Bend, but don’t break – 3rd quarter, 2017
Flexibility is crucial to investment success. Investing means making choices, and having flexibility increases your opportunity set. More selection doesn’t guarantee success, but it certainly helps. EdgePoint Growth & Income Portfolios are structured for flexibility, both at the mandate and Investment team levels.
Flexible on paper…
We strive to be flexible with our investment approach, ensuring that we’re investing in ideas because they’re the best use of capital at the time. This flexibility in the Growth & Income Portfolios starts with the wide capital allocation band and the types of fixed income we can invest in. The fixed-income weight of the balanced Portfolios can be as little as 25% to as high as 60%. The ability to change our fixed-income allocation is a powerful tool that allows us to manage the Portfolios’ risk and long-term return potential. Our flexibility is further enhanced by our ability to invest in any type of fixed-income security across the globe. We primarily focus on corporate bonds as we believe that we have an edge in deep credit analysis, but during periods with tight spreads (and high prices), we can look at alternatives. We’ve invested in investment-grade bonds, high-yield bonds, unrated securities, leveraged loans, preferred shares and convertibles giving us tremendous flexibility to uncover value. You can’t predict where our due diligence will lead us, but our broad investment mandate ensures that we can take advantage of any potential opportunities we uncover.
…and in person
I believe our greatest advantages at EdgePoint are the Investment team’s flexibility and willingness to analyze different parts of the capital structure. Everyone on our Investment team thinks of themselves primarily as business analysts and don’t limit themselves to being a “bond” or “equity” guy. If we’re intrigued by the fundamentals of a business, we endeavour to find the best way to capitalize on our investment thesis. This could lead to an equity investment, a fixed-income investment or a combination of the two. By taking a business centric view of the capital structure, we’re often able to take advantage of relative mispricing and find opportunities that wouldn't be as apparent to an investor focused solely on one asset class.
We believe our professional curiosity and thorough due diligence help us find opportunities, but the unconventional structure of our Investment team makes it possible. Most investment firms have a defined fixed-income and equity team. Although these two groups work for the same company, they compete for investment ideas, investor flows and marketing dollars. They’re technically on the same team but in reality, the operating structure divides them. The EdgePoint Investment team is encouraged and incented to share ideas, looking for both attractive fixed-income and equity opportunities. Many investment ideas start out as potential equity investments and end up producing a fixed-income opportunity or vice versa.
Alere Inc. – A holistic diagnosis
A great example of our cross pollination is our long standing position in Alere. We have owned varying weights of Alere’s equity since 2009, but over that time we've also owned three issues of its subordinated debt and its convertible preferred shares.
Most investors are familiar with our thesis on Alere, one that centers around its leading intellectual property in health care diagnostics. Its founding CEO built a solid business, but several acquisitions left it with a complex balance sheet. Our due diligence led us to believe that there were numerous chances to capitalize on our thesis, starting with Alere's equity but evolving to include a number of interesting fixed-income opportunities.
Our balanced funds benefitted from our initial equity due diligence, allowing us to invest in several of Alere’s high-yield bonds. We were satisfied that the yield these bonds generated more than compensated us for the company’s credit risk. As we became more familiar with the business we realized that the convertible preferred shares represented an interesting opportunity. We felt that these securities had equity-like upside and less risk as they were higher in the capital structure.
The balanced funds made the initial investment in the convertible preferreds, but over time EdgePoint Global Portfolio and Cymbria also participated. Although these Portfolios are predominantly equity-focused, they will invest in fixed income when the opportunity is compelling.
Although we were confident in our thesis, we were cognizant that we could be mistaken and sized all positions accordingly. When we own different securities from the same issuer, we look at our aggregate exposure and don’t let the combined position grow larger than what we deem appropriate.
Abbott Laboratories’ acquisition of Alere closed on October 3, 2017 marking the end to a series of long and profitable investments across EdgePoint Portfolios. Although there were bumps along the road, our thesis ultimately played out and our Portfolios benefitted greatly.
As shown below, all of our investments in Alere’s capital structure were pleasing. It’s a fixed-income investor’s dream to find an investment with equity-like upside and seniority in the capital structure, and the convertible preferreds fit the bill.
|Type||Equity||Preferred||9% 2016||8.625% 2018||6.5% 2020|
Origami and yoga
We believe that EdgePoint Portfolios benefit from flexibility in their structure and that of our Investment team. We strive to find attractive investment opportunities and to capitalize on our theses across different parts of the capital structure. Over the past year credit spreads compressed materially and the probability of interest-rate hikes in North America increased. Investing late in a business cycle, in a market with historically tight spreads and greater interest-rate risk, demands prudence and thorough analysis. We believe that the importance of a flexible investment approach is more important now than ever.