Hedge Fund Bets on Gaming, Shorts Autos to Beat Canada Peers

  • JC Clark shorts grocery stocks amid rising Amazon threat
  • Stewart sees value in Great Canadian, Trican Well Service

JC Clark, which runs a Canadian hedge fund that’s outperformed indexes for almost two decades, is now taking a more defensive approach, shorting sectors that it sees in long-term declines such as grocers, while adding to gaming stocks.

"I think with equities priced to perfection, there’s some risk of a pullback or a correction," Colin Stewart, chief executive officer and co-founder of JC Clark Ltd. said in a recent interview at his Toronto office. "We’re still net-long stocks but if anything I would say we’re gradually becoming more defensive."

Stewart manages the JC Clark Preservation Trust, a long-short equity fund that accounts for C$100 million ($80 million) of JC Clark’s C$250 million of total assets under management. The trust has returned 5.5 percent this year to Aug. 31, outperforming the average 0.3 percent asset-weighted return from the Scotiabank Canadian Hedge Fund Index, which tracks 84 funds. The Preservation Trust’s annualized return since its 1999 inception is 9.8 percent net of fees, compared with a 7 percent return for the S&P/TSX Composite Index, and 5.5 percent for the S&P 500, including dividends.

Stewart expects to increase the fund’s exposure to short positions over the next six months because he’s concerned about rising interest rates and the unwinding of quantitative easing. Today, the fund is about 65 percent net long and 5 percent cash. Investors in short bets gain when a stock declines.

“One of the results of this long period of declining interest rates has been that many of these consumer staple-type businesses that are almost seen as bond proxies have traded up to very high valuation multiples," he said. “If rates start to go up, many of these bond proxies will see their multiples compress."

Grocery Shorts

Stewart declined to name the stocks he’s shorting, but said he has "a few short positions" in the Canadian grocery sector, a space that includes Loblaw Cos., Metro Inc., George Weston Ltd. and Empire Co.

"One of the things we like to look for on the short side is industries that I would call in secular decline, where it’s not just one quarter that there’s going to be bad news," he said, citing food price deflation and growing competition from Amazon.com Inc. and other home-delivery services. "I just think that’s an area that’s going to be under pressure for the foreseeable future."

JC Clark’s Preservation Trust also has a few short positions in Canadian auto parts stocks, a sector that includes Magna International Inc., Linamar Corp. and Martinrea International Inc. Stewart is worried about the Nafta trade renegotiations, as well as the risk of a long-term decline from electric vehicles, strength in the Canadian dollar and a downturn in the U.S. auto cycle.

Bets on Gaming

The fund is looking for companies that have strong free cash flow, high barriers to entry and predictable revenue streams. Stewart is betting on gaming stocks including Pollard Banknote Ltd., which makes scratch-and-win lottery tickets, and Great Canadian Gaming Corp., which recently won a bid to run casinos in the Toronto area.

“Lottery tickets and gambling are pretty steady businesses in good times and bad," Stewart said, adding that he sees 25 percent upside in Pollard shares and believes Great Canadian Gaming could rise to C$40 from about C$32 today. Gaming stocks have been good bets this year, with Great Canadian rising 28 percent, while Pollard has soared 76 percent.

Stewart also holds a long position in Trican Well Service Ltd., a pressure pumping company in the Canadian oil patch. Energy shares are the worst performing sector on the S&P/TSX this year due to languishing oil prices, falling 16 percent over the first eight months of the year before rallying 7.4 percent in September.

"As value investors we tend to gravitate towards areas that are out of favor as a contrarian play," he said. "Energy stocks have been so beat up that there are some value opportunities there."

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