Maxam Diversified Strategies Fund – Q2 2022

Taking advantage of the volatility, selectively.

Maxam Diversified Strategies Fund – Q2 2022 Commentary

Dear fellow investors,

The market environment continues to be dominated by high inflation, rising interest rates, fears of a recession and geopolitical tensions. Equity bellwether S&P 500 index just posted its worst six month start to a calendar year since the 1970s, and broad bond indices are down double digits.

June alone was a particularly cruel month for equity investors. North American equity indices declined between -9% and -15% during the month as additional high inflation readings led to more hawkishness from central banks and increased bearish sentiment. Correlations moved to ‘one’ across companies, sectors, and geographies – there was ‘nowhere to hide’, so to speak.

We believe that the significant market correction in 2022 is presenting us with compelling investment opportunities – fear-driven selling, growth companies at value prices, wide arbitrage spreads – and we are taking advantage, selectively.

The Maxam Diversified Strategies Fund1 declined -7.8% in June and -9.1% through the first six months of the year. Here is the tale of the tape for June and year-to-date:

What’s priced-in?

You’d be hard pressed to watch the news or check a stock quote today without seeing a headline that included: inflation, higher interest rates, recession, or bear market.

Bank of America’s Bull & Bear indicator, compiled from their regular survey of global fund managers, closed out June at “maximum bearish” for a third consecutive week2. The survey also noted that allocations to equities hit their lowest level since October 2008 and uninvested cash was the highest in more than two decades3. Investor sentiment is awful.

Glass half-full view: when EVERYONE is talking about all of the bad news and the challenges for the economy and markets, some of it is certainly already reflected in securities prices. While it is admittedly difficult to know how much bad news is already priced-in, we are seeing compelling investment opportunities in select companies that we are taking advantage of.

Exposures.

The fund remains well-diversified across sectors, strategies, and individual securities. As at the end of the quarter, the fund was invested across 10 industry sectors with no sector weight larger than 14% of net exposure (excluding arbitrage), and the top 10 holdings accounted for 25% of assets. The fund’s net allocation to arbitrage was ~25% on June 30, a high mark for the year. In addition to providing a stable return profile that is uncorrelated with the general market, the fund’s arbitrage allocation is also highly liquid and can be used to opportunistically take advantage of value + catalyst situations that become available in a volatile market.

Through the first five months of the year, the fund held in very well relative to the broad markets and our peers, down approximately -1.5%1. The fund’s arbitrage holdings held their value, and our shorter-duration, value-oriented names outperformed the more speculative growth companies that have been hardest hit in this sell-off (we discussed short vs long duration equities in our Q1 commentary). And then in June, as mentioned above, we saw correlations move to ‘one’ as investors indiscriminately sold securities, regardless of fundamentals or outlook in many cases.

So, we have very poor investor sentiment, equity markets that are already down – some in bear market territory – signs of capitulation and non-fundamentals-based selling. On top of that, some market prognosticators are saying the four most dangerous words in investing: “this time it’s different.”4

The Covid pandemic was something different, or at least more extreme that what investors have seen over the last 100 years or so. However, economies, companies and investors have dealt with recessions, inflation, higher interest rates and geopolitical turmoil many times before.

What we think is not different this time, is taking advantage of opportunities, selectively.

We’ve recently added to our position in H20 Innovation Inc., a water infrastructure and technology company whose shares were down -32% through the first six months of this year. We like this founder led business that has highly recurring revenues and is delivering strong organic and acquisitive growth.

Another existing holding that we’ve been opportunistically adding to is VitalHub Inc. – an enterprise software company providing solutions to the health care industry. VitalHub’s share price is about 20% lower than where it started the year, despite a strong balance sheet, healthy growth, and completing an accretive acquisition.

We have also begun initiating new positions in some companies that we’ve been following for years (including some that we used to own) that are now trading at prices we believe represent excellent reward-to-risk levels. We’ll plan to highlight some of these new positions in future commentaries.

Opportunity knocks.

To be clear, I am not calling a bottom for the equity markets (that’s realistically unknowable), but we are currently seeing security prices that we believe reflect compelling value and opportunity.

We’re taking action, selectively – not with an eye on where we will be next week or next month, but with a view on where values will be as the issues the market is grappling with begin to subside and as our holdings perform.

Instead of trotting out Warren Buffett’s famous “be greedy when others are fearful” quote, we’ll cite another that we think is equally wise today, from legendary investor, Shelby Davis:

‘You make most of your money in a bear market, you just don’t realize it at the time’.

Thank you for your trust and confidence. Please don’t hesitate to reach out with any questions.

Sincerely,

Travis Dowle, CFA

President & Fund Manager

Maxam Capital Management Ltd.

1 Maxam Diversified Strategies Fund, Series F, net of fees and expenses. Inception date June 30, 2009. Please contact us regarding other classes of fund units or visit our website www.maxamcm.com

2https://ca.investing.com/news/stock-market-news/bofas-bull-and-bear-indicator-is-at-maximum-bearish-for-a-third-week-in-a-row-432SI-2713789

3 https://www.reuters.com/markets/europe/funds-full-capitulation-they-slash-stock-allocation-bofa-poll-2022-07-19/

4 According to famous investor Sir John Templeton, “The four most dangerous words in investing are, it’s different this time.”

Maxam Capital Management Ltd. is the manager for the Maxam Arbitrage Fund. Important information about the Fund is contained in the Fund’s Simplified Prospect us, which should be read before investing. This presentation is neither an offer to sell securities nor a solicitation to sell securities. Disclosed historical returns for periods greater than one year are annualized unless otherwise noted and are net of fees and expenses. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Simplified Prospectus before investing. Any indicated rates of return are the historical annual total returns including changes in value and reinvestment of all distributions and does not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. This document is not intended to provide legal, accounting, tax, or investment advice. Please consult an investment advisor and read the prospectus for the Maxam Arbitrage Fund prior to investing. Please contact us for more information at: (604) 685 0201 [email protected] www.maxamcm.com

Maxam Arbitrage Fund – Q2 2022

Stability for your portfolio.

Maxam Arbitrage Fund – Q2 2022 Commentary

Dear fellow investors,

The Maxam Arbitrage Fund1 declined -0.6% in the second quarter of 2022, in what was a very challenging period for both equities and bonds.

The fund has held up very well during the market correction – demonstrating its value as an alternative source of returns and a portfolio diversifier. Over the last 12 months the fund gained +2.2% whereas the iShares Core CAD Universe Bond ETF declined -11.7%2.

Merger and SPAC arbitrage yields are attractive right now, presenting investors with an opportunity to earn returns from a strategy that is uncorrelated with traditional equities and bonds.

State of the arb market.

The overall market narrative continues to be dominated by high inflation, rising interest rates, fears of a recession and geopolitical tensions.

Arbitrage spreads widened during the quarter to levels not seen since the Covid crash in March-April 2020. In addition to tracking the broad risk-off environment, spreads were pressured by a more expensive and difficult market for high yield financings and leveraged loans.

In particular, yields on leveraged buyout transactions widened in early June when reputable private equity firm Thoma Bravo announced that they had renegotiated and reduced the price they had agreed to pay for Anaplan Inc. from $66.00 to $63.75 per share. This deal re-price remains a ‘one-off’ at time of writing with other notable leveraged buyout transactions recently closing on terms.

Also continuing to impact arbitrage spreads and deal timelines is the increased scrutiny that U.S. regulators are applying to mega-cap deals and companies in industries deemed more sensitive to competition issues. 

Despite a challenging market environment, new deal announcements continued to be plentiful during the second quarter, providing us with a robust opportunity set to take advantage of. However, while it is difficult to forecast future deal activity, we are mindful that the present risk-off nature of the markets coupled with rising interest rates and wider credit spreads may be a headwind.

Constructively, market volatility and lower valuations will lead to new opportunities for dealmakers as companies look to make strategic acquisitions and position themselves for future growth. And private equity firms have significant amounts of capital that needs to be deployed which may help temper any slowdown.

Nimble.

Being nimble is an advantage in terms of both seeking returns and managing risk. We enjoy the flexibility and advantage of investing across the capitalization spectrum, providing us with a larger opportunity set. While every merger deal is different, we look favourably on mid and smaller capitalization transactions in the current environment because regulatory risks are typically lower, and the deal timelines are shorter.

Regardless of deal size, we are always focused on transactions that we believe will reach successful completion.

The fund invested in 15 new deals during the quarter, had 14 successful deal closures and experienced no deal breaks (although we did own the Anaplan re-price). As of June 30, the fund held 35 merger arbitrage positions, diversified across market cap, deal type and industry.

Owned deals that successfully closed during the quarter included3: Cerner Corp; Ferro Corp; IntriCon Corporation; Intertape Polymer Group; Noront Resources; Anaplan Inc; Questex Gold & Copper Ltd; SOC Telemed Inc; Veoneer Inc; and Intersect ENT, Inc.

Some notable new positions initiated during the second quarter included3: Covetrus Inc; FAX Capital Corp; GTY Technology Holdings; Points International; Redline Communications; and Sailpoint Technologies.

SPAC yields rise.

Just as traditional IPOs are less likely to come to market during unfavourable market conditions, so too are SPACs. New SPAC issuance continued to slow during the second quarter with less than 20 new SPAC listings, a steep drop from the 54 seen in the first quarter of 20224 (and a far cry from the pace of more than 600 in calendar 2021).

In addition to the weaker market environment, the SEC’s proposed new, and more stringent, rules for SPACs (discussed in our Q1 commentary) are likely making it more difficult for SPAC sponsors to find and consummate deals. SPAC redemption rates, where investors elect to redeem their SPAC shares for the cash held in trust, continued to be high at approximately 80%, during the second quarter4.

A high rate of SPAC redemptions makes it very difficult for investors who bank merely on upside from well-received deal announcements, or for those who speculate on SPAC warrants – which will expire worthless if a deal is not completed. We continue to take a very conservative approach to SPAC warrants, routinely harvesting them post unit split, rather than hoping a deal the market likes will be completed.

From a SPAC arbitrage perspective, the risk-off environment and still well-supplied market with almost 600 SPACs currently seeking acquisitions5 provides us with a very attractive reward-to-risk set-up. SPACs are trading at unlevered annualized yields near 5% on average6 – a return that is backed by short-term government securities (i.e. T-bills) held in trust.

We also note the SPAC cliff on the horizon – almost 95% of listed SPACs are due to liquidate within the next 12 months7, presenting us with an attractive set-up for our systematic and quantitative approach to harvesting SPAC yields.

As of June 30, the fund was well-diversified across 158 SPACs, and we are currently deploying capital at attractive yields.

Looking ahead.

Merger and SPAC arbitrage yields are attractive right now, presenting investors with an opportunity to earn returns from a strategy that is uncorrelated with traditional equities and bonds.

Arbitrage is an attractive strategy for the long-term, and its unique characteristics make it a particularly attractive strategy in the current environment. Rising interest rates are a clear negative for bonds, however they can act as a tailwind for arbitrage because of the low duration nature of the strategy – deals typically complete in just a few months.

In addition to providing a compelling alternative to bonds as interest rates rise, arbitrage strategies also provide excellent diversification to traditional equity market exposure because returns are generated from the successful completion of specific and definitive corporate events. As arbitrageurs we expect to profit regardless of the behaviour and direction of the stock market.

Risk management is central to our quantitative, data-centric and disciplined investment process as we deploy capital into a robust and attractive opportunity set.

Thank you for your trust and confidence. Please don’t hesitate to reach out with any questions.

Sincerely,

Travis Dowle, CFA
President & Fund Manager
Maxam Capital Management Ltd.

1 Maxam Arbitrage Fund, Class F, net of fees and expenses. Inception date October 1, 2020. Please contact us regarding other series of fund units or visit our website www.maxamcm.com

2 iShares Core CAD Universe Bond ETF, ticker XBB.

3 Notable owned deals successfully closing during the quarter is not an exhaustive list. New positions initiated during the second quarter is not an exhaustive list.

4 SPAC statistics sourced from: Maxam internal database and https://icrinc.com/insights/icr-q2-2022-spac-market-update/

5 https://www.spacanalytics.com/

6 Maxam internal database and https://spacinsider.com/stats/

7 Maxam internal database

Maxam Capital Management Ltd. is the manager for the Maxam Arbitrage Fund. Important information about the Fund is contained in the Fund’s Simplified Prospect us, which should be read before investing. This presentation is neither an offer to sell securities nor a solicitation to sell securities. Disclosed historical returns for periods greater than one year are annualized unless otherwise noted and are net of fees and expenses. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Simplified Prospectus before investing. Any indicated rates of return are the historical annual total returns including changes in value and reinvestment of all distributions and does not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. This document is not intended to provide legal, accounting, tax, or investment advice. Please consult an investment advisor and read the prospectus for the Maxam Arbitrage Fund prior to investing. Please contact us for more information at: (604) 685 0201 [email protected] www.maxamcm.com