Q&A
Q&A with Mr. Dan Pembleton
Mr. Pembleton, MBA, CFA is the founder & President of Accilent Capital and is registered as a Portfolio Manager, Investment Fund Manager and Commodity Trading Manager.
Gold and precious metals have recently entered a new bull market. I will share what I wrote in April of 2019 in an investor update, when gold was $1250.00/oz, it is now $1950.00/oz. I wrote:
With the Fed’s first meeting in 2019 they did what is the equivalent of a full stop on the interest rate tightening path they began in December 2015. This was a significant departure from what they had been communicating. As recently as September 2018, they were expecting to take rates as high as 3.5% or higher. This significant pause has had repercussions globally. Now, central banks around the world, except for a very few in developing countries which are struggling with inflation, are on hold and/or are expected to be cutting rates soon. How does this affect gold? The mechanism is through the bond markets. This occurs because gold, very simply, is an asset which pays no interest, yet its value is intrinsic, meaning it depends on nothing else for its value. This is unlike other financial assets which depend on someone paying you money for your asset such as a bond’s interest payments or maturity payment in cash. This makes gold similar to the highest rated bonds (no repayment risk with gold), but it pays no interest. When all the central banks have stopped tightening i.e. raising interest rates, bond investors have an increased incentive to “lock-in” their interest rates by buying bonds. This has the effect of lowering interest rates for these bonds. Lower interest rates decrease the opportunity cost of buying and holding gold. Remember, gold pays you nothing to hold onto it, so the opportunity cost for gold is interest that you give up by not holding a bond instead. What has happened since the Fed signaled it would not raise rates anymore in 2019 and would stop reducing its balance sheet, another form of monetary tightening, bonds in general globally have risen in price, driving their yields, the effective interest rate they pay, lower. This move has been so significant that there are now $10 trillion in bonds globally that yield a negative effective interest rate, meaning that at the end of the term of the bond you have less money than you had at the beginning – “negative nominal interest rates” is the term for this. This is even ignoring inflation which further reduces your purchasing power making the bond investment an even worse investment – “negative real interest rates” is the term to describe this. There are many reasons someone would wish to do this but suffice to say that none of those reasons imply particularly good times economically.
All the reasons outlined above are still valid, and even more so now, which is very good for gold. This is a long-term structural feature of the global economy now and it will feed into the gold price for years to come. There are a few other reasons why Natural Resource investing in non-precious metals will also be successful for many years to come. The following examples are taken from the McKinsey Global Institute quarterly report of November 2011 “A New Era For Commodities”. While China’s growth has slowed in recent years since that report, India’s growth has accelerated. The effect of COVID will be to slow the global economy temporarily. However, the coordinated global efforts to reflate all economies make the below points just as valid in a reasonable investment time horizon as they were in 2011, the year of the original article.
Some interesting points from the article.
With the Fed’s first meeting in 2019 they did what is the equivalent of a full stop on the interest rate tightening path they began in December 2015. This was a significant departure from what they had been communicating. As recently as September 2018, they were expecting to take rates as high as 3.5% or higher. This significant pause has had repercussions globally. Now, central banks around the world, except for a very few in developing countries which are struggling with inflation, are on hold and/or are expected to be cutting rates soon. How does this affect gold? The mechanism is through the bond markets. This occurs because gold, very simply, is an asset which pays no interest, yet its value is intrinsic, meaning it depends on nothing else for its value. This is unlike other financial assets which depend on someone paying you money for your asset such as a bond’s interest payments or maturity payment in cash. This makes gold similar to the highest rated bonds (no repayment risk with gold), but it pays no interest. When all the central banks have stopped tightening i.e. raising interest rates, bond investors have an increased incentive to “lock-in” their interest rates by buying bonds. This has the effect of lowering interest rates for these bonds. Lower interest rates decrease the opportunity cost of buying and holding gold. Remember, gold pays you nothing to hold onto it, so the opportunity cost for gold is interest that you give up by not holding a bond instead. What has happened since the Fed signaled it would not raise rates anymore in 2019 and would stop reducing its balance sheet, another form of monetary tightening, bonds in general globally have risen in price, driving their yields, the effective interest rate they pay, lower. This move has been so significant that there are now $10 trillion in bonds globally that yield a negative effective interest rate, meaning that at the end of the term of the bond you have less money than you had at the beginning – “negative nominal interest rates” is the term for this. This is even ignoring inflation which further reduces your purchasing power making the bond investment an even worse investment – “negative real interest rates” is the term to describe this. There are many reasons someone would wish to do this but suffice to say that none of those reasons imply particularly good times economically.
All the reasons outlined above are still valid, and even more so now, which is very good for gold. This is a long-term structural feature of the global economy now and it will feed into the gold price for years to come. There are a few other reasons why Natural Resource investing in non-precious metals will also be successful for many years to come. The following examples are taken from the McKinsey Global Institute quarterly report of November 2011 “A New Era For Commodities”. While China’s growth has slowed in recent years since that report, India’s growth has accelerated. The effect of COVID will be to slow the global economy temporarily. However, the coordinated global efforts to reflate all economies make the below points just as valid in a reasonable investment time horizon as they were in 2011, the year of the original article.
Some interesting points from the article.
- Demand for energy, food, metals, and water should rise inexorably as 3 billion new middle-class consumers emerge in the next two decades.
- The global car fleet…is expected to almost double to 1.7 billion by 2030.
- China… could annually add floor space totaling 2.5 times the entire residential and commercial square feet of Chicago, while India could add space equal to another Chicago each year.
These types of macroeconomic observations are the starting point for construction of the Investment Thesis. In order to discuss the Investment Thesis it is most useful to look at features of the Fund and highlight how those features came to be.
Firstly, the underlying investment objective of the Pavilion FT funds is to make money on investors’ capital regardless of the tax incentive they receive for investing. When investing in anything, be it bonds, stocks, real estate, etc., as soon as you have made the purchase you have taken on the full risk of owning that asset. Saying to yourself, “as soon as I break even on this asset I am going to sell it” immediately severs the potential to realize the full benefit of taking on the risk of owning the asset in the first place. In the Pavilion funds that possibility of returns is cultivated and returns are actively pursued.
Well, from the above decision some facets of the investment structure naturally emerge. In order to achieve returns in the resource sector time is needed. Some stocks need less time and some will need more. The term of the Fund should not be so short that investee companies don’t have several drilling seasons to grow their resources, develop, and communicate value. On the other hand, the term should not be so long that the Fund completely ignores that harvesting gains and reinvesting in new opportunities while collecting a tax incentive is also productive activity for wealth building. Therefore, the maximum term of the Fund is 63 months, although it can be less.
This longer term brings about another key structural feature of the Pavilion fund. A cash exit, not a mutual fund rollover like most of the competitors, is used to exit the fund. The main reason for this style of exit relates to the statement, “Some stocks need less time, some will need more”. Each stock is unique and when building an initial portfolio it is taken into account that this is a unique sector that is more like venture capital investing; some stocks will be very successful and some will not. Rebalancing such a portfolio is deterred, so each position is managed based on its given individual circumstances. What this means is, as soon as a portfolio is formed each stock begins its own path. Decisions about each stock must be made along the way. Some will perform well early in the fund’s term so some profit and risk may be taken off the table, thus necessitating a sale. Other stocks may disappoint and a choice is made to go into harvest mode on that stock. Each of these decisions drives a sale of stock and cash may be returned to investors as a distribution cheque. This distribution method is employed throughout the term of the fund.
The other major structural decision that was made in designing the product was to allow both Oil and Gas as well as Mining and even Alternative Energy in the fund. This was done for two reasons. First, by allowing more resource sectors, the universe of stocks to invest in becomes larger which hopefully translates into an overall better performance and second is the increased diversification. While O&G and mining are both resource sectors they can diverge in overall returns and diversifying between them benefits the portfolio and investors.
Those are the three big structural/strategic features of the pavilion funds. The rest of the investment thesis could also be called the investment method or the tactical side of constructing and managing the portfolio.
This longer term brings about another key structural feature of the Pavilion fund. A cash exit, not a mutual fund rollover like most of the competitors, is used to exit the fund. The main reason for this style of exit relates to the statement, “Some stocks need less time, some will need more”. Each stock is unique and when building an initial portfolio it is taken into account that this is a unique sector that is more like venture capital investing; some stocks will be very successful and some will not. Rebalancing such a portfolio is deterred, so each position is managed based on its given individual circumstances. What this means is, as soon as a portfolio is formed each stock begins its own path. Decisions about each stock must be made along the way. Some will perform well early in the fund’s term so some profit and risk may be taken off the table, thus necessitating a sale. Other stocks may disappoint and a choice is made to go into harvest mode on that stock. Each of these decisions drives a sale of stock and cash may be returned to investors as a distribution cheque. This distribution method is employed throughout the term of the fund.
The other major structural decision that was made in designing the product was to allow both Oil and Gas as well as Mining and even Alternative Energy in the fund. This was done for two reasons. First, by allowing more resource sectors, the universe of stocks to invest in becomes larger which hopefully translates into an overall better performance and second is the increased diversification. While O&G and mining are both resource sectors they can diverge in overall returns and diversifying between them benefits the portfolio and investors.
Those are the three big structural/strategic features of the pavilion funds. The rest of the investment thesis could also be called the investment method or the tactical side of constructing and managing the portfolio.
Diversification by:
-
Sector – as already stated O&G or Mining or Alternative Energy
-
Within sector, for example within mining:
- Precious metals
- Base metals
- Minerals like potash/phosphorous
- Uranium
- Rare earths
-
By Geography – restricted to within Canada for the tax benefits so it is less important but still a worthwhile endeavor if a choice presents itself.
-
By development stage.
- Very early stage – often private companies which we can do because a three year mandate gives enough time for companies to get listed and provide that bump in value. Another example of the 3+ year structure giving us an investment opportunity.
- Late stage exploration/ Pre-feasibility
- Feasibility study
- Mine startup or restart
- Currently producing mines
Great question, and one that has multiple approaches.
- Management:
The biggest influence on a stock’s value growth is the management team so this is paid attention to at first. Good management is key because they get better access to good properties, negotiate better Joint Ventures and other deals, are hopefully, more efficient with exploration dollars, and can raise exploration money in tougher times keeping a stock on track during lean years (recent history is a good example of that). It doesn’t mean we would never invest with someone who isn’t as proven, but other factors would have to compensate such as a smaller exposure in the portfolio and a prime property. - Property:
Is it likely to have something interesting? “The best place to look for gold is next to a gold mine”. Simple but true. However, the property can’t be drilled like Swiss cheese and have nothing to show for it. What do the option deals look like? - Capital Structure:
20mm or 200mm shares out. Who owns the stock? What price are the warrants outstanding at? What is liquidity like?
One method is through our “Elite investor” relationships. The Fund has relationships with, and therefore deal access to, some of Canada’s best known (at least in investment circles) investors. Generally speaking, when invited to invest in one of these deals the opportunity is seized. This is a pure case of investing with the management. Because these people have proven themselves time and again, the odds of doing well increase. Why do these guys like us? We are good shareholders. The three year term means the shares just bought aren’t out there in six months be flogged, and the cash exits means the whole position doesn’t have to be sold in a matter of days, trampling the stock prices in the process and causing management headaches and distracting them from the real value building activities.
Secondly, in house research: New companies and ideas are constantly being sought and when one is found company management is approached about getting involved.
And thirdly, Brokers: Good brokers bring good deals. We are bombarded with deals all the time. The biggest players are not necessarily, and actually quite probably not, bringing the best deals. We work with brokers that have brought us, or others, winning baskets of deals before.
Secondly, in house research: New companies and ideas are constantly being sought and when one is found company management is approached about getting involved.
And thirdly, Brokers: Good brokers bring good deals. We are bombarded with deals all the time. The biggest players are not necessarily, and actually quite probably not, bringing the best deals. We work with brokers that have brought us, or others, winning baskets of deals before.
The fund is kept small (maxed at around $20mm range per year) for a few reasons.
- Deal flow:
There are only so many great deals out there and particularly with the “elite investor” approach. These deals have to have a significant influence on our portfolios, so growth is curtailed as to avoid diluting that aspect of our investment process. - Liquidity:
These shares eventually have to be sold so taking in too much money won’t allow the positions to be exited in a way that maintains good relationships with investee companies. - Customer service:
Accilent is a boutique firm, if the funds grow too large that edge would be lost. - Nimbleness:
If something is singled out, whether it is a sector/ sub sector or a stock, the funds need to be small in order to meaningfully increase the concentration in that area without compromising the other investment objectives/restrictions. E.g. “If we like Uranium this year, a lot, if we want to bring the portfolio to 25% uranium we only have to find $5 or $6 million in deals to do it and would only have to sell $10mm (or more hopefully) in stock at the end to get out. If we were raising $100mm I would be looking at $25mm and $50mm. So, it is much harder and perhaps impossible to do.” - Scarcity value:
A smaller size creates a little scarcity value for the Pavilion fund and that will serve to improve the Fund’s standing over the long term by not rewarding procrastination by clients and rewarding action. If only $20mm of investment room is available in a year, then it is likely supply would have to be rationed and procrastinators will miss out. This should help encourage earlier action by investors making portfolio construction easier and increasing returns.
Sure. We first look at the big picture and decide on a few major allocations and themes. The first one each year is the O&G vs. Mining decision, which currently is approximately 5%/95%.
Another major theme I have looked at positively over the past few years is Gold and Precious metals. My aim is for 60% maybe 70% of Precious metals in the portfolios. The rest of the sub-sector diversification will create itself based on deal flow and quality unless it seems necessary to intervene specifically to make sure the position isn’t under or overrepresented.
On other aspects of diversification, such as geography, no goals are set but careful monitoring is set in place and geography could be a tiebreaker in final selection. The rest of the process is very dynamic. Because reliance is on companies “coming to market” it’s not like going through a shopping list. It’s a bit like going to the farmer’s market. If no one comes with strawberries it does not matter how much you might want them, you are not getting them, and had better decide quickly how many blueberries you want instead before they are gone. It really is like that.
The other twist is you often do not know how much money you have to invest. So, while you may really like something and think you have put a good emphasis on that company, more money comes in after that deal closes and you have no choice but to buy something else and therefore reduce the emphasis you thought you were placing on the previous investment(s).
It is this complexity and dynamic aspect of FT investing that makes it difficult and also return enhancing and rewarding.
Another major theme I have looked at positively over the past few years is Gold and Precious metals. My aim is for 60% maybe 70% of Precious metals in the portfolios. The rest of the sub-sector diversification will create itself based on deal flow and quality unless it seems necessary to intervene specifically to make sure the position isn’t under or overrepresented.
On other aspects of diversification, such as geography, no goals are set but careful monitoring is set in place and geography could be a tiebreaker in final selection. The rest of the process is very dynamic. Because reliance is on companies “coming to market” it’s not like going through a shopping list. It’s a bit like going to the farmer’s market. If no one comes with strawberries it does not matter how much you might want them, you are not getting them, and had better decide quickly how many blueberries you want instead before they are gone. It really is like that.
The other twist is you often do not know how much money you have to invest. So, while you may really like something and think you have put a good emphasis on that company, more money comes in after that deal closes and you have no choice but to buy something else and therefore reduce the emphasis you thought you were placing on the previous investment(s).
It is this complexity and dynamic aspect of FT investing that makes it difficult and also return enhancing and rewarding.
Glad you asked. The Pavilion structure is actually designed to outperform other funds in all markets but especially in bull markets, this is when we really shine the best. So, through thick and thin, we stick with our structure. Pavilion has, in fact, outperformed almost all other FT funds in Canada over its 12-year life span, including during the worst and longest bear market in decades. If you had invested in all our funds since inception in 2008, you would have experienced an average return per fund of just over 110% on your capital at risk as of July 31st, 2020. Those returns are calculated including the large tax benefits that come with FT investing. I don’t believe there is another FT fund that can say this. As of this writing our 2019 offering is showing returns on capital at risk of 200% or more depending on the Province of the investor (and therefore their top tax rate).
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