The market experienced a wild ride in July, with the PerpetualDiscount index down 8.85% for the month at nadir on July 16, subsequently recovering to a loss of “only” 3.34% as the bargain-hunters swooped in on some very juicy yields. See Best & Worst Performers, which shows results for both parts of the month as well as the whole, and Index Performance, July 2008 for comparison with other subindices and the two exchange-traded funds.
The fund, with its heavy weighting in PerpetualDiscounts (see MAPF Portfolio Composition, July 2008), was not immune to the carnage and declined 2.31% on the month, before fees but after expenses.
|Returns to July 31, 2008|
|Two Years (annualized)||-0.96%||-3.54%|
|Three Years (annualized)||+0.85%||-1.37%|
|Four Years (annualized)||+2.44%||+0.20%|
|Five Years (annualized)||+5.59%||+1.34%|
|Six Years (annualized)||+6.85%||+2.14%|
|Seven Years (annualized)||+7.48%||+2.41%|
|The Index is the BMO-CM “50”|
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 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|
|NAVPU is shown after quarterly distributions.
“Portfolio YTW” includes cash (or margin borrowing), with an assumed interest rate of 0.00%
“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.
“Sustainable Income” is the best available estimate of the fund’s dividend income per unit.
It is very gratifying to see the sharp increase in expected income per unit – if there was no trading in the fund, this would be a constant number. While it is disappointing to see the net asset value per unit decline, it is the expected income per unit that will determine the long term performance of the fund as the market stabilizes.
I must point out, however, that the expected income is a little skewed this month due to the extraordinarily high yield available on WFS.PR.A, which was purchased in quantity during July. At month-end, this position was valued to have a yield of 9.50% (as a dividend!), but the security matures in three years time – so, while the calculation shown is accurate as far as it goes, as a long-term indicator it is expected to decline in three years when WFS.PR.A is redeemed and the proceeds reinvested in a security that will not necessarily yield 9.50%.
If WFS.PR.A had been sold at market value at the end of July and the proceeds reinvested proportionately in the existing portfolio, the “Securities Average YTW” in the table above would have fallen about thirty basis points (0.30%) to approximately 6.66%; this would result in an estimate of “Sustainable Income” of $0.5428; less than is reported, but still a substantial increase from previous figures. It is hoped, of course, that the market will shortly recognize the merits of WFS.PR.A and bid up the price until the yield is – according to me! – more reasonable, which should allow the fund to take a good-sized capital gain when swapping it for another issue with upside potential.
So, despite the poor price performance in July, we must remember that we are fixed-income investors. The expected annual income per unit (these are shown gross of fees and expenses) continues to show an upward path … and it is the income that makes the asset class worthwhile.
I should emphasize, however, that the fund does not explicitly seek to maximize this number. Yield on the portfolio will be given up when it is possible to exchange it for something else that is attractive: credit quality, say, or retractibility. Over the very long term, however, it is the prime objective of fixed income management to maximize the income received from a given amount of capital.
The fund’s heavy weighting in the underperforming PerpetualDiscounts hurt performance for the month; within that group, a relatively large exposure to CM issues was another negative factor. The fund was able to mitigate the effects of these two allocations by frequent trading within these two groups; trading was very heavy during the month, representing approximately 100% of portfolio value.
|Post Mortem: Some Trading in CM PerpetualDiscounts|
7/24 & 7/25
|Dividends||No dividends earned in month|
|This table is an attempt to present fairly a series of trades that are not necessarily the same size and may be groupings of multiple smaller trades. Full disclosure of precise trades will be made when the Financial Statements for 2008 are released.|
As may be seen in the table above, there was considerable chaos in the downward movement of the CM issues, which was mitigated by opportunistic trading between the issues. These trades did not, in and of themselves, change the portfolio’s credit risk or have a material effect on any element of the portfolio’s overall risk profile. Opportunistic trading is what MAPF is all about!
Overall, the market has normalized somewhat since the end of June. The extremely strange – and theoretically unsupportable – relationship that existed a month ago between prices and yields has basically reversed itself – although there remain small pockets of strangeness and always will! Theory will always reassert itself in the long run; it is simply unfortunated that in June I was caught in the underperforming end of the strangeness and hence could not execute trades to exploit the disparities.
And for the future? In the first few days of August, the market has moved higher, with PerpetualDiscounts up 0.72% in the first few days. The average yield on PerpetualDiscounts at month-end was 6.32% (as dividends), equivalent to interest income of 8.85% at the standard equivalency factor of 1.4x. This in turn represents a spread of 270bp over long corporates – and, as has been previously mentioned, the previous 10-year high was 250bp – so, some might say, we are still well within the area of a 10-year buying opportunity!
While it will take the credit crunch a great deal of time to unwind – and while I continue to disdain market timing, these elevated yields should gradually attract bond investors, which will help prices recover. But … keep your eyes on the income! I continue to apply and refine my processes for finding opportunities, such as the CM swaps shown above, to execute swaps with a favourable risk/return profile.
My next article for Canadian Moneysaver will discuss the events of the last two months in more detail and, once the black-out period has expired, will be republished here.