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Jerome Hass is a portfolio manager with Lightwater Partners Ltd. Lightwater manages two long short equity funds: the Lightwater Long Short Fund and the Nimble Fund. He spoke to us about his firm’s investment strategy and shared some of his small cap ideas.
Listen towards the podcast interview with Jerome Hass:http://wpmedia.business.financialpost.com/2016/03/jerome-haas-lightwater-partners-ltd-162216-podcast1.mp3
James West is an investor and also the author from the Midas Letter, an investing research report focused on small cap stocks. The views expressed about this podcast are their own and are presented for general informational purposes only – they ought to not be construed as advice to purchase any securities mentioned.
Transcript of the Conversation:
James West: Jerome, thanks for joining us today.
Jerome Hass: Thanks for having me.
James West: Hey, Jerome, can we start with an overview of the value proposition for clients of Lightwater?
Jerome Hass: Yeah. We run two hedge funds, so we always view ourselves like a hedge fund that hedges. We always believe in having hedging on at all times, and as a result, with our investment style, we are usually largely agnostic to what’s happening on the market. That is, we set a structure in place such that the fund should be able to respond to market conditions at all times. And so we always say you can’t buy fire insurance after the fire; that’s the reason why we also have our short positions and our insurance in position.
James West: Okay, that’s interesting. So you sound like you’re eminently qualified to describe for our audience what exactly is meant by ‘hedging’ and just what exactly is intended with a hedge fund, because you’d be surprised the number of individuals who aren’t in capital markets on the full-time basis don’t actually understand what that means.
Jerome Hass: Okay, well firstly, let’s move on using what a short is. So everybody has got the concept of buy low, sell high on a long position, however when you to understand, they are two independent events. So what a hedge fund can do is, it can reverse the order of those two events, so we sell high and buy low. So consider selling Nortel at $120, buying it back at $4. That’s what a brief position is. And so when we invest, we’ve both long positions and short positions, and what we’re really attempting to do is to emphasize the difference between those long positions and also the short positions to ensure that both can move up or both can go down; it is how they move relative to each other that’s the crucial thing for any hedge fund.
James West: . Okay. Just how does your fund rank in Canada compared to your peers?
Jerome Hass: Well, we run two funds. Therefore the Nimble fund was ranked the very best fund last year; we’d 48 per cent return in the end fees and expenses. Also it seemed to be ranked number 1 in The united states by Preqin. And we also run our flagship fund which has been around for eight years, which was up 6.5 percent this past year.
James West: Awesome. Congratulations on that. So apart from the hedge aspect of your fund, how would you categorize neglect the style, your limitations, your specialties?
Jerome Hass: We’re mid-cap specialists. We concentrate on the Canadian mid-cap market. We look for uncrowded trades that few analysts cover, and that we see persistent and repeatable opportunities in the Canadian mid-cap space simply because there’s much less people that are considering them nowadays.
Andrew Krystal: Andrew Krystal here. Like a portfolio manager at Lightwater, what’s your worst day ever? Worst disaster you’ve ever needed to contend with?
Jerome Hass: Well, the irony in our fund is, when markets really rip, those are in fact generally of low quality days for all of us. So when you receive markets ripping 2 per cent per day, our funds using the insurance in position are always going to underperform in market conditions like that, and people are probably the most frustrating days for the reason that everyone else seems jubilant and enthusiastic, but it is among the downsides of getting a fund with low correlation, is the fact that we do not take part in those enthusiastic days.
James West: Right. So that your speciality is in delivering performance in non-volatile times, whereas everyone else, they hop on the bandwagon and ride the wave up or they jump in to the short trade and ride the wave down; your hedge focus is to be consistently profitable it doesn’t matter what the marketplace is doing?
Jerome Hass: Yeah. I would not state that we don’t prosper in volatile conditions; in January, when the market at some point was down 11 per cent, both of our funds were up at that point. And so volatility is actually something that would be a great advertising tool for all of us. However with our style and process, we are able to remove lots of that industry volatility. And so generally we run about two-thirds of volatility from the index since inception, and that we have low correlation with the market.
James West: Okay. Can you give us some examples of your best success stories in light of that?
Jerome Hass: Well, what we tend to do, we concentrate on the Canadian mid-cap space, and I think both you and your readers have a tendency to focus a little bit more around the small cap space. So we’ve got three small cap suggestions for you, and these are long-only positions.
James West: Great.
Jerome Hass: However the first the first is a reputation I’m pretty sure you’re familiar with: NXT Energy Solutions (TSE:SFD). I understand we read an email that you had on NXT. I know it isn’t the easiest name to understand when it comes to its technology, but we believe it’s well worth the effort. Essentially what their technology does is, it is a less expensive method for companies to identify potential oil wells and gas wells. And so their technology is about 1/30th of the price of 2D and 3D seismic. So consider using a dining table and having three glasses with that table, and thus NXT has a plane that flies across inside a systematic pattern over that, and at no more it, they’ll identify the three spots on the website where you should conduct 2D and 3D seismic, and people would be the three glasses up for grabs.
So instead of doing seismic around the entire table, you are able to concentrate on those three glasses, the region underneath them. And that’s really what NXT’s specialty.
James West: That’s great. I’m relieved to hear someone else realize that; I figured I had been just either delusional or maybe clairvoyant or something like that, but that’s great, yeah.
Jerome Hass: And also the real proof may be the firms that use it. So Pemex, the nation’s oil company in Mexico, the Pakistan National Oil Company both put academic papers on this issue. So a), we think that in a higher level, we’ve got the technology has been validated, but beyond that, we’re practical within our approach, and that we just say, look at who has used it. So Pemex has historically been certainly one of its biggest clients. They recently had their largest ever contract in Bolivia using the national oil company there, as well as in yesteryear, Pacific Rubiales did a kind of blind taste test if you will in Colombia, and that was really the very first test of the technology to see the way it worked relative to their very own existing 2D and 3D seismic.
James West: Okay, so there’s one. What are the other two?
Jerome Hass: We normally avoid resource stocks, but I make the best about this one, because it’s not really a resource play. There’s a company called Khan Resources; KRI may be the symbol. And we think it’s of great interest to investors at this point. To cut an extended story short, they had a uranium mine in Mongolia that was confiscated through the Mongolian government. Which means this was at 2009. They went through the long, arduous process of studying the international court of arbitration, and essentially had a favourable ruling from that.
So these were awarded $100 million USD in compensation. That essentially worked out to about $1.50 per Khan share. So recently, and clearly the share price has been trading below that, because people have long memories of methods long it took Argentina to pay once they defaulted on $100 billion. Well there is a distinction between owing $100 billion and $100 million; it is a lot easier to collect $100 million. So Khan was essentially putting some pressure around the Mongolian government to pay for up, and they recently struck an offer where each side decided to a payment of $70 million USD. So that works out to around $1.10 a Khan share, and that is going to be paid on May 15th.
So you look in the current share price which is trading about $0.80, there is a pretty decent upside there. And also the good news is, other product plans to do any mining or anything beyond paying out the money. Therefore we likely would view it like a cash distribution soon after the receipt. So for us, we see 30 percent potential upside there without any concerns about market risk, and those are the types of trades that people like to focus on.
James West: Great. And also you had a third one?
Jerome Hass: Yeah. A third the first is a business called Callidus Capital Corp (TSE:CBL). And Callidus is definitely an asset-based lender to distressed companies. So Canadians being generally risk-averse in general, they a) can’t stand the fact that they’re lending to distressed companies, and b), they don’t appear to be particularly keen on the CEO.
James West: That’s always an issue.
Jerome Hass: Well, it depends. we think the personality works in our favour, in that a) I think he’s the right guy for running a distressed debt fund, and the other is, I believe he really wants to prove himself in public places markets. So within our instance, we believe his personality is employed in our favour. And there’s been a real disconnect between what’s been happening operationally and the stock price. We believe they’ve gone from strength to strength operationally, yet if you look at the stock price, it’s gone from about $24 to some low around $7 around December. So they’re about to release their results on March 28th; we believe not only will it be a good set of results, there is however another catalyst that needs to be of interest to your readers, and that’s that they have announced four steps they’re going to take in to correct the mismatch between your share price and the operations.
The first they’ve said is, we’re going to introduce a dividend. So everyone like myself thought they’d include a nominal dividend like 1 or 2 per cent; it wound up, it had been a 6 percent dividend when it was announced, and it’s now 8.5 per cent current yield. So it’s attractive enough.
Number two is, they said we’re going to do a normal course issuer bid. So that they executed that, and actually they consumed all of their bullets after November.
The third thing they said these were likely to do is, we’re going to possess a substantial issuer bid. And that’s like a reverse Dutch auction. So we have no idea the timing of that, but we suspect it will be shortly after the quarterly results come out on March 28th. So we can see the impact the substantial issuer bid has already established on the likes of Home Capital Number of late; this really is something that’s designed to address the mismatch between the share price or its trading, and what the management thinks it’s worth. Therefore we see significant upside to that particular. But if it doesn’t, the CEO has been very clear the fourth step is, I will take this private probably at the end of 2016.
So there’s been a report written by CIBC which said the takeout value would be $15.50; CEO has come out very strongly and passionately said hello would be an insult to shareholders to come out having a share price that low, and on his multiple it works to about $21 or $22 per share. So for something that’s trading about $9.30 right now, we believe a), I’m happy to take a seat on an 8 per cent yield; it traded at ridiculously low multiples, it’s trading at approximately C I’m just going to pull-up our numbers here C we’ve got it on, I believe it comes down to, on the forward basis, we’ve it trading at 2.1 x PE or next year, trading for a cheap price to reserve value. We have seen our downside as being limited and our upside to be very good with both the substantial issuer bid and also the potential takeout.
James West: Yeah. Those are three great ideas. That’s awesome.
Andrew Krystal: Jerome, Lightwater Partners, I needed to ask you about sectors. What sectors do you see benefitting most from an environment nowadays seen as a negative rates of interest and anemic GDP growth?
Jerome Hass: We’re agnostic to sectors. We try and remove just as much risk as possible through our pair trading strategies. Then when you consider a pair trade, or when you invest in a stock, you generally have three major risk types: you have the market risk, that is, the marketplace goes up and down; you’ve industry-specific risk, and lastly you have company-specific risk. So the reason we love to pair trading because we view it as being a very precise method to invest, for the reason that, if you feel about a fraction that you have the market risk and also the industry specific risk and also the company specific risk in the numerator, plus the denominator. Therefore we can cancel out or largely lessen the industry-specific risk, we are able to largely lessen the market-specific risk, and what we’re playing is company specific over company specific. So we’re agnostic to sectors.
Andrew Krystal: You mean such as the spiritual metaphor?
Jerome Hass: Yes.
Andrew Krystal: Towards the god of profit imperative.
James West: That’s right.
Andrew Krystal: What exactly relating to this Liberal, Federally, the policy of deficit spending? How can you see that affecting things?
Jerome Hass: Well, I believe there’s a lot of enthusiasm that’s place in to some of these infrastructure plays. We’re skeptical from the impact that they’re going to have, especially the result they’re going to have on productivity. A few of the proposals which have gone through have been in the paper today, such as toll roads on existing highways; less than sure how that affects productivity. If they put it into something similar to the power east pipeline, that’s actually something that would help the productivity and the financial state. However i don’t believe a lot of the proposed infrastructure projects are going to have much of a positive effect on the economy.
James West: Okay, so Jerome, finally, why not provide us with an overview of what kind of clients are most suitable for Lightwater, and just how are you finding them?
Jerome Hass: Well, firstly, we believe all customers are appropriate. My mother is 85 and it is the second biggest holding in her portfolio. Now, she’s a bit biased within this, but our view is the fact that our product is a medium to reduce risk profile. I am talking about, we have two thirds from the volatility, we take less than half the chance of the market, yet we still outperform the marketplace over our eight year history. So we think it’s appropriate for all investors.
A lot of investors tend to come through investment advisors, and we prefer to work with investment advisors as our partners. But we do get some high value people who are accredited investors, who can come straight to us.
James West: Okay. Jerome, that was a fantastic first interview. I wish to thank you very much for the time today.
Jerome Hass: Well, thank you very much to have me.
Andrew Krystal: Take care, Jerome.
