Season's greetings from the EdgePoint team!

Happy Holidays!

From our EdgePoint family to yours, wishing you all the joys of the season, health, and happiness throughout the coming year! 

Plaid Day at our Toronto and Montreal offices

This week's interesting finds

Zack Chetrat – Partner since 2017 (Cambie & West Broadway – Vancouver, British Columbia)

This week in charts

More Americans are joining the ‘cashless’ economy

Young adults are staying with their parents

 

More Canadian renters than ever before

Sea Change (Howard Marks memo)

“The overall period from 2009 through 2021 (with the exception of a few months in 2020) was one in which optimism prevailed among investors and worry was minimal. Low inflation allowed central bankers to maintain generous monetary policies.  These were golden times for corporations and asset owners thanks to good economic growth, cheap and easily accessible capital, and freedom from distress. This was an asset owner’s market and a borrower’s market.  With the risk-free rate at zero, fear of loss absent, and people eager to make risky investments, it was a frustrating period for lenders and bargain hunters.

“Inflation began to rear its head in early 2021, when our emergence from isolation permitted too much money (savings amassed by people shut in at home, including distributions from massive Covid-19 relief programs) to chase too few goods and services (with supply hampered by the uneven restart of manufacturing and transportation). Because the Fed deemed the inflation “transitory,” it continued its policies of low interest rates and quantitative easing, keeping money loose.  These policies further stimulated demand (especially for homes) at a time when it didn’t need stimulating.

“Inflation worsened as 2021 wore on, and late in the year, the Fed acknowledged that it wasn’t likely to be short-lived. Thus, the Fed started reducing its purchases of bonds in November and began raising interest rates in March 2022, kicking off one of the quickest rate-hiking cycles on record.  The stock market, which had ignored inflation and rising interest rates for most of 2021, began to fall around year-end.

“How has this change manifested itself in investment options? Here’s one example: In the low-return world of just one year ago, high yield bonds offered yields of 4-5%. A lot of issuance was at yields in the 3s, and at least one new bond came to the market with a “handle” of 2. The usefulness of these bonds for institutions needing returns of 6 or 7% was quite limited.  Today these securities yield roughly 8%, meaning even after allowing for some defaults, they’re likely to deliver equity-like returns, sourced from contractual cash flows on public securities.  Credit instruments of all kinds are potentially poised to deliver performance that can help investors accomplish their goals.”

Quebec Shuns Bitcoin Mining in Bid to Conserve Power

The government-owned utility Hydro-Quebec asked a provincial regulator last month to reallocate the 270 megawatts of energy, equivalent to the energy consumed by roughly 97,000 households, that it had set aside for crypto mining.

It is also a sharp reversal from 2018, when the then-CEO of Hydro-Quebec said bitcoin business was necessary to boost provincial consumption to offset what he feared was declining demand that would put the utility into a “death spiral.”

At the end of the last year, Canada was the fourth-largest producer of bitcoin, behind the U.S., China—where illicit bitcoin mining continues despite a 2018 government ban—and Kazakhstan, according to the University of Cambridge Judge Business School.

Hydro-Quebec charges the lowest rates for industrial power in North America, with average prices as of April 1 of 3.93 cents per kilowatt-hour in Montreal, its largest city, according to the utility’s data. Industrial customers in Houston paid an average of 10.33 cents. The average cost in North America is 8.22 cents, according to Hydro-Quebec.

Now, the utility says that demand for electricity in the province will grow 14% over the next 10 years and it needs to direct energy to higher priority areas, such as exports.

Quebec has signed agreements to provide power to New York City and Massachusetts. The provincial utility is trying to build transmission lines through Maine to supply power to New England, a project that could bring the province more than $7 billion in revenue over the next 20 years.

This week’s fun finds

Becoming Athletic In My 50s

This was a new feeling — and one that was, for me, incredibly weird and foreign. What had changed? Why was I suddenly digging the feeling of exercise?

Part of it was that really vigorous cycling crept into my life as a functional activity. I wasn’t having to “set time aside to exercise”, or fit it into my calendar. I was just, well, moving around town and doing errands. I was Getting Stuff Done. I didn’t classify it as an athletic activity or a sport: It was “mobility”, autonomy. Since I’m also a big ol’ treehugger focused on climate-change mitigation, it also felt rad and empowering to suddenly schlep all over town — and carry heavy loads — without using a car.

But along the way, I also realized I was vibing with many of the thrills of athletics. I enjoyed pushing the limits of my endurance. In the fall of 2020, for example, my son and I decided to try cycling a full “century”, 100 miles in a single day. We hit the road one morning in early September, and holy moses by dinner we’d made our way to Philadelphia. When I arrived at Philly’s city hall, it felt astounding to have hauled such ass entirely under my own steam. It was a wild, giddy boost to one’s self-esteem. “After you’ve traveled a serious distance on a bike,” as I later wrote, “it’s hard to feel down on yourself.”

But most obviously, long-distance cycling finally helped me figure out what motivated all these sporty folks, who I’d regarded for decades with such dank suspicion. I now understood them, a little. Specifically, I felt the pleasure of figuring out what my body — and what my willpower — was capable of.

YouTube Stars Cash In Video Rights for Millions of Dollars

Spotter Inc. and Keli Network Inc., which does business as Jellysmack, are flooding the personalities behind top YouTube channels with offers to license their old videos, pitching the deals as timely infusions that can help them expand their businesses.

The startups offer cash sums in exchange for the future advertising sales generated by a YouTube creator’s old videos, striking deals that can stretch for as long as five years.

Spotter said it had spent $740 million on content licensing agreements since 2019 after announcing earlier this year that it planned to invest $1 billion by the middle of 2023. Jellysmack has put aside $500 million for similar deals.

SoftBank Group Corp.’s Vision Fund invested in both companies, betting the videos would increase in value as YouTube stars attract larger audiences. Other smaller firms are also pitching deals to creators.

The Murky Path To Becoming a New York Times Best Seller

No one outside The New York Times knows exactly how its best sellers are calculated—and the list of theories is longer than the actual list of best sellers. In The New York Times’ own words, “The weekly book lists are determined by sales numbers.” It adds that this data "reflects the previous week’s Sunday-to-Saturday sales period" and takes into account "numbers on millions of titles each week from tens of thousands of storefronts and online retailers as well as specialty and independent bookstores." The paper keeps its sources confidential, it argues, "to circumvent potential pressure on the booksellers and prevent people from trying to game their way onto the lists." Its expressed goal is for “the lists to reflect what individual consumers are buying across the country instead of what is being bought in bulk by individuals or associated groups.” But beyond these disclosures, the Times is not exactly forthcoming about how the sausage gets made.

Laura B. McGrath, an assistant professor of English at Temple University who teaches a course on the history of the best seller, compares The New York Times’ list to the original recipe for Coca-Cola: “We have a pretty good idea of what goes into it, but not the exact amount of each ingredient.”

Although the list claims to be a numerical ranking with full autonomy from The New York Times Book Review, some of the sources I spoke with believe that an element of editorial curation must be at play. “To my knowledge, The New York Times tracks sales of books, and the sales are what is ‘supposed to’ decide where those books sit on the list. However, the truth is, it's much more editorialized,” Sarah*, a book publicist who has worked at two Big Five houses, suggested to me. “There is quite a bit taken into consideration—i.e., are the book sales mostly bulk buys? Are they mostly indie bookstore sales? Are they mostly Amazon sales? Even which list the book would be considered for has a huge effect.” For example, whether a book is considered for the Hardcover Nonfiction weekly list or the Advice, How-To, & Miscellaneous weekly list might affect whether it becomes a best seller at all.

Times spokesperson Melissa Torres denied in an email that any editorial judgments are involved in constructing the best seller list.

This week's interesting finds

Alex Gramegna – Partner since 2019 (100 St. – Edmonton, AB) 

This week in charts 

Pandemic saving habits have ended 

Vanguard quits net zero climate effort, citing need for independence 

Vanguard Group Inc is pulling out of a major investment-industry initiative on tackling climate change, the world's biggest mutual fund manager said on Wednesday, explaining it wants to demonstrate independence and clarify its views for investors. 

One focus of criticism has been the effort known as the Net Zero Asset Managers (NZAM) initiative, launched in late 2020 to encourage fund firms to reach net zero emission targets by 2050 and limit the rise in global temperatures. As of Nov. 9, NZAM counted 291 signatories representing some $66 trillion in assets under management. 

As recently as May Vanguard was touting commitments it had made in line with NZAM's goals. On Wednesday Vanguard posted a statement on its website saying industry initiatives like NZAM can create confusion. 

"We have decided to withdraw from NZAM so that we can provide the clarity our investors desire about the role of index funds and about how we think about material risks, including climate-related risks—and to make clear that Vanguard speaks independently on matters of importance to our investors," Vanguard said in the statement. 

Vanguard rivals including BlackRock Inc (BLK.N) have taken the opposite stand and said their NZAM participation does not conflict with their independence. A BlackRock spokesman said on Wednesday the company remains part of NZAM. 

Daniel Wiener, chairman of Adviser Investments in Newton, Massachusetts and a longtime Vanguard observer, said the firm's withdrawal showed it lacked a strong leader on ESG issues that BlackRock has in its CEO Laurence Fink. 

"Backing out of this thing is simply Vanguard blowing with the winds of constant change. They don’t have a strong personality like Fink to champion a cause," Wiener said. 

German strategy paper targets China trade dependence 

Germany's Economy Ministry recommends excluding using components from providers from authoritarian states in critical infrastructure and imposing stricter requirements for firms dealing with China, a strategy paper seen by Reuters shows. 

Those German firms particularly exposed to China should share details on that business with the government and undergo regular stress tests, according to the ministry's "Internal Guidelines on China", marked confidential. 

Deep trade ties bind Asia and Europe's biggest economy, with rapid Chinese expansion and demand for Germany's cars and machinery fuelling German growth over the past two decades. China became Germany's single biggest trade partner in 2016. 

Germany did not aim to decouple from its top trade partner, China, said the paper, first reported on by online portal The Pioneer. But Russia's invasion of Ukraine had shown the high risks of close economic relations with autocratic states seeking alternative world orders. 

KLM chief encourages passengers to take the train to cut emissions 

KLM’s chief executive has encouraged passengers to take the train rather than fly on some short-haul journeys to help cut carbon emissions, saying the airline sector should stop viewing rail as a competitor. 

“If [you] have a good alternative you should really use it,” Marjan Rintel told the Financial Times in an interview. “If you’re serious on reaching your sustainability goals, the train is not a competitor. We need to work together.” 

Rintel said KLM had already block-booked seats on the train service linking Amsterdam to Brussels and Paris in response, and she had urged the business “to develop the relationships with the Dutch railways, to see what we can do at short notice to motivate our customers to go by train to Brussels or Paris”. 

KLM was also looking at making it easier to buy flight and train tickets in a single booking and was in discussions with rail companies in the Netherlands and France about making transfers easier, Rintel said. 

However, she expressed no interest in becoming directly involved in running train services and said the airline would work with NS and the Eurostar Group, owner of the cross-Channel Eurostar service and of the Thalys service linking France, Belgium, Germany and the Netherlands.   

Music Deal Maker With Rights to Tens of Thousands of Songs Faces Chorus of Investor Unease

Investors are demanding a change of tune at Hipgnosis Songs Fund Ltd., the London-listed investment vehicle that owns the rights to tens of thousands of songs written by artists such as Shakira, Lindsey Buckingham and the Red Hot Chili Peppers. 

A spokesman for the investment adviser to the fund said it adds value through active song management. It is benefiting from growth in premium streaming services and other new sources of revenue that are boosting the global music industry, he said. 

When times were good, Hipgnosis tapped investors repeatedly for new equity funding to buy more songs, acquiring catalogs at what some music executives viewed as high prices. 

The rush of deals fed into higher sales, boosting the stock price and its ability to raise more money. From its 2018 listing onward, Hipgnosis has raised about 1.3 billion pounds in equity, equivalent to about $1.58 billion, and borrowed hundreds of millions of dollars more. 

[Founder] Mr. Mercuriadis has struck separate deals with Blackstone, which agreed in late 2021 to take a majority stake in Hipgnosis Song Management Ltd., which advises the listed fund. The investment adviser also manages a second private fund for Blackstone, known as Hipgnosis Songs Capital. 

This year, however, Hipgnosis stock has fallen roughly 35% and now languishes below its listing price.

This week’s fun finds 

Santa came early to the EdgePoint office 

Our littlest partners came into the office to see Santa and his elves. There was mad science, presents and a lot of laughter. 

Changing the wrap game 

Several EdgePoint partners and volunteered their time with Holiday Helpers to wrap presents for families in need. 

Fortunately, there were no reported paper cuts.   

EdgePointers go back to school 

Internal partners and alumni of Michael Power – Saint Joseph High School, Anna, Stefania and Daniela, along with Chief Camp Counsellor Montana, presented our Edge-ucation Camp on financial literacy at their old high school.

This week's interesting finds

Alex O’Hara – Partner since 2021 (Queens Quay – Toronto, ON)   

It's back – The EdgePoint ornament 

Like most people, we took down our holiday ornament in the new year, but we’ve brought it back to the EdgePoint store for a limited time. Spread joy this season by lowering our investors' fees with any profit from store sales.   

This week in charts 

Neither stocks nor bonds have done well this year   

Saying no to cryptocurrency was a glorious moment for Canada’s investment advisers 

Crypto is still in its infancy and may yet turn out to be a reliable financial asset we commonly invest in or use for making payments. What advisers got right was the idea of staying away during a speculative frenzy that could only end badly. The price of bitcoin, ethereum and other coins is down by half to two-thirds or more this year. FTX, a once-celebrated crypto exchange, has filed for bankruptcy protection with debts in the billions of dollars. 

For the most part, though, crypto has mostly been a story of individual investors buying in on their own while advisers and money managers mainly watched from the sidelines. Back in March, 2021, I wrote a piece with the headline Why Your Investment Adviser Hates Bitcoin. I surveyed advisers on LinkedIn and found a stern resistance to incorporating it into client portfolios on the basis that it was hard to value and thus too risky. 

Resisting crypto at its peak took some conviction because prices were rising so fast. Bitcoin pretty much quadrupled from November, 2020, to the same month last year, and other cryptocurrencies soared as well. To stand against crypto as an adviser was to risk coming off like an apologist for an outdated and decaying financial system – just the sort of thing crypto investors saw themselves as rebelling against. 

The pressure on advisers to accept crypto must have been intense, given how much faith individual Canadians put in the sector. “Polls seem to indicate that Canadians are more likely to be invested in crypto than American, Australian, or British households,” says a recent report from the independent analysis company Morningstar. 

Big traders flock to US equity options with fleeting lifespans 

Options provide the right to buy or sell assets at a fixed price by a given date. Zero-day options provide this right for the shortest possible period, expiring the same day they are purchased. 

While options trading has risen broadly since the start of the coronavirus pandemic, Goldman Sachs strategist Rocky Fishman said ultra-short-dated options have been “the strongest area of volume growth”. He estimated that roughly 44 per cent of S&P 500 index options that have been traded in the third and fourth quarter of this year had less than one day to expiry. 

The vast majority of the volumes appear to be flowing from professional traders such as asset managers, hedge funds and banks and not retail investors, research shows. 

Some have pointed to the surge in options trading as one propellant of the wild intraday market swings registered this year. Market makers that sell options contracts will hedge their positions to avoid making a bet on the market’s direction. 

That hedging can, at times, accelerate broader shifts. If market makers sold a large number of call options that would pay out if the S&P 500 were to rise, for example, they could hedge their position by purchasing S&P 500 futures. Some believe that index futures trading can in turn affect the prices of underlying stocks. 

Rental housing investor Starlight halts distributions on two funds, citing variable-rate mortgage woes

Starlight Investments, one of Canada’s largest owners of apartment buildings and multifamily properties, is halting monthly payouts on two of its funds, another sign that higher interest rates are causing trouble across the real estate sector – even for the most sophisticated managers and investors.

Starlight, which owns $25-billion worth of properties and real estate securities in Canada and the United States, paused distributions on two funds that specialize in U.S. properties: the U.S. Residential Fund and the U.S. Multi-Family (No. 2) Core Plus Fund. Combined, the two funds have $840-million in assets under.  

The Starlight portfolios benefitted from this strength, with average rents on properties in the larger U.S. Residential Fund jumping 17 per cent year-over-year in the third quarter. Yet rising interest rates are now biting because both funds rely on short-term, variable-rate mortgages to finance their purchases. 

“The size and pace of interest rate increases has been unprecedented and has resulted in interest rates that are significantly higher than projected at the time the fund financed its properties,” Starlight wrote to investors Friday. In response, the company is halting distributions that paid a 4-per-cent annual yield.

Investor Howard Marks: ‘The short run is by far the least important thing 

I arrive 10 minutes early for our lunch at Il Gattopardo, near the Museum of Modern Art in Midtown Manhattan, to find that my guest is already sitting at his usual corner table. He’s dressed in a smart grey suit and tie, and his customary clear-framed glasses. As befits a man whose entire world view is predicated on anticipating what could go wrong, he is, in his own words, “pathologically prompt. I can’t be late if I want to.” 

As we enjoy our simple main course, Marks expounds one of his core philosophies: that economic cycles are driven by the pendulum of human emotion. “In real life, things fluctuate between pretty good and not so hot, but in the market, things go from flawless to hopeless,” he says. “Nothing’s ever flawless and nothing is ever hopeless, but when people reach those extremes, it’s a good opportunity for the contrarian.” 

We’re lunching in late September. The US Federal Reserve has quickly raised interest rates to curb inflation and there has been a correction in equity markets. For Marks, “we’re in what I call the zone of reasonableness . . . And when it’s in fair territory, there’s nothing brilliant to do.”   

This week’s fun finds 

Here are the ages you peak at everything throughout life

‘Zombie’ virus revived after 50,000 years trapped in Siberian permafrost 

Scientists are thawing out these ancient viruses in order to assess their impacts on public health. As the permafrost, or permanently frozen ground, melts in the Northern Hemisphere, the thawing ice releases tons of trapped chemicals and microbes. 

“Due to climate warming, irreversibly thawing permafrost is releasing organic matter frozen for up to a million years, most of which decomposes into carbon dioxide and methane, further enhancing the greenhouse effect,” the study’s authors wrote. “Part of this organic matter also consists of revived cellular microbes (prokaryotes, unicellular eukaryotes) as well as viruses that remained dormant since prehistorical times.” 

Is Wine Fake?

Just because wine experts can judge the characteristics of wine doesn’t mean we should care about their assessments of quality. Most of the research I found showed no blind preference for more expensive wines over cheaper ones. 

Here my favorite study is Goldstein et al., “Do More Expensive Wines Taste Better? Evidence From a Large Sample of Blind Tastings.” They look at 6,175 tastings from 17 wine tasting events and find that, among ordinary people (nonexperts), “the correlation between price and overall rating is small and negative, suggesting that individuals on average enjoy more expensive wines slightly less.” But experts might prefer more expensive wine; the study found that if wine A cost 10 times more than wine B, experts on average ranked it seven points higher on a 100-point scale. However, this effect was not quite statistically significant, and all that the authors can say with certainty is that experts don’t dislike more expensive wine the same way normal people do.