GI Report July 2011

G.I. Capital Corp. Portfolio Report for July 2011

www.gicapital.ca

Benchmark represented by: 40% i-Shares Scotia Capital Universe Bond Index, 20% TSX Composite Index, 40% MSCI World Index, in CDN$. Note: The composite portfolio includes all relevant medium risk portfolios that meet the composite guidelines. Composite returns include dividends and are net of all fees. Past performance is not indicative of future returns. 1

G.I. Capital Corp. July 29, 2011 Report Summary Markets continued their slide into July. By now you are all certainly aware of

the current extreme volatility in the financial markets, as well as the

underlying reasons which have been delivered in blow by blow format by

the media. To reiterate, US politicians, in typical partisan fashion, squabbled

about whether or not to raise the debt ceiling from its 14.3 trillion level (at

this point, what's another trillion or two?) Investors were already worried

about a US default--something that is impossible to happen when you can

just print more money to pay your debts. Nevertheless, the partisan

rambling of the republicans and democrats only served to focus the entire

world on a predicament the US was in, i.e. either to be fiscally irresponsible

and keep building debt until it implodes on itself; or be responsible, balance

the budget, and yank the much-needed stimulus from a slowing economy.

And of course, in the background there is Europe with its own sovereign

debt crisis.

So now it appears that the market is struggling between: I) is this a

complete over-reaction, as the market often does in these scenarios? Or ii)

is this just like 2008 where there is much more damage to come.

Certainly, in the short term it looks like a buying opportunity (as of time of

writing in August), but prudence demands that we reduce exposure and

risk, just in case there's something else darker lurking out there that we are

not aware of yet. At the time of writing our net equity exposure is down to

~25%, and we will look to lighten up a bit more as the market rallies.

One of the major differences between now and 2008, is that 2008 was a

liquidity driven crisis, where even those who saw great value in the market

were forced to sell to meet margin calls and redemptions. Today we are

awash in liquidity. Corporations in North America are sitting on a trillion dollars of cash. John Manley, CEO of the Canadian Council of Chief

Executives (CCCE) stated that in an impromptu survey of Canadian CEOs,

30 responded saying that they planned to capital spend (collectively) 100

billion over the next 3 years. Institutions are managing portfolios with

greater exposure to more liquid assets, less leverage, and a greater

allocation to cash as is mandated by the exchanges, custodians and banks.

US financial institutions are also much safer now with over a trillion dollars

sitting in excess reserves.

G.I. Capital Corp. is a wealth management firm

specializing in developing

customized investment

solutions for its clients.

We are a boutique firm

focused on managing our

client’s portfolios, offering

a high level of research

and service to a limited number of clients. Our

client base consists of

professionals, executives

and business owners.

Our medium risk composite was up slightly for the month of July, despite the continued slide in the markets.

We had strong performance from Alternative Income Fund, and High yield, which bounced back nicely, as

well as moderate performance from Long-Short Equity, Hedge Funds and Fixed Income. Offsetting this was

a loss on Private Equity. The composite return for the last 12 months is 6.78%, and the average 12 month

rolling return over the last year is 8.78%.

Our positioning is changing slightly with the increased volatility. We are bringing down our market exposure,

through some selective shorts or trimming positions; raising cash levels; and generally trying to increase the

liquidity of the overall portfolio.

G.I. Capital Alternative Income Fund: Note: we have included the full monthly report for Alternative Income

Fund at the end of this report. The fund had another great month, up 1.26%, bringing the 1 year return to

11.50% (net of all costs except management fees).

Market Review

We continue to witness further price deterioration in the markets as investors globally were worried about the

resolution of the US debt ceiling, further economic slowdown and European sovereign debt problems. The

TSX declined by 2.67% to 12,946, while the S&P 500 in New York fell 2.15% to 1,292. The MSCI World

index was down 1.9% finishing July at 1,306.

Portfolio Performance for Accredited Clients

Asset Allocation for Portfolio by Strategy


www.gicapital.ca


level of individuals and corporations, which has undoubtedly been

shaken by the markets. The confidence level will translate into

purchasing decisions which will shape the growth of the global

economy. In addition, the central banks have learned from 2008 to

react quickly to any market dislocation.

The US government has painted itself into a corner and cannot get

out of it. The US can ill afford any interest rate increases because it

will put a huge strain on the deficit and on the rating of its debt. As far

as the math goes, every 1% rise in the government bond yields

increases interest expense by USD 140 billion, which is 7% of annual

Federal tax revenue. Hence, we expect the printing press will

continue to run, which means that the USD will continue to devalue.

One of the biggest critics of the USD has been former Russian Prime

minister Putin, who by all accounts is still running Russia. Recently in

a statement he said the following about the US and the Dollar: “They

are living like parasites off the global economy and their monopoly of

the Dollar”. Now Putin is not completely off his rocker, as he does

have some good economic experience in this arena. He took Russia

in the middle of the financial crises in 1998 with a Debt to GDP level

in excess of 100%, down to its current ratio of around 30%. His major

remedy was to devalue the Russian ruble and implement a number of

austerity programs. It also did not hurt that the commodity market

took off soon after, flushing government coffers with a lot of tax

rubles.

Gold had another strong month in July rallying 8.4% to USD 1583 per

ounce, on the back of uncertainty in the markets and a lack of trust of

politicians in the US and Europe. In addition, we are getting closer to

gold’s strong seasonal trend which gold experiences between August

and February. This seasonality is supported by the Indian wedding

season in August and September. The unprecedented run in gold is

pointing to the competitive devaluation of global currencies which has

already started.

Portfolio Changes

We spoke extensively last month about our position in Armtec debt.

In July, we saw an interesting dislocation develop between the notes

(8.875% Sep 2017) and the convertible debentures (6.5% Jun 2017).

The notes, of course, are senior to the debentures, and so one would

expect they would trade at a lower yield to maturity than the

debentures. However, the debentures rallied to a 9.5% YTM, while

the notes stayed stuck at almost 12%. We would account for this as

the difference between the more conservative institutional bond

holders who hold the notes, versus the more erratic retail investor

base that likely hold the converts. In any case, we elected to sell the

converts and buy the notes, thereby moving up the capital structure,

and at the same time adding 2.5 points of annual yield.

Market Performance

In Toronto, a sharp move out of equity due to the perceived slow

down in the global economy, caused more economically sensitive

stocks to decline. The financial, industrial and the IT sectors led the

decline, falling 5.6%, 6.6% and 8.8% respectively. The Materials

sector rebounded by 1.6%, while the gold sector was the biggest

winner jumping 6.7% on the back of the rise in the price of gold.

Globally, the European markets were hit extremely hard in July. The

French CAC 40 led the decliners falling 7.8%, while Australia’s S&P

200 and India’s Sensex both fell by 4% and 3.4% respectively.

European investors are concerned about what the bail outs of the

smaller Europeans members such as Greece, Italy, Ireland, etc will

do to the economies and banking systems of the stronger E.U.

members such as Germany and France. French and German

financial institutions have large holdings of the sovereign bonds of the

weaker nations, and could be at risk of financial distress if the smaller

nations were to default on their financial obligations.

On the economic front, the US ISM Manufacturing index fell to 50.9%

in July, its lowest level in two years, a decline of 8% from the

previous month. However, a reading above 50% still indicates an

expansion in the economy. Consumer spending in the US fell 0.2%

in June, marking the first decline since September 2009. The OECD

leading indicators in key countries such as France and Germany are

continuing to fall, but they are still in growth territory. US GDP rose

only 1.3% in Q2 indicating a significant slowdown in growth after

many revisions downwards. Part of the problem with the tepid growth

in Q2 had to do with one time issues which are being resolved in Q3,

e.g. a Japanese earthquake, significant jump in the oil prices and

higher food cost. The majority of Japanese industry should return to

levels close to full operation by the end of July.

On the positive side, the US reporting season started stronger than

expected. So far for Q2, 71% of companies have beat revenue

forecasts, which is the highest pace since Q4 2004. However, of the

345 companies that have reported, only 5.8% have raised guidance,

while 6.1% have lowered guidance.

We believe the economy is slowing down, which is really what is

driving the markets lower. However, we have seen this show before,

in the summer of 2007 and 2010, as well as in 2004. As the economy

slowed down, the Fed came in with a stimulus package. We have no

doubt that Q3 is coming in one form or another. Testifying before the

congress in July, Fed Chairman Ben Bernanke left the door open for

additional stimulus packages, such as incremental bond purchases or

other measures in order to keep interest rates low if the US recovery

falters.

Based on this analysis, it is difficult to conclude that we are in a

recession or will be in one soon. A number of factors in Q2 have

actually reversed in Q3; however we are monitoring the confidence


www.gicapital.ca


G.I. Alternative Income Strategy

• The Alternative Income Strategy is an alternative to traditional bond funds that trade in publicly traded securities, which although carry very low credit risk, currently have minimal return.

• The Alternative Income Strategy seeks to invest in alternative income strategies like private mortgages and asset backed loans that offer higher returns, while still providing reasonable security to cover the loans.

• The strategy’s objectives are to preserve capital, minimize volatility, have a low or zero correlation with stock and bond markets, and achieve an annualized return of 8-10% net of all fees.

Percentage Loan To Average Expected Average

Security Type Weighting Value Ratio Maturity (Months) Expected Yield

First Mortgage9.4% 64% 18 11.4%

Subordinated First40.9% 60% 39 12.7%

Second Mortgage24.1% 74% 4 11.6%

Real Estate Equity16.9% n.a. 46 10.0%

Asset Backed Loans8.3% 50% 5 13.0%

Cash0.4% 0% 0 0.0%

100.0% 11.3%

Fund Stats

Weighted Average Yield Weighted Average LTV Ratio Weighted Average Maturity

(Months)

11.26% 56.97% 27

This monthly update does not constitute or purport to constitute a complete description of the G.I. Capital Corp. Alternative Investment Strategy and is in all

respects subject to the more detailed provisions found in the fund's declaration of trust. The Alternative Income Strategy is only available to GI clients who have engaged GI to manage their account under the alternative income mandate as outlined in their investment policy statement. The returns above are net of

all fees, other than management fees. The references to the target rates of return are provided for illustrative purposes only and there can be no assurance that

the fund will be able to achieve the targeted rates of return.

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec YTD1

2010 -- -- -- -- -- -- 0.84% 0.78% 0.87% 0.80% 0.83% 0.54% 4.75%

2011 0.63% 0.68% 1.33% 0.91% 0.72% 1.91% 1.26% 7.67%

Portfolio Performance for Alternative Income Strategy

Portfolio Breakdown by Allocation

G.I. Capital Corp. www.gicapital.ca

Mark Irwin, CFA Tel: 647-776-4028 E-mail: [email protected]

Jim Goren, CFA Tel: 647-776-4029 E-mail: [email protected]

Bill Hallman, CFA Tel: 905-510-0963 E-mail: [email protected]

Documents

GI Report July 2011