I received a call today from a client who is most concerned about the preferred share market in general and Malachite Aggressive Preferred Fund in particular. It will not have escaped notice that the fund price has been declining in recent months – when will it end?
However, the most important thing about fixed-income investing – and an investment in preferred shares is, for broad asset allocation purposes, an investment in fixed income – is that it is represents an investment in fixed income. A very circular definition to be sure, but I hope my meaning will be made plain shortly.
From now on, I will report sustainable dividends per unit as part of my regular portfolio disclosures. This number will be calculated as follows:
- SustDiv is the expected income per unit per year
- NAVPU is the Net Asset Value Per Unit
- PortYield is the Yield-to-Worst of the Portfolio
- Leverage is the degree of leverage in the portfolio
First – I should emphasize that “Leverage” should not be taken as meaning that the fund is leveraged on a regular basis. The fund can often hold relatively large cash balances, either positive or negative, to facilitate trading. If I attempt to purchase one security and sell another, I might not get filled on both sides to the same extent. If I don’t, I won’t force the cash to zero, by buying or selling something at whatever price it takes … I’ll (generally) wait until the next day and patiently wait until the market cooperates. These cash positions are normally wiped out fairly quickly – but when they exist at month end, the fund reporting can look a little odd! Note that in the table below, most of the “Leverage Factors” are less than 1.0, indicating that the fund was holding cash until it could be invested advantageously.
While the figures for Sustainable Income have been worked out in a mathematically precise manner, I must caution investors that these amounts will not necessarily be paid out to them in four equal installments annually. As may be seen from the historical distributions recorded on the Quarterly Performance Reporting Page, distributions are ‘lumpy’. This results from several factors:
- Sometimes, the market wants to capture the dividend a lot more than I want to keep it! Let us say that an issue is fairly priced at $25.00 (flat) and earns a $0.30 dividend tomorrow. The market price should be $25.30. Sometimes, the market really wants to capture the dividend, and the price goes up to $25.40. Why would I keep the issue? Why not just sell, and take $0.40 as a capital gain, instead of $0.30 as a dividend? I don’t have a good answer for that … so I sell. Naysayers may whine that this requires me to have a fairly good idea of what the “fair price” is … but that’s what I do!
- Sometimes I want to capture the dividend more than the market wants to keep it. Perhaps, in the above example, the market price of the issue is only $25.20. Well – I’ll be trying to buy it! If I can get it at that price then I will earn a $0.30 dividend right away and be left with an issue fairly priced at $25.00 … which is good business!
- The fund does not exclusively seek to maximize yield. I do not blindly purchase whatever yields the most.
- I might, for instance, trade so that while I’m giving up yield, I’m picking up credit (e.g., I might wish to sell a Pfd-2(low) issue at a yield of 5.00% in order to buy a Pfd-1 issue at a yield of 4.80%).
- There might be other instances whereby I can increase my ‘fair value’ while decreasing yield … I might wish to sell a perpetual at 5.00% in order to buy a retractible at 4.80%.
The first item on the above list will have the effect of reducing the dividend distribution, but increasing the capital gain distribution. The second item will have the opposite effect. The third item will not have a direct effect on distributions, but will reduce my reported portfolio yield. When the trades are successful, each will have the effect of ultimately putting more money in the unitholders’ pockets.
The fund is managed with an objective of maximizing fair value. I am indifferent as to whether this comes in the form of dividends or capital gains; I am indifferent as to whether the quarterly distributions of dividends are bigger or smaller than average.
From the above discussion, it should be understood that these calculations are a guide, intended to illustrate the idea that expected income per unit will be fairly constant. Successful trading – as has occurred in the past – will lead, eventually, to excess distributions and hence, more units.
|Calculation of MAPF Sustainable Income|
Many will observe that this is much like one’s attitude should be when holding a bond, preferred share, or other fixed income vehicle directly: in the absence of credit disasters, it keeps on paying its agreed rate.
The RY.PR.F issue, for instance, is now quoted at 20.73, down a lot from its issue price of $25.00, but it’s still paying the same dividend now as when it started: $1.1125 annually. It would have been a lot nicer to have bought that dividend stream for $20.73, of course, rather than having paid $25.00 … but I can’t time the markets and I don’t think anybody else can either (as I have discussed elsewhere). What I do think MAPF can do – and what MAPF has historically been able to do – is to trade between issues, selling them when they’re ten cents expensive in order to buy something else that’s ten cents cheap, and passing those gains through to unitholders.