PrefBlog

Sometimes everything works.

There are times – such as June of this year – when everything goes wrong. The market doesn’t just behave in a manner differently from that expected by quantitative models, but differently from basic common sense. All you can do at such times is review your models, review your assumptions, review your application … and if everything seems all right, sit tight! It will happen occasionally; no permanent harm is done unless you’re a leveraged forced seller, as were the quants in August ’07.

But sometimes the market cooperates enthusiastically, being just inefficient enough to allow a trade to be put on and then snapping back to normalcy to allow a profitable reversal. That’s what happened in December:

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.

All I can say is … don’t expect this every month, folks! My indices – and my records of external indices – go back to 1993-12-31; the worst month according to the HIMIPref™ PerpetualDiscount index and the “BMO-CM 50” was November, 2008. The best month in that period, by both measures, was December, 2008. The mood swing of the market exacerbated normal inefficiency and made huge bargains available that were promptly resold at ludicrous profit.

When it works, it really, really works!

The yields available on high quality preferred shares remain elevated, which is reflected in the current estimate of sustainable income.

As discussed in the post MAPF Portfolio Composition: December 2008, the fund has positions in splitShares, which complicate the calculation greatly. Since the yield is, by and large, higher than that of the perpetuals despite the fact that the term is limited, the sustainability of the calculated “sustainable yield” is suspect, as discussed in August. Additionally, the calculated yield for the fixed-floater in the portfolio, BCE.PR.I, depends on the presumed value of Canada Prime (3.50%) and the percentage of Canada Prime paid on par value (100%); both of these figures may change.

However, if the entire portfolio except for the PerpetualDiscounts were to be sold and reinvested in these issues, the yield of the portfolio would be the 7.49% currently shown for the PerpetualDiscounts segment of the portfolio and the sustainable yield would be calculated as $8.0464 * 7.49% = $0.6027, significantly less than the figure calculated above, but still an increase from last month’s adjusted figure and continuing the long-term upward trend.

Additionally, the bulk of SplitShares held at month end were tendered for retraction; the remainder is almost entirely BNA.PR.C which does not mature until 2019, so the fat yield will be enjoyed for some time yet!

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 is due to constant exploitation of trading anomalies.

Trading in December was frenetic, with portfolio turnover of about 200%. Many of these trades were not just intra-sector, but intra-issuer; that is, between similar issues of the same issuer, notably the PerpetualDiscount issues of CM, BMO and SLF. These trades were, in aggregate, highly profitable.

Of interest is the position held in November of FFN.PR.A. Readers will remember that I mourned the fact that it had been unprofitable to month-end, but that sad situation was rectified in December:

A major trade was executed from PerpetualDiscounts into SplitShares when – against all reason – the split share with a short term maturity and well-buffered against default underperformed the PerpetualDiscount index. This trade – into FFN.PR.A; discussed in the post on portfolio composition – is not yet profitable, but I am confident that it will become so in the near future.

Readers will also remember the November 24 trade from WFS.PR.A to FBS.PR.B; to continue that table:

2008 has been a tumultuous year, with declines in prices unparalleled in recent memory. The fund has not escaped unscathed, but has greatly outperformed its benchmark while remaining fully invested at all times. Enormous volatility in the market aggravated the normal inefficiency, particularly in the third quarter and provided the fund with ample opportunites for favourable trading.

And now we will see what 2009 brings…

This entry was posted on Tuesday, January 6th, 2009 at 5:30 pm and is filed under MAPF. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.