MAPF Portfolio Composition: September, 2014

Turnover remained steady in September, at about 10%.

There is extreme segmentation in the marketplace, with OSFI’s NVCC rule changes in February 2011 having had the effect of splitting the formerly relatively homogeneous Straight Perpetual class of preferreds into three parts:

  • Unaffected Straight Perpetuals
  • DeemedRetractibles explicitly subject to the rules (banks)
  • DeemedRetractibles considered by me, but not (yet!) by the market, to be likely to be explicitly subject to the rules in the future (insurers and insurance holding companies)

This segmentation, and the extreme valuation differences between the segments, has cut down markedly on the opportunities for trading. Another trend that hasn’t helped was the migration of PerpetualDiscounts into PerpetualPremiums (due to price increases) in early 2013 – many of the PerpetualPremiums had negative Yields-to-Worst and those that don’t aren’t particularly thrilling; speaking very generally, PerpetualPremiums are to be avoided, not traded! While market weakness since the peak of the PerpetualDiscount subindex in May, 2013, has mitigated the situation somewhat, the population of PerpetualDiscounts is still exceeded by that of PerpetualPremiums – most of which are trading at a negative Yield-to-Worst.

To make this more clear, it used to be that there were 70-odd Straight Perpetuals and I was more or less indifferent as to which ones I owned (subject, of course, to issuer concentration concerns and other risk management factors). Thus, if any one of these 70 were to go down in price by – say – $0.25, I would quite often have something in inventory that I’d be willing to swap for it. The segmentation means that I am no longer indifferent; in addition to checking the valuation of a potential buy to other Straights, I also have to check its peer group. This cuts down on the potential for trading.

There is no real hope that this situation will be corrected in the near-term. OSFI has indicated that the long-promised “Draft Definition of Capital” for insurers will not be issued “for public consultation in late 2012 or early 2013”, as they fear that it might encourage speculation in the marketplace. It is not clear why OSFI is so afraid of informed speculation, since the constant speculation in the marketplace is currently less informed than it would be with a little bit of regulatory clarity.

As a result of this delay, I have extended the Deemed Maturity date for insurers and insurance holding companies by three years (to 2025-1-31), in the expectation that when OSFI finally does provide clarity, they will allow the same degree of lead-in time for these companies as they did for banks. This had a major effect on the durations of preferred shares subject to the change but, fortunately, not much on their calculated yields as most of these issues were either trading near par when the change was made or were trading at sufficient premium that a par call was expected on economic grounds. However, with the declines in the market over the past nine months, the expected capital gain on redemption of the insurance-issued DeemedRetractibles has become an important component of the calculated yield.

Due to further footdragging by OSFI, I will be extending the DeemedMaturity date for insurance issues by another two years in the near future.

Sectoral distribution of the MAPF portfolio on September 30 was as follows:

MAPF Sectoral Analysis 2014-09-30
HIMI Indices Sector Weighting YTW ModDur
Ratchet 0% N/A N/A
FixFloat 0% N/A N/A
Floater 0% N/A N/A
OpRet 0% N/A N/A
SplitShare 5.1% (-3.0) 3.63% 7.40
Interest Rearing 0% N/A N/A
PerpetualPremium 0% N/A N/A
PerpetualDiscount 16.4% (+4.0) 5.44% 14.78
Fixed-Reset 23.4% (-0.9) 4.45% 9.93
Deemed-Retractible 44.5% (+1.0) 5.76% 8.07
Scraps (Various) 10.2% (+0.2) 5.86% 11.00
Cash 0.3% (-1.3) 0.00% 0.00
Total 100% 5.28% 9.84
Totals and changes will not add precisely due to rounding. Bracketted figures represent change from August month-end. Cash is included in totals with duration and yield both equal to zero.
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. These issues are analyzed as if their prospectuses included a requirement to redeem at par on or prior to 2022-1-31 (banks) or 2025-1-3 (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: NVCC Status Confirmed and the January, February, March and June, 2011, editions of PrefLetter for the rationale behind this analysis. (all recent editions have a short summary of the argument included in the “DeemedRetractible” section)

Note that the estimate for the time this will become effective for insurers and insurance holding companies was extended by three years in April 2013, due to the delays in OSFI’s providing clarity on the issue.

The “total” reflects the un-leveraged total portfolio (i.e., cash is included in the portfolio calculations and is deemed to have a duration and yield of 0.00.). MAPF will often have relatively large cash balances, both credit and debit, to facilitate trading. Figures presented in the table have been rounded to the indicated precision.

There was a shift during the month from SplitShares (selling PVS.PR.B, which is backed by BAM.A) at an average price in the range of 25.25-30) into PerpetualDiscounts (BAM.PR.M & BAM.PR.N, at an average post-dividend-equivalent price of about 21.25. Those wonderful PVS.PR.B (formerly BNA.PR.C) are probably around the top of their price range (closing the month at 25.05 bid, for a yield of 4.39%) and the PerpetualDiscounts, with BAM.PR.M closing the month at 21.10 bid for a yield of 5.67%) look like a better way to use my exposure limit for BAM. This continues a series of opportunistic swaps that commenced in August.

One trade that has afforded many hours of nervous contemplation over the past few months has been the June trade of the low-coupon DeemedRetractible GWO.PR.I into the low-spread FixedReset GWO.PR.N at a take-out of about $1.00. The graph of the bid difference shows why:

Click for Big

It is easy to see – in a qualitative sense – why HIMIPref™ wanted to execute the swap in mid-June, but it turned out to be too soon and I wasn’t feeling very happy when the take-out was around $1.75 in August! However, readers will appreciate that I am now feeling a bit happier about the trade!

A similar swap was from SLF.PR.C into SLF.PR.G in August, with a take-out of about $0.35. That chart of bid differences is:

Click for Big

So, regrettably, that second trade is still underwater, but at least it didn’t start losing big money instantly the way the GWO swap did!

Credit distribution is:

MAPF Credit Analysis 2014-9-30
DBRS Rating Weighting
Pfd-1 0 (0)
Pfd-1(low) 28.0% (+1.3)
Pfd-2(high) 48.1% (+0.1)
Pfd-2 0%
Pfd-2(low) 13.4% (-0.3)
Pfd-3(high) 0.7% (+0.7)
Pfd-3 3.7% (-0.7)
Pfd-3(low) 3.6% (+0.5)
Pfd-4(high) 0.7% (0)
Pfd-4 0%
Pfd-4(low) 0.9% (+0.1)
Pfd-5(high) 0% (0)
Pfd-5 0.6% (-0.5)
Cash 0.3% (-1.3)
Totals will not add precisely due to rounding. Bracketted figures represent change from August month-end.
The fund holds a position in AZP.PR.B, which is rated P-5 by S&P and is unrated by DBRS

Liquidity Distribution is:

MAPF Liquidity Analysis 2014-9-30
Average Daily Trading Weighting
<$50,000 16.3% (+5.7)
$50,000 – $100,000 4.8% (-5.4)
$100,000 – $200,000 63.2% (+13.8)
$200,000 – $300,000 14.3% (-11.9)
>$300,000 1.1% (-1.0)
Cash 0.3% (-1.3)
Totals will not add precisely due to rounding. Bracketted figures represent change from August month-end.

MAPF is, of course, Malachite Aggressive Preferred Fund, a “unit trust” managed by Hymas Investment Management Inc. Further information and links to performance, audited financials and subscription information are available the fund’s web page. The fund may be purchased either directly from Hymas Investment Management or through a brokerage account at Odlum Brown Limited. A “unit trust” is like a regular mutual fund, but is sold by offering memorandum rather than prospectus. This is cheaper, but means subscription is restricted to “accredited investors” (as defined by the Ontario Securities Commission) or those who subscribe for $150,000+. Fund past performances are not a guarantee of future performance. You can lose money investing in MAPF or any other fund.

A similar portfolio composition analysis has been performed on the Claymore Preferred Share ETF (symbol CPD) (and other funds) as of August 31, 2012, and published in the October (mainly methodology), November (most funds), and December (ZPR) 2012, PrefLetter. While direct comparisons are difficult due to the introduction of the DeemedRetractible class of preferred share (see above) it is fair to say:

  • MAPF credit quality is better
  • MAPF liquidity is a bit lower
  • MAPF Yield is higher
  • Weightings
    • MAPF is much more exposed to DeemedRetractibles
    • MAPF is much less exposed to Operating Retractibles
    • MAPF is much more exposed to SplitShares
    • MAPF is less exposed to FixFloat / Floater / Ratchet
    • MAPF weighting in FixedResets is much lower

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