Accelerate Monthly -Trade Wars: The Risk Awakens

February 16, 2025 — The Tariff Man struck back in what the Wall Street Journal called The Dumbest Trade War in History.

While we all know how economically damaging President Trump’s on-again, off-again, trade war is for the global economy and the capital markets, he seems to thrive on the attention and uncertainty it generates. President Trump’s opening trade war salvo was fired last month when he vowed a crushing 25% tariff on all Canadian and Mexican imports to the U.S., confirmed via a social media post over a weekend. He rapidly changed his mind once the capital markets opened for trading Monday morning, spooked by the losses encountered by his main scorecard, the Dow Jones Industrial Average. Had the threat proceeded, it may have been as disastrous as the 1930 Smoot-Hawley Tariff Act, which significantly prolonged the devastating Great Depression.

Nevertheless, the 47th U.S. President did not stop there. The subsequent trade war shot was a 25% tariff on all steel and aluminum imports to the U.S., along with a continued pledge to make Canada the 51st state, aiming for maximum unpredictability in potentially negotiating concessions with America’s main trading partners (and allies). Perhaps I forgot to read that chapter in his book, The Art of the Deal.

Tariffs represent taxes on imports, raising the price of foreign goods. These price increases ultimately flow to consumers, who pay more for everyday products and subsequently see their disposable income and spending power reduced.

A one-way implementation of tariffs is rare. More often than not, the country where tariffs were placed implements retaliatory tariffs, inciting a trade war and worsening the economic pain felt by end consumers. The net result of a trade war is that commerce between nations declines, supply chains are damaged, and companies and consumers suffer writ large. Meanwhile, the economy and stock market take a hit due to uncertainty, creating a negative feedback loop of declining commerce and squeezed profit margins.

The movie, Star Wars: The Force Awakens, the seventh episode in the Star Wars saga, correlates well with the current Trump-induced trade wars. In the film, the galaxy finds itself under threat from a powerful authoritarian regime called the First Order (the United States), led by Supreme Leader Snoke (President Trump) and his enforcer Kylo Ren (Elon Musk). The First Order has a devastating superweapon, the Starkiller Base (tariffs), capable of destroying entire star systems (the global economy).

However, all is not lost. A rebel group called the Resistance (Canada) wages a war against the First Order to stop the evil regime. While the would-be leader of The Resistance, Luke Skywalker (Justin Trudeau), has vanished, a new hero, Rey (Pierre Poilievre), steps in to protagonist’s shoes to try to defeat The First Order.

After some epic battles and painful losses, ultimately, the Resistance is victorious, defeating the evil First Order and seeing justice prevail.

Will the heroes in the Trade Wars find the same gratifying result? Only time will tell, but investors can learn from what made Rey and her freedom fighters successful against Supreme Leader Snoke and his villainous First Order regime.

The key to the Resistance’s success was their resilience along with the power of hope, despite being outnumbered and outgunned by the First Order. While resilience serves investors well in sticking with an asset allocation plan through volatile markets, in the place of hope (which is not a strategy), we place diversification, which can arm investors with a tool powerful enough to defend against the Starkiller Base (or the market volatility caused by tariffs, to carry the analogy).

Investment portfolio diversification is the practice of spreading investments across multiple asset classes that have low or negative correlations with one another. The goal is to reduce overall portfolio risk and volatility, which is attained by including uncorrelated assets.

Contrary to popular belief, private assets do not necessarily have a low correlation to public securities or exhibit low volatility, for that matter. Private assets only appear non-volatile or uncorrelated because their values are not marked-to-market. One can attain the same effect for their public securities portfolio by simply not checking the prices. That said, obliviousness is not a solution. However, it should be noted that the volatility and correlation of an asset are caused by its underlying economic drivers, not whether an asset is public or private. For example, for an equivalent asset base and capital structure, a private REIT will exhibit the same volatility and correlation characteristics as a public REIT.

When asset classes are uncorrelated, they tend to respond differently to market conditions. When one asset declines in value, others may hold steady or even increase. This dynamic reduces the likelihood that all investments will suffer losses simultaneously, helping to stabilize portfolio returns over time. Therefore, when an allocator is evaluating whether to add an asset to a portfolio, the asset’s correlation with the rest of the portfolio should be one of the primary considerations.

Interestingly, an uncorrelated asset can enhance portfolio returns, even if it has a negative expected return, through a concept known as the rebalancing bonus (also known as volatility harvesting). Here’s how it works:

When you combine two or more assets with uncorrelated (or negatively correlated) returns, the portfolio may benefit from periodic rebalancing. When one asset goes up, the other might go down, and vice versa, and a portfolio can gain from the divergent price movements. Suppose asset A returns +8% annually with volatility, and asset B returns -2% annually but with a low or negative correlation to A. When A rises and B falls, you rebalance by selling some A and buying more B at a lower price. When B bounces back (even temporarily), and A corrects downward, you sell B high and buy A low. This buy-low, sell-high rebalancing cycle generates incremental returns that can more than offset B’s long-term negative return.

The rebalancing bonus enjoyed by the allocator arises from the fact that the overall portfolio volatility is lower (given uncorrelated assets reduce portfolio volatility), and compounding works better with reduced volatility. The key condition is that the uncorrelated asset is volatile enough and moves differently from the other assets. The rebalancing opportunities from this divergence create the potential for a positive effect on overall portfolio returns.

The key condition for adding diversifiers to a portfolio, with the goal of reducing volatility and increasing return, is their lack of correlation to one’s existing portfolio (assumed to be stocks and/or bonds). In pursuit of this objective, we discuss three proven portfolio diversifiers (uncorrelated return streams) below.

Gold is the investing world’s first diversifier. Known as a valued and treasured asset throughout history, from the ancient Egyptians throughout the Roman Empire to today, gold has relatively consistently increased in value over the ages. Moreover, from a modern asset allocation perspective, the precious metal is the capital markets’ oldest diversifier, as displayed by its (very) long-term correlation with stocks of around zero. Over time, gold has proven uncorrelated with the broad equity index.

More importantly, gold tends to rise during equity sell-offs, exhibiting a negative correlation in times of financial crisis. For example, during the 2008 financial crisis, gold rose by 5% while global equities fell by approximately -40%. This performance dynamic of generating positive returns while equities suffer not only helps cushion portfolio downside and reduce investor stress, but also propels the aforementioned rebalancing bonus, increasing the overall portfolio return.

From first principles: When one hears the word “tariff” or “trade war”, one’s first consideration should be to own gold in a diversified portfolio. Gold thrives on uncertainty, as investors flock to the most reliable safe haven asset. Recently, there has been no shortage of economic uncertainty. Consequently, the yellow metal has continued its bull run, which commenced in early 2024.

The core benefit of hedge funds is their uncorrelated return stream and portfolio diversification potential. Contrary to misleading media headlines, the primary goal of hedge funds is not to beat the S&P 500. The goal of a “hedged” fund is to produce an uncorrelated return stream that helps diversify a portfolio and hedge downside volatility, ultimately increasing portfolio return while reducing risk. Hedge funds serve as a value-added addition to a traditional portfolio, not as a replacement.

Two tried-and-true hedge fund strategies that have provided uncorrelated returns over time are merger arbitrage and absolute return.

Over the past five years, merger arbitrage has exhibited a correlation of 0.13 with equities and 0.09 with bonds, while absolute return has demonstrated a correlation of 0.13 with stocks and -0.06 with bonds. These metrics meet the definition of uncorrelated.

Pairing uncorrelated assets creates a powerful return stream. The orange line below showcases the portfolio benefit of pairing of merger arbitrage (ARB) and absolute return (HDGE), compared to stocks and bonds (blue line), primarily via the increased return and reduced volatility.

Source: Accelerate, Bloomberg

Uncorrelated return streams are best used as portfolio diversifiers, instead of core portfolio replacements, that enhance portfolio returns while reducing portfolio risk. A level and a stud finder cannot make a tradesperson more effective on their own, however, when added with a hammer and a nail, the tradesperson becomes better functioning with a further diversified tool kit.

Portfolio diversifiers, via uncorrelated return streams, are powerful tools in the toolkits of capital allocators. An allocator’s primary role is to optimize a portfolio’s risk-adjusted return, and the more effective portfolio tools an allocator has in pursuing their goal, the higher the probability of a satisfactory outcome.

Just as Supreme Leader Snoke tried to use the Starkiller Base to create chaos and dominate the galaxy in Star Wars, President Trump is using tariffs to stoke volatility and fear such that the United States can hold dominion over its trading partners, meanwhile, damaging the global economy and capital markets.

Now more than ever, in the age of the Trade Wars, allocators should be prepared for heightened uncertainty and volatility. The best defense to protect portfolios is to utilize several uncorrelated return streams within a diversified asset allocation framework.

Accelerate manages five alternative investment solutions, each with a specific mandate:

• Accelerate Arbitrage Fund (TSX: ARB): Merger Arbitrage
• Accelerate Absolute Return Fund (TSX: HDGE): Absolute Return
• Accelerate OneChoice Alternative Portfolio ETF (TSX: ONEC): Multi-Asset
• Accelerate Canadian Long Short Equity Fund (TSX: ATSX): Long Short Equity
• Accelerate Diversified Credit Income Fund (TSX: INCM): Private Credit

Please see below for fund performance and manager commentary.

ARB began 2025 with a flattish month, with a mixed performance of the Fund’s diversified merger arbitrage strategy.

Positive contributors to the Fund in January included the closing of the following mergers: Manitex/Tadano, Poseida Therapeutics/Roche, Smartsheet/Blackstone/Vista Equity Partners, Universal Stainless/Aperam, Barnes Group/Apollo, and O3 Mining/Agnico Eagle Mines.

The main detractor for the Fund’s monthly shortfall in target performance was Juniper Networks, whose stock price suffered when the Department of Justice (DOJ) chose to challenge its merger with Hewlett Packard Enterprise at month end. While all signs pointed to deal approval and closure in January, the lame-duck DOJ leadership (which will turnover shortly as Trump’s new antitrust head, Gail Slater, is confirmed) chose to sue to block the deal, despite support in favour of the merger from DOJ staff and industry customers. We discussed the transaction in our last memo, Are Merger Funds Better Than Bond Funds? However, don’t take our word for it — the Wall Street Journal Editorial Board had a good critique regarding the illogical choice by the DOJ to try to stop the merger in the column, Where’s DOGE When You Need It? Nevertheless, the companies have vowed to push forward, and we believe it is probable that the merger will close successfully later this year.

ARB added three new merger arbitrage investments in January (out of sixteen announced in North America) and two new SPAC arbitrage investments via blank check IPOs (out of eight new issues). Currently, ARB is 128.2% long and -4.6% short (132.8% gross exposure), approximately evenly split between merger arbitrage and SPAC arbitrage.

We are pleased to announce that BarclayHedge awarded ARB a #6 global performance ranking (and the top hedge fund in Canada) in the merger arbitrage category for 2024.

Positive long short factor performance, primarily in the U.S. equity market, led to a 2.5% gain for HDGE in January.

The value, quality, and trend long short portfolios generated positive alpha of between 1.3% and 3.4%. Meanwhile, the operating momentum long short basket was up 0.3%, and the price momentum factor portfolio declined by -1.3%, as stocks with positive price momentum underperformed those with negative momentum.

Top contributors to the Fund’s return include long positions in Celestica, Stride, and Sprouts Farmers Market, and top detractors include short positions in Beyond, Corsair Gaming, and Titan Machinery.

ONEC generated a 2.7% return in January, with a broad positive contribution from most alternative asset classes.

Gold was the top-performing asset, gaining 7.7% as it continued its rally, supported by persistent inflation and increased macro uncertainty. Private credit also performed well, contributing a 5.3% return as its high yield continued and NAV discounts narrowed.

The real assets bucket started the year strong, with the Fund’s infrastructure and real estate allocations adding 2.6% and 2.1%, respectively. ONEC’s hedge fund allocations also contributed positively, as absolute return generated a 2.5% gain and risk parity added 2.3%, while the managed futures sleeve ticked up 1.3%. Lastly, the leveraged loan, long short equity, and commodity allocations gained less than 1%, while the merger arbitrage portfolio was flat.

ATSX generated a 0.9% return, compared with the benchmark TSX 60’s 4.2% gain.

The underperformance of the Fund in January was due to mixed long-short factor performance in the Canadian equity market. Specifically, low quality stocks outperformed high quality securities by 460bps and overvalued stocks outperformed undervalued ones by 180bps. Conversely, stocks with positive operating momentum outperformed those with negative operating momentum by 600bps.

Top contributors to the Fund’s monthly return include long positions in Celestica and Kinross Gold, along with a short position in Ag Growth International. Top detractors include a long position in Hammond Power and short positions in Mag Silver and Newmont.

Private credit was one of the best performing asset classes last month, as demonstrated by INCM’s 5.3% return.

The year started with a broad-based rally in the asset class, with liquid private credit funds on average trading from a NAV discount to a slight premium by month’s end.

Persistent inflation in the U.S., with core CPI stuck above 3% in January, supports a higher-for-longer interest rate environment, buoying private credit yields. There may be just one, or even zero, rate cuts from the Fed in 2025. Nonetheless, a higher base rate favours the approximate 10% yield in private credit, which has increased allocator confidence in the asset class.

We are pleased to announce that INCM is the top performing fixed income ETF in Canada, according to TD Securities.

Source: TD Securities, Accelerate

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-Julian

Disclaimer: This distribution does not constitute investment, legal or tax advice. Data provided in this distribution should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information in this distribution is based on current market conditions and may fluctuate and change in the future. No representation or warranty, expressed or implied, is made on behalf of Accelerate Financial Technologies Inc. (“Accelerate”) as to the accuracy or completeness of the information contained herein. Accelerate does not accept any liability for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on all or any part of this research and any liability is expressly disclaimed. Past performance is not indicative of future results. Visit www.AccelerateShares.com for more information.