Quarterly Bulletin Q2 – 2016

A multitude of risk factors have unsettled the markets during the first six months of the year. Britain’s decision to exit the European Union (51.9% vs 48.1%) has sent shock waves through financial markets and rattled investors who underestimated its risk. It is the most recent and blatant example of the growing global trend towards protectionism. It will have tremendous repercus- sions on the geopolitical landscape including this fall’s US election.

Quarterly Bulletin Q1 – 2015


The first quarter of 2015 saw weaker than anticipated economic data south of the border. However, accompanying this slowdown in consumption, which was deemed temporary, was a new injection of stimulus to the global financial system. In theory then, we have a recipe for US stock prices to rise in the coming months, that is, unless geopolitical risks spoil the mix…


Quarterly Bulletin Q4 – 2014


Risk Taking is Still in Fashion

At long last Q4 2014 saw the return of volatility to financial markets, a healthy and even desir-able event for markets which lately have been a little too linear. While the US, UK and Canada seem to be planning an increase to their prime rates in 2015, Europe is going in the opposite direction, injecting stimulus wherever they can. Across the Pacific, Japan continues its “monetary experiment” by flooding its economy with liquidity 4-5 times what the US employed in its post-crisis programs. Central banks pur-sue diametrically opposed paths, and while investors are questioning the impacts, they are not modifying their allocation to risk, at least for the time being…


Quarterly Bulletin Q3 – 2014


Q3 2014 allowed some financial terms, absent from our lexicon for several years to resurface. Indeed, despite globalization which has been accelerating for decades, many economists and investors are now once again arguing in favor of the “decoupling” of economies to the benefit of the US and UK and to the detriment of Europe and Japan.

A More Positive North-American Landscape

After a disappointing first quarter, economic data in the US & Canada improved markedly, contrary to what we’ve seen in Europe. Whether looking at leading economic indicators, GDP, or industrial production,Canada and the US did well. On the other hand, inflation remains low, the labor force participation rate in the US has resumed its downward trend, and some sectors, notably the automotive, appear to be fundamentally driven by “very accommodative” credit conditions. In short, North American growth continues, but at a slower pace. In Europe, the situation is definitely less rosy, with confidence measures, leading economic indicators and consumption all down, this time not only in peripheral countries, but also in Germany.

Optimism vs. High Expectations vs. Central Banks

The scenario seems to be repeating: Economic expectations are still high, and markets remain prone to risk-taking, however reality may be disappointing. Central banks are on diverging tangents, with anticipations for significant and rapid rate hikes in the US and UK, whereas in Europe and Japan, investors clamor for more quantitative measures. With emerging countries experiencing moderate growth, and global growth hovering around only 3%, there is a good chance that economic forecasts for the US and the UK are overly optimistic and that the market will once again be letdown by the “decoupling” theory. Oil prices, however, could act as a counterweight. With the price at the pump in the US hovering around $3.50 per gallon, it is at its lowest level in four years. The result is a defacto tax break for all consumers which may serve to stimulate consumption through the end of the year.

In the short term, the probabilities of a recession in Canada or the US remain very low; rather the economy will more likely produce further moderate growth, an outcome that should continue to support risky assets. It is worth noting that on a total return basis, medium and long term North American bonds remain attractive relative to equity markets; however, we consider the European bond market far too expensive when compared to the US and Canada.

Market Reflections Q3 - 2014 Table


Fixed Income

The fixed income arbitrage segment contributed positively to the Fund’s overall performance, but to a lesser extent than during the first half of the year. Within the “credit” sub-portfolio (i.e. spreads), positive performance was driven primarily from positioning on the curve, which maximized the “rolldown” component. The Beta, i.e. the duration of the long portion of the portfolio, is still shrinking. We have also been able to add value via the interest rate curve. Our positioning, based on an anticipated flattening of the short end of the curve in Canada, was very favorable this last quarter. We are similarly positioned in the United States, but because the curve has remained steep, no gain was generated.

From a credit standpoint, the last quarter in 2014 began as the mirror image of Q3. We are employing all of the capital allocated to this strategy, but our general positioning remains very cautious. The Beta is low, still awaiting a timely decline to add to our positions. When this occurs, government credit (provinces, municipalities, agencies) will be favored as they offer a better return on capital (ROC) when compared to corporate credit.

Our expectations on the yield curve remain unchanged, and in fact, our convictions have been strengthened. We continue to foresee a flattening of the curve in Canada and the US in the 5 year and under sector, and a steepening beyond the 5 year horizon. Our outlook remains the same; we do not expect a bullish or bearish movement in the key interest rate in Canada or the US for at least a year. We are therefore looking to profit from the very steep portion of the interest rate curve, particular- ly in the US.

Market Events

The market event segment of the portfolio was active with 36 new arbitrage situations added to the portfolio in the quarter; all tied to mergers and acquisitions. Of these, 25 were played in a conventional manner, i.e. through the purchase of the shares of the target, 4 using the spread between a subscription receipt of the acquirer and the shares, while in 7 situations we were able to use the target’s debt to lower the overall risk level of the arbitrage position.

The results of the 3rd Quarter showed little impact of an aborted transaction in September. The Fund suffered a loss of 1.5%, within our maximum loss limits per position, when Auxilium Parmaceuticals (AUXL), which was to be acquired by QLT Inc. in a share deal, itself become the target of a takeover bid by another pharmaceutical company. At a 50% premium this new offer obviously led to a significant loss on the short position initially established on AUXL, in combination with the QLT share price falling below pre-deal levels. A perfect storm in fact, but one that left few traces, as the rest of the portfolio performed well during the period.

The decline in rates has encouraged more issuers to refinance their debt at a lower cost, and we were able to extract attractive returns from announced redemption events. We are also actively increasing the use, where possible, of a combination of shares, convertible / straight debt or even options, of companies involved in announced merger and acquisition deals. The goal: To ensure the best possible risk / return profile for the arbitrage position, while still seeking to protect capital (see example in box).Market Reflections Q3 - 2014 Text

It is only because of the proximity and collaboration of Amethyst’s three mangers (Mathieu in fixed income, Bradley in convertibles and Marc in mergers and acquisitions), that we can conduct our analysis of merger and acquisition transactions in a broader context to determine the optimal recipe for possible inclusion in the portfolio. This edge, which few competitors can offer, is based primarily on the divers and complementary skills of our mangers. It is a symbiosis that would be hard to envision or replicate outside of a hedge fund.

Convertible Securities

Convertibles continued to perform in the 3rd quarter despite low volatility and a lack of new issuance. The focus throughout
the quarter was on aligning our hedges, optimizing our positions and maintaining our defensive puts. Our continued diversification away from materials has held us in good stead despite the drop in commodity prices during the period, and we ended the quarter with less than a third of the convertibles sub-portfolio in energy and materials. Newly added positions have been in either larger, more liquid credit issuers or have been added at relatively reduced weighting in the portfolio so as to remain nimble. Prudence has been of the essence in this uncertain economic environment.

Returns were somewhat limited by a lack of volatility with coupon income becoming a larger driver of returns as a result. Credit spreads have been consistent with a general tightening bias. Despite the continued low volatility, we have been tactically trading some of our core positions by reacting to motivated buyers and sellers and being an opportunistic liquidity provider. We also continue to exploit the continuing evolution of the Canadian bank sector’s capital structure through systematic preferred share redemptions although this opportunity has become slightly less lucrative as their intent has become well telegraphed.

We continue to maintain market puts using “in the money” US convertibles. As the underlying equity has risen, we have rolled into issues with lower absolute value to maintain the put value. This way we maximize the hedging effect should markets decline systematically. We have also been enhancing the realized return using “out of the money” options with high implicit volatility with some success. In contrast to Q2, the new issues market has been quiet, with no new names added to the sub-portfolio via primary markets.

We believe that we are well positioned going into Q4 with liquid positions of relatively high coupon, high quality credits at the core of our Canadian convertible portfolio. We remain cautious and expect modest returns in Q4 as economic and geopolitical uncertainty persist.

Market Reflections Q3 - 2014 Graph


On the eve of the closing of a fifth year of consecutive economic expansion and continued increases in North American stock markets, the positions our portfolio reflect a prudent approach. Special emphasis is placed on liquidity and protection of downside risk in order to maintain our ability to participate in the many ad hoc arbitrage opportunities, while ensuring that we can make an exit in the event that markets falter.

Marc Amirault
Principal Manager

Quarterly Bulletin Q2 – 2014


Since the last phase of “QE” in September 2012, markets have remained largely prone to risk-taking. Despite certain sectors of the market becom- ing increasingly frothy (High Yield and European Bank Credit in particular), risky assets continue to be bid up, driven by massive central bank intervention since the crisis. Just recently, the European Central Bank (ECB) once again intervened by lowering its key interest rate and by providing low interest loans to non-financial companies (the new LTRO program). Understandably, this move favored riskier Eu- ropean assets and helped to significantly decrease the cost of borrowing for countries in the Eurozone. The impacts are clearly evident: Spain and Italy are borrowing at levels never before seen… Not bad for countries with anemic growth, staggering unemployment and rising national debt!

Surprise decline in the U.S. in Q1, but course maintained

U.S. first quarter GDP was more affected by the cold temperatures than many believed. Accompanied by a slight decrease in invento- ries, economic activity in the U.S. fell by 2.9% during this period. However, data from the end of April showed encouraging signs and employment demonstrated average gains of over 200k per month. Since the beginning of the year inflation has rebounded slightly, but concentrated mostly on energy and food prices, not wages. In Canada (GDP Q1 = +1.20%), the positive growth was driven by an increase in consumption, strong demand in the resource sector (solid industrial production growth) and exports, spurred-on by the correction of the Canadian dollar. The second quarter also looks solid, but with less robust levels of construction.

Just like the first quarter, economic expectations remain strong for the second half of 2014, but the risk is that results may be much more measured. Paradoxically, companies continue to gener- ate record profits and outlooks remain positive although capital expenditure (capex) is anemic. Nevertheless, it is our opinion that the likelihood of a Canadian or USA recession remains very low in the short-term. Notwithstanding the potential external shocks or crises mentioned in our last newsletter, the North American economy is likely to continue its slow advance, a scenario which remains supportive of risky assets.

Nevertheless, the imminent end of the U.S. QE program, recent increases in rates at the short-end of the curve and complacent valuation of certain assets, could all three drive an increase in volatility in the coming months. In the event that any weakness materializes, the decline may be short-lived, but of significant amplitude. Careful selection of asset mix and investment horizons, accompanied by appropriate risk hedging is imperative in such an environment.


Q2 - 2014 Table (EN)

Fixed Income

Like in the first quarter of 2014, the fixed income arbitrage segment of the portfolio had a positive contribution in line with the Jan-Mar period. Even the “credit spread” segment, which consists of more directional positions, although of a much smaller overall weight, performed well.

The tightening of credit spreads in some provinces, notably those in Quebec, as well as maximizing the “Rolldown” component of the portfolio were supportive of the positive results, despite a low Beta. The evolution of the interest rate curve was also favorable. Strategic positioning in this sub-segment benefited from flattening at the short end of the curve in both Canada and USA, while at the tactical level, we took advantage of range bound pricing at the long end of the curve on both sides of the border.

The third quarter began with an almost maximum allocation of capital to the fixed income arbitrage segment, however strategic positioning on credit spreads remain very prudent. Although markets continue to be “risk on”, the portfolio’s beta has been kept deliberately very low. For markets, the steady march upward continues, however, we believe that certain inves- tors are becoming complacent, ignoring the risk / return trade off. Therefore, the duration of the credit spread segment will only be in- creased on a material widening of spreads, and in the meantime, we will remain patient. Our expectations on the interest rate front remain unchanged, i.e. no movement in Canada or the United States for quite some time (12-15 months). In both Canada and the USA, we continue to anticipate a flattening of the yield curve in the 5 year and under, and a steep- ening of the curve for longer maturities. Our few directional positions seek to profit from the current unusually acute slope of the curve, es- pecially in the USA.

Convertible Securities

A rising tide lifts all ships, pushing up equity and bond prices, through tightening bond spreads. The Canadian convertible universe continues to exhibit improving underlying fundamentals and valuations, tightening spreads (50 bps during Q2) but, unfortunately for arbitrageurs like us, little to no volatility. While we keep making money as perceived credit improves, our continued commitment to adhering to our delta hedge and protecting fund capital guarantees both underperformance relative to equity indices and protection for our investors from a reversal of the uninterrupted advance in these indices.

The lack of volatility, manifest since the almost uninterrupted run-up of equity indexes began in 2009 remains an undesirable opportunity cost. Although this does not result in negative performance, it does limit performance by depriving the convertible debt sub-portfolio of one of its two sources of returns: the dynamic component, generated by constantly adjusting deltas as the price of the underlying stock changes. With few opportunities to cover short positions on a pullback of the underlying equity, the full capture of the embedded option premium is incomplete.

In contrast, one thing that appears to be changing recently is liquidity and the number of new issues. We have been able to improve diversification in the convertible portion of the fund with quality new issues in Canada. While listing of the one billion dollar BlackBerry convertible was a non-event as only $4,000 face value traded, there being only three holders, other new issues have been liquid. We added 10 Canadian convertibles in the second quarter, of which 5 were via new issues, and all outside of the materials sector and of decent quality and pricing.

The Fund’s performance, although not earth shattering in the second quarter, bodes well. We strived to offer a satisfactory return to those who feel that the recent increase in equity valuations is suspect given the economic landscape. We do our best to maintain a balance between preserving upside potential while protecting investor capital against a market correction. In this latter regard, we are well hedged and would profit from a little volatility while maintaining a decent carry.

Q2 - 2014 Graph (EN)

Market Events

The upsurge in mergers and acquisitions, for which we have impatiently waited for quite some time continued into the second quarter in Canada and even accelerated in the US reaching a new record. The Fund participated in 13 Canadian transactions out of a total of 25 during the period, as reported by Bank of America Merrill Lynch. The only cancelled transaction was Transglobe Energy when the acquirer, CRCL, itself received and accepted a purchase offer from Glencore. The cost of the cancellation, however, was limited to less than 30 bps.

In the U.S., the record level of activity comes in part from pharmaceutical companies seeking to reduce their tax burden through the acquisition of companies located in countries with a lower tax rate (“Tax Inversion”), allowing them to relocate certain activities. We can expect the U.S. government to block this tax leakage as soon as the two chambers reach an agreement. Meanwhile, the number and size of transactions to arbitrate and the resulting spreads have turned very attractive. But just as in the Canadian segment, the Fund also experienced one deal failure in the U.S. when a buyer (MSM) became prey to a hostile bid. However, we were able to react very quickly by covering our short position on MSM and going long, even before the official market open thereby limiting the impact to 20 bps.

We continue to innovate and diversify, combining mergers and acquisition with fixed income, convertibles, and listed options. By hedging, to the extent possible, a transaction using options and equity, but using the long convertible bond as the main arbitrage instrument allows to comingle 3 important dynamics: a) a limited downside to a merger situation where the outcome is uncertain; b) a positive carry along the way, without an opportunity cost due to closing delays; and, c) still generate a generous return should the deal close as expected. The DFC Financial transaction illustrates this strategy, with a position that generated 25bps (or over 5% on capital usage) in the quarter alone.

From April to June, a total of 5 M&A positions were added to the portfolio through the target’s convertible debt. Finally, the Canadian market abounds in preferred shares issued by banks after the 2008 crisis, which are now subject to redemption. The portfolio has included 11 of these positions during the same period.

Crystalline is one of only a handful of managers offering expertise in each of the Event Driven/M&A, Convertible and Fixed Income arbitrage strate- gies, a combination that adds to our edge vs. our competi- tion who tend to stick to one or another of these strategies.

We recall the difficult period surrounding 2012 and the first half of 2013, which was marked by a sequence of negative events of unusual intensity and frequency (“fat tail” type), then followed by a sharp decline in valuations in a substantial part of the convertible portfolio. This plight, a first since the Fund’s crea- tion in 1998, was finally extinguished around June 2013.

Since then, Amethyst has generated an annual return of 8.1% (6.2% offshore), with an annualized volatility of less than 3.3%. This performance exceeds that of the short-term 3-month rate by nearly 7.1% (6.0% offshore), and reminds us of the long 10 year period from July 1998 to June 2008 when the Fund had an average annual return of 6.9% above the risk free rate, with a volatility of 4.6% and on average had positive returns on 9-10 out of 12 months.

Although we cannot predict the endurance of this new period of normal returns, we are encouraged by the quality of the issuers in our convertible portfolio, the increasing mergers and acquisitions activity, and the almost complete deployment of the Fund’s available capital.

Marc Amirault
Principal Manager
mamirault@arbitrage- canada.com

Quarterly Bulletin Q1 – 2014


The first quarter 2014 will have been, for the nth time since 2009, favorable to risk assets! Despite a more difficult January, February and March have been profitable for the main global asset classes. Major stock exchanges performed well and demand for credit product remains very strong, particularly for lower quality assets. In contrast, certain sectors and sovereign regions remain under pressure.

Many emerging markets were forsaken during this period, leading to a decline in their stock markets and currencies. In China, less rosy economic data combined with suspicions of looming bank credit problems,

have affected the price of some base metals, in particular copper, with a correction of almost 10%. In Canada, the materials sector sub-index appears not to have been unduly affected, recording an increase of over 9% during the same period.

In the U.S., Q1-2014 data was weaker than anticipated by most economists. The blame was placed squarely on an abnormally cold and capricious winter in the eastern half of the continent, enough so that it slowed economic activity. In spite of this, the majority of analysts remain optimistic, expecting a reversal of the weakness seen in Q1 in subsequent quarters. We are, however, less convinced of this “transient” weather effect.

Cautious Optimism

To sustain or even increase the value of risk assets, companies will have to reinvest their excess liquidity, otherwise the gap between the real and paper economies may become unsustainable. We expect the FED to continue its exit from the current “QE” program, as the marginal contribution to the economy seems to be increasingly benign. Emboldened risk taking in the race for returns and share repurchases financed through bond issues at near zero marginal cost, seem to be the primary outcome of this endless supply of cash. In theory at least, the “QE” program should be concluded this fall so as to avoid a further escalation of risks. In contrast, we believe that the chances of the FED increasing the key interest rate is more remote than the market is anticipating.

Certain factors and developments with the potential to disrupt the current course of the global economy deserve special attention:

• The winding down of QE and the evolution of inflation

• Credit problems in China and the crisis in Ukraine

• Constrained market liquidity in the event of investors repositioning to “Risk Off”

• Emerging markets and the U.S. technology sector.


Q1- 2014 Table (EN)

Fixed Income
The year started off well with a positive performance through the first quarter. The fixed income portfolio’s primary segment, focused on carry from credit spreads, began 2014 defensively positioned in the hope of increasing exposure at more attractive levels. Unfortunately, the appetite for risk did not abate during the quarter, making it difficult to find and profit from abnormally high spreads as desired. Nevertheless, this purely non- directional segment contributed positively to performance, although its low beta limited gains.

Positions on both Canadian and U.S. yield curves were also profitable in the first quarter, particularly in January. The original position, based on the expectation of the curve flattening both in Canada and the U.S., benefited from January’s significant decline in rates.

The second quarter begins again with a defensive stance in credit spreads and very low beta. As in Q1, we continue to expect a decline in the value of risk assets, however, the difference this time being that the portfolio is geared toward taking advantage of credit spreads widening in certain sectors (e.g. 5 yr. bank debt vs 5 yr. provincial debt). On a historical basis, spreads are abnormally tight in this area. On the interest rate curve, the portfolio is positioned for flattening on both sides of the border in the 5 yr. and under, and a steepening of the curve for the 5 yr. and above. Our outlook remains the same; i.e. no change in the Canadian or U.S. key interest rates for quite some time (12-15 months). We therefore continue to take advantage of the steep yield curve, particularly in the U.S.

Market Events

Although we only participated in nine Canadian M&A transactions in Q1, we are finally seeing the tides turn, with several clues pointing to a resurgence in activity. The large inventory of properties for sale in the oil sector is melting away. These transactions are giving rise to the resurgence of event driven opportunities that we can arbitrate: in many cases, the issuance of subscription receipts by the buyer, usually a public company, which allows it to complete an equity financing before the closing of the acquisition.

While relatively rare between 2007 and 2012, this phenomenon appears to be increasing, to the benefit of the Fund. As the backlog of land for sale shrinks, buyers will have to return to the more traditional growth route of acquiring companies outright. The move seems to have already begun, with three proposed M&A transactions in April in the oil sector.

South of the border, the number of transactions announced seems to increase every month. With the overall capital allocated to arbitrage relatively stable, we can expect a return to more interesting profit margins on deals. Meanwhile, convertible debentures of companies subject to takeover offers are increasingly sought after. Adding options and short positions in the equity of the underlying allows us to enhance the risk-return profile of these market events.

We have also begun to arbitrage close to maturity U.S. convertible debt. The conversion of these instruments at maturity can become quite complex as issuers often reserve the right to pay all or part of the conversion in cash, according to a VWAP (Volume Weighted Average Price share) formula calculated over a number of trading days, instead of issuing shares based on the debenture’s conversion ratio. Due to this complexity, many investors prefer to sell their debenture slightly below their conversion value so as to avoid having to manage the conversion process, thus providing us with an opportunity to generate returns at very low risk.

Convertible Securities

Q1-2014 proved a welcome continuation of the second half of last year, further validating our strategic repositioning of the portfolio in early 2013 when we deemphasized resource-related convertibles while increasing the weightings in other sectors. This rebalancing became possible during the 18-month ‘global depression’ in commodity related countries, when the securities of many non-resource issuers also experienced abnormally low valuations.

Despite this rebalancing, energy and materials contributed more than half the performance this quarter as the price of gold stabilized and the sustained demand for energy buoyed valuations. There have been no negative credit events in the portfolio and several pre-existing situations are nearing closure. In the case of Great Basin Gold, final conditions should be met in the near future for a final payout. As for Jaguar Mining, the new shares should be listed in the massively delevered company by the time this publication goes to press. Interestingly, we’ve also noted renewed interest among investors for project financing. Overall, we expect these trends to continue and that the convertible portfolio performance will continue normalizing.

Q1 - 2014 Graph (EN)

Amethyst’s warrant and convertible books are constructed to capitalize on two sources of return: yield, and volatility. The latter acts as a saw tooth to capital markets, tending to cut into traditional performance as violent swings instill doubt and fear among investors, but also providing return opportunities for delta hedged strategies. Unfortunately, volatility has been very limited of late as many securities in the portfolio went either straight up, down or sideways. At the same time, new issues of warrants and hedgeable convertibles have been scarce in recent quarters.

Therefore we have been emphasizing ‘carry’ over volatility, trying to crystallize the latter by using listed options, and trolling U.S. M&A transactions for fixed income based opportunities either through straight or convertible bonds, where inadequate risk reward dynamics are exhibited by the equity. We continue to look for less volatile credits with higher coupons and modest dividends on their underlying securities to provide stable fixed carry while sacrificing gamma trading if it can’t be captured up front with options.


In short, fixed-income arbitrage continues to contribute regularly, credit spreads on our convertibles are contracting, and the pool of opportunities is expanding with a return to more normal deal flow and conditions favorable to other types of event driven situations. Provided that the overall picture does not suffer from a major shock, this will be the first time since mid 2012 that all three cylinders of Amethyst’s performance engine should contribute simultaneously, allowing for an expected return above the Fund’s historical average.

Marc Amirault
Principal Manager
mamirault@arbitrage- canada.com

Quarterly Bulletin Q4 – 2013

Q4 - 2013 Comic (EN)


« Quantitative Easing = Risk Taking »

This seems to have been the magic formula in 2013, a remarkable year for risk assets, most notably for equities and corporate bonds. The desire to “not miss the boat” seemed to dominate from start to finish. Few would have predicted such remarkable global stock market performance in 2013, with such a low volatility and despite the very real instabilities:

  • Endless Budget talks and the temporary U.S. government shutdown;
  • The collapse of Cyprus in the spring;
  • The increase of over 100 basis points on government 10 year rates in most G7 countries, and the corre- sponding increase in the cost of borrowing for corporations;
  • The debate surrounding the reduction (“tapering”), or the withdrawal of stimulus by the US Fed;
  • Mitigated growth resulting from revised expectations for revenues, increasingly saturated profit margins, and the increase in labor costs and the weighted average cost of capital “WACC”.


These apprehensions didn’t slow down investors, who piled into just about everything that had done well the previous year. With a record level of new bond issues in the USA, a gain of over 7% on

USA high yield (HY) bonds despite a marked increase in reference rates (“benchmarks”), gains of nearly 30% for the S&P after a 15% run in 2012, more risk averse investors were largely penalized by opportunity cost. In fact, it is the countries with major quantitative easing (QE) programs like the USA, UK and Japan whose markets had literally extraordinary performance… and Canada was not among them.

Among the near universal enthusiasm, there were however some major disappointments: The Japanese currency falling by nearly 20%, the desertion of emerging markets and, importantly, the commodity market especially for metals, with significant corrections for gold and silver. The drops in prices were responsible for the striking underperformance of resource-tied countries such as Canada, Australia, South Africa, and whose monetary policies did not offer the luxury of stimulus. Even on the bond side, some indices such as the Canadian DEX had a negative return in 2013, a first since 1994.

Q4 - 2013 Table (EN)

 Weak and in some cases, fragile growth…. but improving

Was the general state of the economy in 2013 robust enough to justify such strong performance of global risk assets?

The economic picture is less rosy than the rise in the stock market would have you believe, but it is improving. Despite growth below historical averages (about 2% in Canada and USA, and 3% globally), investor confidence is at pre- 2008 levels and leading economic indicators are approaching their 5 year peaks. Employment is improving in the United States … although the labor force is still in free fall, at its lowest level since 1978 at a time when total US population was 80 million lower than today (!). Which means that the published 7% unemployment rate is a bit of a smokescreen.

In Europe, data suggests a similar progression to that of the USA, but the area is facing the worst employment crisis in its history. With unemployment over 12% for the entire region, commercial banks are not lending, the European Central Bank is not injecting liquidity and the money supply is slowly crumbling, unlike in other G7 countries, and to top it all off, the strength of the Euro vs. the USD at $ 1.40 is seriously hampering exports. In short, there remains a lot of conflicting data in an otherwise improving but still very uncertain economic landscape.

Cautious Optimism for 2014

Despite the roller coaster at the beginning of the year, markets have definitely started 2014 on a positive note. Economists’ expectations are high, supported by the planned gradual reduction of QE in the US which is seen as a sign, on the one hand, that the economy is strong enough to take over from central banks and that on the other hand, this economic cycle will continue for the next few years, thereby again favoring risk assets. A certain level of complacency seems to have emerged. Investors are more and more ignoring certain risks while chasing returns, especially in Europe.

America is definitely doing better: stronger housing market, increased vehicle sales, stronger job creation, etc. But it is clear that companies are doing little to improve their situation. More concerned with their stock price, companies are pursuing programs for implementing special dividends and share buybacks; we believe they will be compelled to contribute directly to the economy by spending and investing the cash accumulated on their balance sheets in recent years. Otherwise, it will become increasingly difficult to justify a significant appreciation of risk assets other than by the expansion of valuation multiples.

Q4 - 2013 Household Consumer Credit (EN)


Fixed Income

The fixed income arbitrage sub-portfolio closed 2013 with decent performance and 10 out of 12 months positive. May and June proved to be difficult though, as a tactical and strategic positioning on the yield curve proved costly. We were nonetheless able to adjust the portfolio accordingly.

Within the credit segment (i.e. spreads), which represents almost 60% of the profits generated in the sub-portfolio, we started off 2013 with a view of exploiting the very steep curve (carry roll-down) observed on mid-term provincial, banking 3 -5 years and municipal short term credits. The strategy paid off, particularly in the fall, which prompted us to reduce the sub-portfolio’s Beta given the strong year-end run-up.

Q4 - 2013 Labor Participation (EN)

Despite the strong performance, the 5-yr and less Canada credits remain at attractive levels when compared to recent US and European performance. On the flip-side, we wish to maintain a rather defensive positioning as we enter 2014, as noted previously, we believe some risk assets to be overpriced at this stage. If markets continue to perform, the sub-portfolio will benefit, but to a lesser extent given the lower portfolio Beta, while in the case of a drop, the portfolio will be less exposed and we will have some dry powder.

Positions on the yield curve represent about 40% of last year’s profits. Contrary to credit, expectations are based on a short to mid-term horizon, which by definition imply a more dynamic trading approach. The emergence in late spring 2013, of discussions among FED members about a possible reduction of QE took markets by surprise, forcing us to close certain positions and tweak our strategy, operations that bore fruit at the end of the summer. Increases on the interest curve started appearing when the US market began anticipating and pricing in increases of the Fed Funds rate for summer 2015, some- thing we find (and still find) to be opportune.

Therefore, credit wise 2014 is starting off on a defensive tone, initiated last October to lower the general risk level by seeking refuge in short term banks and municipals and profit from the steep yield curve in those areas. We expect a flattening of the yield curve in Canada and the US, and more specifically on the short term portion since no movement in Canadian or US central bank rates are expected for some time (15-18 months).

Event Driven

With only 90 announced transactions between compa- nies (where at least one party is public), according to Bank of American – Merrill Lynch, 2013 recorded the lowest level of mergers and acquisi- tions in Canada over the past 12 years, considerably less than the previous low of 110 transactions recorded in 2003. These figures contrast sharply with the peak of 210 transactions announced in 2009.

Despite a less severe situation in the United States, merger & acquisition opportunities south of the boarder carried very different margins than domestic deals. In Canada, the events at the end of 2012, which decimated the industry wide capital allocated to arbitrage, supported more attractive margins through 2013, despite the lower deal-flow. Throughout the year, the capital that we deployed on domestic trans- actions was constrained by our MPTL (Maximum Permis- sible Total Loss) limits and liquidity, while in the United States, the lack of expected return on the specific transaction subset of interest to the Fund seriously restricted the use of available capital. Our investment discipline remains, as always arbitrage, and as such, less capital was allocated to this segment of the portfolio than historically. Only three transactions were aborted during the year, a failure rate that is in line with the historical norm for the Fund.

We also participated in the arbitrage of seven subscription receipts, a number two to three times higher than the historical average. These receipts are issued by purchasers to finance an announced acquisition, but are conditional on its successful completion. Arbitrage of receipts tends to offer a very low risk, with the added benefit of compensating the holders for any dividends paid by the issuer. Although receipts reduce the cost related to the payment of a short dividend resulting from a delay in the closing of the transaction, however this feature can lead to adverse tax consequences for the offshore Fund by reducing the expected return. In some cases, excluding such a transaction from the offshore portfolio will create divergent performance from the onshore Fund.

Exceptionally, in 2012 Amethyst experienced two sud- den and costly cancelled bond buybacks. In 2013 no comparable events transpired – as should be the case. These 2012 cancellations were the only ones that I’ve experienced throughout my career. During the last quarter of 2013, we have been busy arbitraging the repurchase of preferred shares mainly by Canadian banks as the new Basel III rules render them obsolete. The return on these trades in not huge, but their low risk makes them attractive. Once again, when dividends are involved, these positions are rarely economically viable for the offshore portfolio given the withholding taxes to which non-Canadians are subject.

Q4 - 2013 Graph (EN)


2013 was a difficult year with respect to the perfor- mance of our convertible bond portfolio. While volatility may have been low, perfor- mance was negative despite us deploying additional resources for credit analysis and modeling, our continual delta adjustments, membership on creditor committees, preemptive legal action with distressed companies and many other progressive steps initiated by Crystalline. On the flip-side, we take some comfort in knowing that we outperformed our competition, some of who experienced considerable drawdowns.

Traditionally, Canadian convertible bonds and warrants offer an acceptable level of liquidity in both the primary and secondary markets, while hedging is cheap with stock borrow readily available and no dividends offsetting coupon income. Attractive opportunities have largely been concentrated in the energy and materials sector. However, with the price of gold and other metals re- treating, the viability of mining projects initially financed using 2011 and 2012 commodity prices were put into question and access to further financing dried up leaving some companies scrambling. As a result, some investors began to price companies using a worst case scenario which was exacerbated by selling as investors reduced exposure to resources generally. Many of these companies have had difficulty readjusting to lower commodity prices and tighter access to capital.

This macro picture also had a pernicious effect on the market structure as well. As fund money flows have been against resources, redemptions forced managers to liquidate positions, if not winding down entirely. The closing of FlatIron in November 2012 had repercussions stemming first from distressed selling, and then from lower demand and liquidity. Other players merely exited the Canadian convertible space and put their capital to use elsewhere.

The result was a three tier pricing matrix in the Canadian convertible market: Retail yield seekers keeping at-the- money convertibles priced around par and trading on yield; US distressed funds owning the busted (below 50% of parity) space; and carry-trade hedgers seeking full-delta positions on deep in-the-money converts. This left demand at the $50, $100, and above $120 levels, resulting in liquidity buckets rather than on a smooth continuum. Consequently, paired positions hedged on a delta basis delivered inconsistent returns as bond prices remained sticky around these levels while the underlying equity price varied. This behavior was observed not only across resources related issues, but across all economic sectors of the Canadian market.

As we all know, it is not in the interest of long term returns to throw out the proverbial baby with the bathwater – although prudent risk management remains imperative. Despite the below normal liquidity, throughout the year we have successfully reduced our exposure to commodity dependent convertibles by a third and rede- ployed this capital towards non-cyclical sector positions. We fully expect much of the drawdown in the convertible portfolio to bounce back as companies prove our analysis right by demonstrating their viability. Though some losses have necessarily been crystallized, the Fund is in a position where the risk of downsides is contained and upside remains considerable.


Several factors lead us to believe that the worst is behind us. One should keep in mind that the performance of Amethyst and Topaz are positive for the second half of 2013 and conditions favor the continuation of this trend.

On the one hand, the growth of corporate balance sheets over the last five years and low level of Canadian M&A activity in 2013, suggest a rebound in M&A transactions is on the horizon. In the resource sector, opportunities for acquiring assets are plentiful, and shareholders of many companies are beginning to run out of patience. In addition, the margins ob- served in 2013 are likely to persist if activity increases. A rebound will allow us to deploy more capital into M&A opportunities with higher profitability.

Convertible debt prices are currently abnormally low in Canada. In some cases, pricing and implied credit spreads are comparable to the through of 2008. As we said then, such situation can- not remain in the long term, as investors inevitably realize that risk premiums are inflat- ed and push prices back in line. The outlook for 2014 is for a reversal to the mean where volatility will return and pricing will normalize. Already we are seeing a return to the resource sector as valuations stabilize and worse case scenarios fail to materialize. We continue to monitor risk and diversify the portfolio as necessary across issuers and industry sectors.

Despite the long period of sub-par performance in recent quarters, it was imperative that we devote the effort and attention necessary to protect the capital in the Fund while still ensuring that we maintain suitable levels of upside potential.

We are extremely grateful for the trust and patience of our investors, and believe they will be well rewarded as the portfolio gradually recovers and its regains its normal cruising speed and annualized return objective.

Marc Amirault
Principal Manager



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