The fund underperformed the TXPR index in July (results for the BMO-CM “50” index are not yet available), weighed down by its heavy weighting in FixedResets, particularly those with a low Issue Reset Spread.
ZPR, is an ETF comprised of FixedResets and Floating Rate issues and a very high proportion of junk issues, returned -XX%, -XX% and -XX% over the past one-, three- and twelve-month periods, respectively (according to the fund’s data), versus returns for the TXPL index of -5.31%, -9.07% and -17.26% respectively. The fund has been able to attract assets of about $1,004-million since inception in November 2012; AUM increased by $16.4-million in June; given an index return of -5.31% a decrease of about $52-million was expected, so there was a very significant cash inflow over the month. I feel that the flows into and out of this fund are very important in determining the performance of its constituents … although for this month it appears that buying from this ETF was swamped by other sellers!
TXPR had returns over one-, three- and twelve-months of -4.10%, -7.53% and -11.47% respectively with CPD performance within expectations.
Returns for the HIMIPref™ investment grade sub-indices for the month were as follows:
| HIMIPref™ Indices Performance to July 31, 2015 |
||
| Sub-Index | 1-Month | 3-month |
| Ratchet | N/A | N/A |
| FixFloat | N/A | N/A |
| Floater | -10.78% | -11.82% |
| OpRet | N/A | N/A |
| SplitShare | +0.07% | +0.69% |
| Interest | N/A | N/A |
| PerpetualPremium | -0.84% | -1.05% |
| PerpetualDiscount | -2.01% | -5.98% |
| FixedReset | -4.09% | -6.69% |
| DeemedRetractible | -1.47% | -2.48% |
| FloatingReset | -2.71% | -2.45% |
Malachite Aggressive Preferred Fund’s Net Asset Value per Unit as of the close July 31, 2015, was $8.9795.
| Returns to July 31, 2015 | ||||
| Period | MAPF | BMO-CM “50” Index | TXPR Total Return |
CPD – according to Blackrock |
| One Month | -4.66% | -3.84% | -4.10% | N/A |
| Three Months | -8.39% | -6.95% | -7.53% | N/A |
| One Year | -10.64% | -11.00% | -11.47% | -11.66% |
| Two Years (annualized) | -1.14% | -3.83% | -3.69% | N/A |
| Three Years (annualized) | -0.12% | -2.00% | -2.33% | -2.72% |
| Four Years (annualized) | +0.61% | -0.42% | -0.73% | N/A |
| Five Years (annualized) | +3.48% | +2.15% | +1.42% | +0.91% |
| Six Years (annualized) | +5.38% | +3.40% | +2.48% | |
| Seven Years (annualized) | +11.52% | +3.83% | +2.96% | |
| Eight Years (annualized) | +9.00% | +2.33% | +1.48% | |
| Nine Years (annualized) | +8.61% | +2.15% | ||
| Ten Years (annualized) | +8.20% | +2.24% | ||
| Eleven Years (annualized) | +8.13% | +2.50% | ||
| Twelve Years (annualized) | +9.01% | +2.79% | ||
| Thirteen Years (annualized) | +9.34% | +3.05% | ||
| Fourteen Years (annualized) | +9.48% | +3.12% | ||
| MAPF returns assume reinvestment of distributions, and are shown after expenses but before fees. | ||||
| CPD Returns are for the NAV and are after all fees and expenses. | ||||
| Figures for National Bank Preferred Equity Income Fund (formerly Omega Preferred Equity) (which are after all fees and expenses) for 1-, 3- and 12-months are -3.78%, -6.10% and -8.08%, respectively, according to Morningstar after all fees & expenses. Three year performance is -0.72%; five year is +2.36% | ||||
| Figures for Manulife Preferred Income Class Adv [into which was merged Manulife Preferred Income Fund (formerly AIC Preferred Income Fund)] (which are after all fees and expenses) for 1-, 3- and 12-months are -4.13%, -7.99% & N/A, respectively. | ||||
| Figures for Horizons AlphaPro Preferred Share ETF (which are after all fees and expenses) for 1-, 3- and 12-months are -3.33%, -6.16% & -9.25%, respectively. Three year performance is -1.04% | ||||
| Figures for National Bank Preferred Equity Fund (formerly Altamira Preferred Equity Fund) are -3.62%, -6.59% and -10.70% for one-, three- and twelve months, respectively. | ||||
| The figure for BMO S&P/TSX Laddered Preferred Share Index ETF is -5.32%, -9.08% and -17.51% for one-, three- and twelve-months, respectively. Two year performance is -7.67%. | ||||
| Figures for NexGen Canadian Preferred Share Tax Managed Fund (Dividend Tax Credit Class, the best performing) are -3.3%, -7.2% and -4.7% for one-, three- and twelve-months, respectively. | ||||
| Figures for BMO Preferred Share Fund are -6.63% and -10.25% for the past three- and twelve-months, respectively. | ||||
| Figures for PowerShares Canadian Preferred Share Index Class, Series Fare -3.94%, -7.46% and -12.64% for the past one, three and twelve months, respectively. The two-, three- and five-year figures are -4.98%, -4.01% and -0.31%, respectively. | ||||
| Figures for the First Asset Preferred Share Investment Trust (PSF.UN) are -5.74%, -9.21 and -14.77 for the past one, three and twelve months, respectively. The two-, three-, four- and five-year figures are -6.79%, -4.44%, -3.09% and -1.45%, respectively. | ||||
MAPF returns assume reinvestment of dividends, and are shown after expenses but before fees. Past performance is not a guarantee of future performance. You can lose money investing in Malachite Aggressive Preferred Fund or any other fund. For more information, see the fund’s main page. The fund is available either directly from Hymas Investment Management or through a brokerage account at Odlum Brown Limited.
A problem that has bedevilled the market over the past four years has been the OSFI decision not to grandfather Straight Perpetuals as Tier 1 bank capital, and their continued foot-dragging regarding a decision on insurer Straight Perpetuals has segmented the market to the point where trading has become much more difficult. Until the market became so grossly segmented, there were many comparables for any given issue – but now banks are not available to swap into (because they are so expensive) and non-regulated companies are likewise deprecated (because they are not DeemedRetractibles; they should not participate in the increase in value that will follow the OSFI decision I anticipate and, in addition, are analyzed as perpetuals). The fund’s portfolio was, in effect ‘locked in’ to the low coupon DeemedRetractibles due to projected long-term gains from a future OSFI decision to the detriment of trading gains, particularly in May, 2013, when the three lowest-coupon SLF DeemedRetractibles (SLF.PR.C, SLF.PR.D and SLF.PR.E) were the worst performing DeemedRetractibles in the sub-index, and in June, 2013, when the insurance-issued DeemedRetractibles behaved like PerpetualDiscounts in a sharply negative market. Nowadays, the fund is ‘locked-in’ to the low-spread FixedResets from these companies: GWO.PR.N, MFC.PR.F, and SLF.PR.G.
In May, insurance DeemedRetractibles performed worse than bank DeemedRetractibles:
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… and slightly worse than Unregulated Straight Perpetuals.
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Correlations were OK for banks (26%), good for insurance (59%) but not very good for unregulated issues (14%; not shown).
A lingering effect of the downdraft of 2013 has been the return of measurable Implied Volatility but given my recent updates in recent daily market reports, I will not discuss them further in this post.
Sometimes everything works … sometimes it’s 50-50 … sometimes nothing works. The fund seeks to earn incremental return by selling liquidity (that is, taking the other side of trades that other market participants are strongly motivated to execute), which can also be referred to as ‘trading noise’ – although for quite some time, noise trading has taken a distant second place to the sectoral play on insurance DeemedRetractibles; something that dismays me, particularly given that the market does not yet agree with me regarding the insurance issues! There were a lot of strongly motivated market participants during the Panic of 2007, generating a lot of noise! Unfortunately, the conditions of the Panic may never be repeated in my lifetime … but the fund will simply attempt to make trades when swaps seem profitable, without worrying about the level of monthly turnover.
There’s plenty of room for new money left in the fund. I have shown in PrefLetter that market pricing for FixedResets is very often irrational and I have lots of confidence – backed up by my bond portfolio management experience in the markets for Canadas and Treasuries, and equity trading on the NYSE & TSX – that there is enough demand for liquidity in any market to make the effort of providing it worthwhile (although the definition of “worthwhile” in terms of basis points of outperformance changes considerably from market to market!) I will continue to exert utmost efforts to outperform but it should be borne in mind that there will almost inevitably be periods of underperformance in the future.
The yields available on high quality preferred shares remain elevated, which is reflected in the current estimate of sustainable income.
| Calculation of MAPF Sustainable Income Per Unit | ||||||
| Month | NAVPU | Portfolio Average YTW |
Leverage Divisor |
Securities Average YTW |
Capital Gains Multiplier |
Sustainable Income per current Unit |
| June, 2007 | 9.3114 | 5.16% | 1.03 | 5.01% | 1.3240 | 0.3524 |
| September | 9.1489 | 5.35% | 0.98 | 5.46% | 1.3240 | 0.3773 |
| December, 2007 | 9.0070 | 5.53% | 0.942 | 5.87% | 1.3240 | 0.3993 |
| March, 2008 | 8.8512 | 6.17% | 1.047 | 5.89% | 1.3240 | 0.3938 |
| June | 8.3419 | 6.034% | 0.952 | 6.338% | 1.3240 | $0.3993 |
| September | 8.1886 | 7.108% | 0.969 | 7.335% | 1.3240 | $0.4537 |
| December, 2008 | 8.0464 | 9.24% | 1.008 | 9.166% | 1.3240 | $0.5571 |
| March 2009 | $8.8317 | 8.60% | 0.995 | 8.802% | 1.3240 | $0.5872 |
| June | 10.9846 | 7.05% | 0.999 | 7.057% | 1.3240 | $0.5855 |
| September | 12.3462 | 6.03% | 0.998 | 6.042% | 1.3240 | $0.5634 |
| December 2009 | 10.5662 | 5.74% | 0.981 | 5.851% | 1.1141 | $0.5549 |
| March 2010 | 10.2497 | 6.03% | 0.992 | 6.079% | 1.1141 | $0.5593 |
| June | 10.5770 | 5.96% | 0.996 | 5.984% | 1.1141 | $0.5681 |
| September | 11.3901 | 5.43% | 0.980 | 5.540% | 1.1141 | $0.5664 |
| December 2010 | 10.7659 | 5.37% | 0.993 | 5.408% | 1.0298 | $0.5654 |
| March, 2011 | 11.0560 | 6.00% | 0.994 | 5.964% | 1.0298 | $0.6403 |
| June | 11.1194 | 5.87% | 1.018 | 5.976% | 1.0298 | $0.6453 |
| September | 10.2709 | 6.10% Note |
1.001 | 6.106% | 1.0298 | $0.6090 |
| December, 2011 | 10.0793 | 5.63% Note |
1.031 | 5.805% | 1.0000 | $0.5851 |
| March, 2012 | 10.3944 | 5.13% Note |
0.996 | 5.109% | 1.0000 | $0.5310 |
| June | 10.2151 | 5.32% Note |
1.012 | 5.384% | 1.0000 | $0.5500 |
| September | 10.6703 | 4.61% Note |
0.997 | 4.624% | 1.0000 | $0.4934 |
| December, 2012 | 10.8307 | 4.24% | 0.989 | 4.287% | 1.0000 | $0.4643 |
| March, 2013 | 10.9033 | 3.87% | 0.996 | 3.886% | 1.0000 | $0.4237 |
| June | 10.3261 | 4.81% | 0.998 | 4.80% | 1.0000 | $0.4957 |
| September | 10.0296 | 5.62% | 0.996 | 5.643% | 1.0000 | $0.5660 |
| December, 2013 | 9.8717 | 6.02% | 1.008 | 5.972% | 1.0000 | $0.5895 |
| March, 2014 | 10.2233 | 5.55% | 0.998 | 5.561% | 1.0000 | $0.5685 |
| June | 10.5877 | 5.09% | 0.998 | 5.100% | 1.0000 | $0.5395 |
| September | 10.4601 | 5.28% | 0.997 | 5.296% | 1.0000 | $0.5540 |
| December, 2014 | 10.5701 | 4.83% | 1.009 | 4.787% | 1.0000 | $0.5060 |
| March, 2015 | 9.9573 | 4.99% | 1.001 | 4.985% | 1.0000 | $0.4964 |
| June, 2015 | 9.4181 | 5.55% | 1.002 | 5.539% | 1.0000 | $0.5217 |
| July, 2015 | 8.9795 | 5.61% | 0.995 | 5.638% | 1.0000 | $0.5063 |
| NAVPU is shown after quarterly distributions of dividend income and annual distribution of capital gains. Portfolio YTW includes cash (or margin borrowing), with an assumed interest rate of 0.00% The Leverage Divisor indicates the level of cash in the account: if the portfolio is 1% in cash, the Leverage Divisor will be 0.99 Securities YTW divides “Portfolio YTW” by the “Leverage Divisor” to show the average YTW on the securities held; this assumes that the cash is invested in (or raised from) all securities held, in proportion to their holdings. The Capital Gains Multiplier adjusts for the effects of Capital Gains Dividends. On 2009-12-31, there was a capital gains distribution of $1.989262 which is assumed for this purpose to have been reinvested at the final price of $10.5662. Thus, a holder of one unit pre-distribution would have held 1.1883 units post-distribution; the CG Multiplier reflects this to make the time-series comparable. Note that Dividend Distributions are not assumed to be reinvested. Sustainable Income is the resultant estimate of the fund’s dividend income per current unit, before fees and expenses. Note that a “current unit” includes reinvestment of prior capital gains; a unitholder would have had the calculated sustainable income with only, say, 0.9 units in the past which, with reinvestment of capital gains, would become 1.0 current units. |
||||||
| DeemedRetractibles are comprised of all Straight Perpetuals (both PerpetualDiscount and PerpetualPremium) issued by BMO, BNS, CM, ELF, GWO, HSB, IAG, MFC, NA, RY, SLF and TD, which are not exchangable into common at the option of the company (definition refined in May, 2011). These issues are analyzed as if their prospectuses included a requirement to redeem at par on or prior to 2022-1-31 (banks) or 2025-1-31 (insurers and insurance holding companies), in addition to the call schedule explicitly defined. See OSFI Does Not Grandfather Extant Tier 1 Capital, CM.PR.D, CM.PR.E, CM.PR.G: Seeking NVCC Status and the January, February, March and June, 2011, editions of PrefLetter for the rationale behind this analysis.
The same reasoning is also applied to FixedResets from these issuers, other than explicitly defined NVCC from banks. |
||||||
| Yields for September, 2011, to January, 2012, were calculated by imposing a cap of 10% on the yields of YLO issues held, in order to avoid their extremely high calculated yields distorting the calculation and to reflect the uncertainty in the marketplace that these yields will be realized. From February to September 2012, yields on these issues have been set to zero. All YLO issues held were sold in October 2012. | ||||||
| Calculations of resettable instruments are performed assuming constant contemporary GOC-5 and 3-Month Bill rates. For June 30, 2015, yields of 0.91% and 0.52%, respectively, were assumed; base rates in July were 0.62% and 0.40%, respectively. | ||||||
The 29bp drop in GOC-5 did not help the sustainable yield calculation!
Significant positions were held in DeemedRetractible, SplitShare and NVCC non-compliant regulated FixedReset issues on June 30; all of these currently have their yields calculated with the presumption that they will be called by the issuers at par prior to 2022-1-31 (banks) or 2025-1-31 (insurers and insurance holding companies) or on a different date (SplitShares) This presents another complication in the calculation of sustainable yield, which also assumes that redemption proceeds will be reinvested at the same rate.
I will also note that the sustainable yield calculated above is not directly comparable with any yield calculation currently reported by any other preferred share fund as far as I am aware. The Sustainable Yield depends on:
i) Calculating Yield-to-Worst for each instrument and using this yield for reporting purposes;
ii) Using the contemporary value of Five-Year Canadas to estimate dividends after reset for FixedResets. The assumption regarding the five-year Canada rate has become more important as the proportion of low-spread FixedResets in the portfolio has increased.
iii) Making the assumption that deeply discounted NVCC non-compliant issues from both banks and insurers, both Straight and FixedResets will be redeemed at par on their DeemedMaturity date as discussed above.
I no longer show calculations that assume the conversion of the entire portfolio into PerpetualDiscounts, as the fund has only a small position in these issues.
Most funds report Current Yield. For instance, ZPR reports a “Dividend Yield” of 4.5% as of August 29, 2014, but this is the Current Yield, a meaningless number. The Current Yield of MAPF was 4.89% as of August 29, but I will neither report that with any degree of prominence nor take any great pleasure in the fact that it’s a little higher than the ZPR number. It’s meaningless; to discuss it in the context of portfolio reporting is misleading.
However, BMO has taken a significant step forward in that they are no longer reporting the “Portfolio Yield” directly on their website; the information is taken from the “Enhanced Fund Profile” which is available only as a PDF link. CPD doesn’t report this metric on the CPD fact sheet or on their website. I may have one less thing to mock the fundcos about!
It should be noted that the concept of this Sustainable Income calculation was developed when the fund’s holdings were overwhelmingly PerpetualDiscounts – see, for instance, the bottom of the market in November 2008. It is easy to understand that for a PerpetualDiscount, the technique of multiplying yield by price will indeed result in the coupon – a PerpetualDiscount paying $1 annually will show a Sustainable Income of $1, regardless of whether the price is $24 or $17.
Things are not quite so neat when maturity dates and maturity prices that are different from the current price are thrown into the mix. If we take a notional Straight Perpetual paying $5 annually, the price is $100 when the yield is 5% (all this ignores option effects). As the yield increases to 6%, the price declines to 83.33; and 83.33 x 6% is the same $5. Good enough.
But a ten year bond, priced at 100 when the yield is equal to its coupon of 5%, will decline in price to 92.56; and 92.56 x 6% is 5.55; thus, the calculated Sustainable Income has increased as the price has declined as shown in the graph:
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The difference is because the bond’s yield calculation includes the amortization of the discount; therefore, so does the Sustainable Income estimate.
Different assumptions lead to different results from the calculation, but the overall positive trend is apparent. I’m very pleased with the long-term results! It will be noted that if there was no trading in the portfolio, one would expect the sustainable yield to be constant (before fees and expenses). The success of the fund’s trading is showing up in
- the very good performance against the index
- the long term increases in sustainable income per unit
As has been noted, the fund has maintained a credit quality equal to or better than the index; outperformance has generally been due to exploitation of trading anomalies.
Again, there are no predictions for the future! The fund will continue to trade between issues in an attempt to exploit market gaps in liquidity, in an effort to outperform the index and keep the sustainable income per unit – however calculated! – growing.
Low-Spread FixedResets: July 2015
August 3rd, 2015As noted in MAPF Portfolio Composition: July 2015, the fund now has a large allocation to FixedResets, mostly of relatively low spread.
Many of these were largely purchased with proceeds of sales of DeemedRetractibles from the same issuer; it is interesting to look at the price trend of some of the Straight/FixedReset pairs. We’ll start with GWO.PR.N / GWO.PR.I; the fund sold the latter to buy the former at a takeout of about $1.00 in mid-June, 2014; relative prices over the past year are plotted as:
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Given that the June month-end take-out was $5.70, this is clearly a trade that has not worked out very well.
In July, 2014, I reported sales of SLF.PR.D to purchase SLF.PR.G at a take-out of about $0.15:
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There were similar trades in August, 2014 (from SLF.PR.C) at a take-out of $0.35. The June month-end take-out (bid price SLF.PR.D less bid price SLF.PR.G) was $5.01, so that hasn’t worked very well either.
November saw the third insurer-based sector swap, as the fund sold MFC.PR.C to buy the FixedReset MFC.PR.F at a post-dividend-adjusted take-out of about $0.85 … given a June month-end take-out of $4.46, that’s another regrettable trade, although another piece executed in December at a take-out of $1.57 has less badly.
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This trend is not restricted to the insurance sector, which I expect will become subject to NVCC rules in the relatively near future and are thus subject to the same redemption assumptions I make for DeemedRetractibles. Other pairs of interest are BAM.PR.X / BAM.PR.N:
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… and FTS.PR.H / FTS.PR.J:
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Note that the last point in this graph, results from a nonsensical quote supplied by the Toronto Stock Exchange, as discussed on July 31. I have not checked whether this lamentable state of affairs is due to inadequate Toronto Stock Exchange reporting or inadequate Toronto Stock Exchange supervision of market-makers.
… and PWF.PR.P / PWF.PR.S:
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I will agree that the fund’s trades highlighted in this post may be decried as cases of monumental bad timing, but I should point out that in May, 2014, the fund was 63.9% Straight / 9.5% FixedReset while in May 2015 the fund was 12% Straight / 86% FixedReset, FloatingReset and FixedFloater (The latter figures include allocations from those usually grouped as ‘Scraps’). Given that the indices are roughly 30% Straight / 60% FixedReset & FloatingReset, it is apparent that the fund was extremely overweighted in Straights / underweighted in FixedResets in May 2014 but this situation has now reversed. HIMIPref™ analytics have been heavily favouring low-spread issues and the fund’s holdings are overwhelmingly of this type.
Summarizing the charts above in tabular form, we see:
December 2013
MAPF Trade
December 2014
3.65%+130
4.5%
4.35%+141
4.45%
4.20%+141
4.50%
4.60%+180
4.75%
4.25%+145
4.75%
4.40%+160
4.80%
Changes were varied from May month-end to June month-end.
In January, a slow decline due to fears of deflation got worse with Canada yields plummeting after the Bank of Canada rate cut with speculation rife about future cuts although this slowly died away.
And in late March / early April it got worse again, with one commenter attributing at least some of the blame to the John Heinzl piece in which I pointed out the expected reduction in dividend payouts! In May, a rise in the markets in the first half of the month was promptly followed by a slow decline in the latter half; perhaps due to increased fears that a lousy Canadian economy will delay a Canadian tightening. Changes in June varied as the markets were in an overall decline.
All in all, I take the view that we’ve seen this show before: during the Credit Crunch, Floaters got hit extremely badly (to the point at which their fifteen year total return was negative) because (as far as I can make out) their dividend rate was dropping (as it was linked to Prime) while the yields on other perpetual preferred instruments were skyrocketing (due to credit concerns). Thus, at least some investors insisted on getting long term corporate yields from rates based (indirectly and with a lag, in the case of FixedResets) on short-term government policy rates. And it’s happening again!
There is further discussion of the extremely poor YTD performance of FixedResets in the post eMail to a Client.
Here’s the June performance for FixedResets that had a YTW Scenario of ‘To Perptuity’ at mid-month.:
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The market continues to be rather disorderly; correlations between Issue Reset Spread and monthly performance for July are basically zero. Interestingly, the correlation for returns against term to reset was a little better, although still lousy at 8% and 15% for Pfd-2 and Pfd-3 issues respectively.
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