, so every morning when we walk into the office, we are reminded of them, and they are the last thing we see when we shut off the lights at night. Adding a new rule is not a common occurrence (we have had ten since inception), but we just added a new one, and we think after a month of double-digit returns in North American stock indices, it's one worth sharing.   

It's better to have no ideas than to act on a bad idea. 

In this spirit, we continue to hold a smaller portfolio of select floating rate reset preferred shares. We reduced positions in the names that rose materially and decreased our long position in Government of Canada 5- and 7-year bonds, which were our hedge against a material fall in rates. We expected inflation to continue lower and offer central bankers the opportunity to pause or even pivot toward a lower-rate environment, which is precisely what has happened. We telegraphed that in our August and September letters. What we didn't expect was the Canadian government to reverse its February 2023 decision that denied corporations from receiving eligible tax-free dividends. By overturning this decision, a large cohort of institutional investors returned to the preferred share market, like stampeding wildebeests. We like to reference an expression: "Luck is at the crossroads between opportunity and preparation."

The preferred share trade is a fine example of this – the right idea with the good fortune of better timing than expected. We also have been focusing on other interest rate-sensitive areas, which we strongly believe possess the best risk-adjusted return profile by a country mile. Earlier this year, we invested 10% of the fund into an issuer's 9.75% coupon bonds. The bonds were trading in the mid $ 90's, which, after speaking to the company several times over nine months, we had certainty would be called at par. The bonds were trading at $97 when the company repaid us $100 in early November. The total holding period return was North of 20% annualized for our partners. We continue to hold Onex Corp (mentioned in past letters), which is now up nearly 50% in the past six months. We remain extremely excited for the coming quarters. The Net Asset Value of Onex shares was last reported in early November to be C$139.51. This number will likely have risen with higher stock prices and lower interest rates in the past 50 days. We firmly believe the shares will trade north of $120 next year, a further 33% gain from current market prices and a near-perfect double in the 12 months since mentioning the idea in our letter. Fidelity (a small mutual fund company you may have heard of) just announced they now hold 15% of the company's shares! A famous investor by the name of David Einhorn has been accumulating a position as well. It's nice when large pools of capital and savvy managers catch on to a great idea after you've acquired a large stake for yourself.   

The merger arbitrage business has not offered much in the way of acceptable returns in 2023, which is normal during bear markets. More money tends to flood into fewer opportunities, pushing down returns while market risk is elevated—a bad combination. We have intentionally avoided allocating much capital to this strategy and intend to minimize the fund's exposure until markets offer more fairly priced opportunities. 

What else are we looking at? 

We continue to look for opportunities that possess catalysts for change that the investing community has not embraced. We are keenly aware the Dow Jones Industrial Average is the first major North American index to exit the 25-month bear market we have all suffered. The NASDAQ and S&P 500 are both within 3% of doing the same. We are very positive about the outlook for interest rates in 2024 and feel markets will always rise in anticipation of higher earnings and remain elevated in 2024. However, we expect volatility to be a more significant factor in 2024 than markets currently anticipate. We forecast weakness in some sectors as the lagging effect of higher interest rates continues to take effect. We will not be surprised to see markets check back 5% in any given month due to weakening economic activity. This is normal, and we firmly believe any weak economic activity will be met with lower and lower interest rates and further disinflation. In late 2021 and early 2022, the vast majority of professionals thought 10-year rates would peak at 2.5%. They peaked at 5% (we wrote in our letters that 3.5 to 4.0% was realistic). Recently, the US 10-year bond is yielding around 4%. Think ~3% next year, and then consider high-yielding dividend securities with long-term track records of protecting their payouts in tough times and growing them in good times. We also think high-yield debt will do very well as refinancing windows open and financial conditions ease. As soon as we have identified and acquired the next home run idea for the fund, we will gladly write it up. But until then, remember sometimes it's better to have no ideas than to act on a bad one. 

Two facts to leave you with:  

1. Since 1993, only 10% of actively managed funds outperformed their North American benchmark indexes. 
2. You are almost 49% better off (lower risk and/or higher return) to invest in funds where the managers personally invest at least $1,000,000 of their own money. 

The Caravel Capital Fund qualified under both markers. For the month ending November, Jeff and Glen redeemed $250K from their holdings in the fund. The employees of the fund remain its largest investors. 

We would like to wish all our partners a Merry Christmas, happy holidays, and the very best wishes for a prosperous and peaceful 2024. 

We thank you for your continued confidence and capital. 

Jeff, Glen, and Jack