Category: MAPF

The fund underperformed in April, due largely to the under-weighting in bank DeemedRetractible issues. Additionally, PerpetualPremiums, which are also under-weighted by the fund, did quite well despite the negative yield-to-worst on many of the issues.

These figures compare with the average return for the DeemedRetractible index of -0.02%. Regretably, performance calculation for issues having undergone a change of terms during the month – i.e., the insurers and insurance holding companies – is not enabled by the software.

ZPR, is a relatively new ETF comprised of FixedResets and Floating Rate issues, with a very high proportion of junk issues, which returned -1.21% for the month, and +0.94% over the past three months (according to my calculations from the fund’s NAV data and distribution data; our regulators are hard at work protecting you from performance data since the fund has been extant for less than a year), versus gains for the TXPL index of +% and +%, respectively. The fund has been able to attract assets of about $739.9-million in five and a half months, $221-million of this in April alone, and I feel that has had a great effect on the prices of its targetted preferreds and their close relations.

Weak performance amongst TXPL’s favoured issues in April resulted in a total return of -1.15% for the month, bringing the three-month return to +1.09%. TXPR had returns over these periods of -0.62% and +1.08%, respectively; it is interesting to note that the latter figures (for the three months ending April 30) are almost identical.

Investment-grade FixedResets as a group came back to earth in April, returning -0.52% and increasing their median YTW to 2.77%. PerpetualPremiums did better with +0.30% over the month while DeemedRetractibles were almost flat at -0.02%.

Malachite Aggressive Preferred Fund’s Net Asset Value per Unit as of the close April 30, 2013, was 10.8468.

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 two 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. The fund occasionally finds an attractive opportunity to trade between GWO issues, which have a good range of annual coupons (but in which trading is now hampered by the fact that the low-coupon issues are trading near par and are callable at par in the near term), but is “stuck” in the MFC and SLF issues, which have a much narrower range of coupon, while the IAG DeemedRetractibles are quite illiquid. Until the market became so grossly segmented, this was not so much of a problem – 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 is, in effect ‘locked in’ to the MFC & SLF issues due to projected gains from a future OSFI decision, to the detriment of trading gains.

SLF DeemedRetractibles may be compared with PWF and GWO:

It is quite apparent that that the market continues to treat regulated insurance issues (SLF, GWO) no differently from unregulated issues (PWF) – despite the fact that the PWF issues are much more subject to unfavourable calls in the near term and should, logically, be deprecated on those grounds alone without any fancy-pants arguments about imposition of the NVCC rule!

In fact, one can make an argument that the SLF issues are doing better than they should be now, as they were downgraded by DBRS earlier this year, which no longer considers them credit-equivalent to GWO and PWF.

Those of you who have been paying attention will remember that in a “normal” market (which we have not seen in well over a year) the slope of this line is related to the implied volatility of yields in Black-Scholes theory, as discussed in the January, 2010, edition of PrefLetter. The relationship is still far too large to be explained by Implied Volatility – the numbers still indicate an overwhelming degree of directionality in the market’s price expectations.

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. 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 recent issues of PrefLetter that market pricing for FixedResets is demonstrably stupid 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.

Significant positions were held in DeemedRetractible and FixedReset issues on April 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). This presents another complication in the calculation of sustainable yield. The fund also holds a position various SplitShare issues which also have their yields calculated with the expectation of a maturity at par.

I will no longer show calculations that assume the conversion of the entire portfolio into PerpetualDiscounts, as there are currently only four such issues of investment grade, from only two issuers. Additionally, the fund has no holdings of these issues.

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 (set at 1.23% for the March 28 calculation) to estimate dividends after reset for FixedResets.

Most funds report Current Yield. For instance, ZPR reports a “Portfolio Yield” of 4.69% as of April 30, 2013 and notes:

Portfolio yield is calculated as the most recent income received by the ETF in the form of dividends interest and other income annualized based on the payment frequently divided by the current market value of ETFs investments.

In other words – it’s the Current Yield, a meaningless number. The Current Yield of MAPF is 5.13%, but I will neither report that with any degree of prominence nor take any great pleasure in the fact that it’s higher than the ZPR number. It’s meaningless; to accord it any prominence in portfolio reporting is misleading.

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:

The difference is because the bond’s yield calculation includes the amortization of the discount; therefore, so does the Sustainable Income estimate.

Thus, the decline in the MAPF Sustainable Income from $0.5500 per unit in June, 2012, to $0.4452 per unit in March should be looked at as a simple consequence of the fund’s holdings; virtually all of which have their yields calculated in a manner closer to bonds than to Perpetual Annuities.

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 is 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.

Turnover remained very low in April, at about 4%.

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 has been the migration of PerpetualDiscounts into PerpetualPremiums (due to price increases) – many of the PerpetualPremiums have negative Yields-to-Worst and those that don’t aren’t particularly thrilling; speaking very generally, PerpetualPremiums are to be avoided, not traded! This effect has caused the first of the three segments noted above to be untradeable for most practical purposes.

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 its peers, 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, 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 has obviously 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 are either trading near par or were trading at sufficient premium that a par call was expected on economic grounds.

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

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.

Credit distribution is:

Liquidity Distribution is:

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 lower
• MAPF Yield is higher
• Weightings in
  • 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

I am please to announce that the fund’s 2012 Audited Financial Statements and the 2012 Portfolio Transaction Record have been released and are available for download via the Malachite Aggressive Preferred Fund web page.

The fund underperformed in March, due again to strong performance from FixedReset, Floating Rate and junk issues held by ZPR.

For example, of the sixteen BCE issues tracked by HIMIPref™ (which are heavily weighted in the indices, but which are not held at all by the fund):

By way of illustration, BCE issues comprise 10.62% of the February 28 BMO-CM 50 Index.

ZPR, is a relatively new ETF comprised of FixedResets and Floating Rate issues, with a very high proportion of junk issues, which returned a stunning +1.34% for the month, and +3.22% over the past three months (according to my calculations from the fund’s NAV data), versus gains for the TXPL index of +1.39% and +3.34%, respectively. The fund has been able to attract assets of about $518.7-million in four and a half months, $240-million of this in March alone, and I feel that has had a great effect on the prices of its targetted preferreds and their close relations.

At time of writing (March 31), the Total Return Index Values for the two S&P/TSX preferred share indices are not available, but TXPR was +0.93% on the month to March 27, while TXPL was +1.22%; there was a jump of as-yet undetermined magnitude on the last day of the month. Approximately 62.4% of TXPR is included in TXPL; a little algebra results in the estimation that the components of TXPR not included in TXPL returned a mere +0.45% in the month to March 27 – a stark illustration of the effect of ZPR and its massive secondary market requirements.

Investment-grade FixedResets as a group continued their unsustainable price appreciation in March, rising 1.18% – quite a feat when the median Yield-to-Worst (YTW) for this segment was 2.86% p.a. at February month-end! The median YTW declined to a mere 2.51% by the end of March. PerpetualPremiums also recorded an unsustainable +0.83% over the month while DeemedRetractibles were the worst performing of the three groups, returning +0.61% – which is also above their YTW expectations, but not by as much!

Malachite Aggressive Preferred Fund’s Net Asset Value per Unit as of the close March 28, 2013, was 10.9033 after a dividend distribution of 0.130357.

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 year 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. The fund has done well by trading between GWO issues, which have a good range of annual coupons (but in which trading is now hampered by the fact that the low-coupon issues are trading near par and are callable at par in the near term), but is “stuck” in the MFC and SLF issues, which have a much narrower range of coupon, while the IAG DeemedRetractibles are quite illiquid. Until the market became so grossly segmented, this was not so much of a problem – 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 is, in effect ‘locked in’ to the MFC & SLF issues due to projected gains from a future OSFI decision, to the detriment of trading gains.

SLF DeemedRetractibles may be compared with PWF and GWO:

It is quite apparent that that the market continues to treat regulated insurance issues (SLF, GWO) no differently from unregulated issues (PWF) – despite the fact that the PWF issues are much more subject to unfavourable calls in the near term and should, logically, be deprecated on those grounds alone without any fancy-pants arguments about imposition of the NVCC rule!

In fact, one can make an argument that the SLF issues are doing better than they should be now, as they were recently downgraded by DBRS, which no longer considers them credit-equivalent to GWO and PWF.

Those of you who have been paying attention will remember that in a “normal” market (which we have not seen in well over a year) the slope of this line is related to the implied volatility of yields in Black-Scholes theory, as discussed in the January, 2010, edition of PrefLetter. The relationship is still far too large to be explained by Implied Volatility – the numbers still indicate an overwhelming degree of directionality in the market’s price expectations.

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. 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 recent issues of PrefLetter that market pricing for FixedResets is demonstrably stupid 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.

Significant positions were held in DeemedRetractible and FixedReset issues on March 28; 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. This presents another complication in the calculation of sustainable yield. The fund also holds a position various SplitShare issues which also have their yields calculated with the expectation of a maturity at par.

I will no longer show calculations that assume the conversion of the entire portfolio into PerpetualDiscounts, as there are currently only four such issues of investment grade, from only two issuers. Additionally, the fund has no holdings of these issues.

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 (set at 1.23% for the March 28 calculation) to estimate dividends after reset for FixedResets.

Most funds report Current Yield. For instance, ZPR reports a “Portfolio Yield” of 4.68% as of March 22, 2013 and notes:

Portfolio yield is calculated as the most recent income received by the ETF in the form of dividends interest and other income annualized based on the payment frequently divided by the current market value of ETFs investments.

In other words – it’s the Current Yield, a meaningless number. The Current Yield of MAPF is 5.06%, but I will neither report that with any degree of prominence nor take any great pleasure in the fact that it’s higher than the ZPR number. It’s meaningless; to accord it any prominence in portfolio reporting is misleading.

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:

The difference is because the bond’s yield calculation includes the amortization of the discount; therefore, so does the Sustainable Income estimate.

Thus, the decline in the MAPF Sustainable Income from $0.5500 per unit in June, 2012, to $0.4237 per unit in March should be looked at as a simple consequence of the fund’s holdings; virtually all of which have their yields calculated in a manner closer to bonds than to Perpetual Annuities.

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 is 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.

Turnover returned to more normal levels in March, at about 7%.

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 has been the migration of PerpetualDiscounts into PerpetualPremiums (due to price increases) – many of the PerpetualPremiums have negative Yields-to-Worst and those that don’t aren’t particularly thrilling; speaking very generally, PerpetualPremiums are to be avoided, not traded! This effect has caused the first of the three segments noted above to be untradeable for most practical purposes.

To make this more clear, since I’ve been asked the question recently, 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 its peers, I also have to check its peer group. This cuts down on the potential for trading.

However, there have been some hopeful signs: trading picked up a little in December and remained at this elevated level in January; there was some frenzied trading on January 14, although February’s turnover was very low. The long promised OSFI Draft Definition of Capital for Insurers may clarify the status of the Insurer-issued DeemedRetractibles and make them homogeneous with Bank-issued DeemedRetractibles (as I expect) or with unregulated Straight Perpetuals (which would surprise me … but a lot of things happen that surprise me).

Sectoral distribution of the MAPF portfolio on March 28 was as follows:

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.

Credit distribution is:

The increase in holdings of Pfd-2(high) issues at the expense of Pfd-1(low) is due to the downgrade of SLF by DBRS, not to any trading.

Liquidity Distribution is:

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 lower
• MAPF Yield is higher
• Weightings in
  • 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

The fund slightly underperformed in February, due again to strong performance from junk issues held by ZPR.

For example, of the sixteen BCE issues tracked by HIMIPref™ (which are heavily weighted in the indices, but which are not held at all by the fund):

By way of illustration, BCE issues comprise 10.62% of the February 28 BMO-CM 50 Index.

ZPR, is a relatively new ETF comprised of FixedResets and Floating Rate issues, with a very high proportion of junk issues, which returned a stellar +0.82% for the month, and +2.76% over the past three months, versus gains for the TXPL index of +0.87% and +2.89%, respectively. The fund has been able to attract assets of about $279-million in three and a half months and I feel that has had a great effect on the prices of its targetted preferreds and their close relations.

It may also be noted that FixedResets and DeemedRetractibles had the same performance in February: +0.47%. Such performance (equivalent to about 6% per year) is completely unsustainable for these indices, which had median YTWs of 2.87% and 2.88%, respectively, at month end. However, the particular DeemedRetractibles held by the fund have a longer duration than the index DeemedRetractibles, about 6.5 compared with the median for the index, of about 0.25. It is my forecast that these attributes will eventually lead to significant outperformance.

Malachite Aggressive Preferred Fund’s Net Asset Value per Unit as of the close February 28, 2013, was 10.9484.

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 year 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. The fund has done well by trading between GWO issues, which have a good range of annual coupons (but in which trading is now hampered by the fact that the low-coupon issues are trading near par and are callable at par in the near term), but is “stuck” in the MFC and SLF issues, which have a much narrower range of coupon, while the IAG DeemedRetractibles are quite illiquid. Until the market became so grossly segmented, this was not so much of a problem – 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 is, in effect ‘locked in’ to the MFC & SLF issues due to projected gains from a future OSFI decision, to the detriment of trading gains.

SLF DeemedRetractibles may be compared with PWF and GWO:

It is quite apparent that that the market continues to treat regulated insurance issues (SLF, GWO) no differently from unregulated issues (PWF) – despite the fact that the PWF issues are much more subject to unfavourable calls in the near term and should, logically, be deprecated on those grounds alone without any fancy-pants arguments about imposition of the NVCC rule!

In fact, one can make an argument that the SLF issues are doing better than they should be now, as they were recently downgraded by DBRS, which no longer considers them credit-equivalent to GWO and PWF.

Those of you who have been paying attention will remember that in a “normal” market (which we have not seen in well over a year) the slope of this line is related to the implied volatility of yields in Black-Scholes theory, as discussed in the January, 2010, edition of PrefLetter. The relationship is still far too large to be explained by Implied Volatility – the numbers still indicate an overwhelming degree of directionality in the market’s price expectations.

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. 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. A large chunk of the January’s trading was triggered by a market participant whose poorly executed portfolio rebalancing roiled the market mid-month.

There’s plenty of room for new money left in the fund. I have shown in recent issues of PrefLetter that market pricing for FixedResets is demonstrably stupid 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.

Significant positions were held in DeemedRetractible and FixedReset issues on February 28; 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. This presents another complication in the calculation of sustainable yield. The fund also holds a position various SplitShare issues which also have their yields calculated with the expectation of a maturity at par.

I will no longer show calculations that assume the conversion of the entire portfolio into PerpetualDiscounts, as there are currently only four such issues of investment grade, from only three issuers. Additionally, the fund has no holdings of these issues.

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:

The difference is because the bond’s yield calculation includes the amortization of the discount; therefore, so does the Sustainable Income estimate.

Thus, the decline in the MAPF Sustainable Income from $0.5500 per unit in June to $0.4510 per unit in February should be looked at as a simple consequence of the fund’s holdings; virtually all of which have their yields calculated in a manner closer to bonds than to Perpetual Annuities.

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 is 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.

Turnover plunged in February to less than 1%.

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 has been the migration of PerpetualDiscounts into PerpetualPremiums (due to price increases) – many of the PerpetualPremiums have negative Yields-to-Worst and those that don’t aren’t particularly thrilling; speaking very generally, PerpetualPremiums are to be avoided, not traded! This effect has caused the first of the three segments noted above to be untradeable for most practical purposes.

To make this more clear, since I’ve been asked the question recently, 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 its peers, I also have to check its peer group. This cuts down on the potential for trading.

However, there have been some hopeful signs: trading picked up a little in December and has remained at this elevated level in January; there was some frenzied trading on January 14; and the low-reset FixedResets are showing good volatility. Additionally, the long promised OSFI Draft Definition of Capital for Insurers may clarify the status of the Insurer-issued DeemedRetractibles and make them homogeneous with Bank-issued DeemedRetractibles (as I expect) or with unregulated Straight Perpetuals (which would surprise me … but a lot of things happen that surprise me).

Sectoral distribution of the MAPF portfolio on February 28 was as follows:

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.

Credit distribution is:

The increase in holdings of Pfd-2 issues at the expense of Pfd-2(high) is due to the downgrade of HSB by DBRS, not to any trading.

Liquidity Distribution is:

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 lower
• MAPF Yield is higher
• Weightings in
  • 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

The fund underperformed in January, as DeemedRetractibles (+0.04%) were greatly outperformed by FixedResets (+0.67%) and PerpetualPremiums (+0.75%). Additionally, there was strong performance by junk issues (rated Pfd-3(high) or lower by DBRS).

For example, of the sixteen BCE issues tracked by HIMIPref™ (which are heavily weighted in the indices, but which are not held at all by the fund):

Another illustration of relative returns in January was provided by ZPR, an ETF comprised of FixedResets and Floating Rate issues, with a very high proportion of junk issues, which returned a stellar +1.03% for the month.

Malachite Aggressive Preferred Fund’s Net Asset Value per Unit as of the close January 31, 2013, was 10.8931.

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 year 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. The fund has done well by trading between GWO issues, which have a good range of annual coupons (but in which trading is now hampered by the fact that the low-coupon issues are trading near par and are callable at par in the near term), but is “stuck” in the MFC and SLF issues, which have a much narrower range of coupon, while the IAG DeemedRetractibles are quite illiquid. Until the market became so grossly segmented, this was not so much of a problem – 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 is, in effect ‘locked in’ to the MFC & SLF issues due to projected gains from a future OSFI decision, to the detriment of trading gains.

SLF DeemedRetractibles may be compared with PWF and GWO:

It is quite apparent that that the market continues to treat regulated insurance issues (SLF, GWO) no differently from unregulated issues (PWF) – despite the fact that the PWF issues are much more subject to unfavourable calls in the near term and should, logically, be deprecated on those grounds alone without any fancy-pants arguments about imposition of the NVCC rule!

Those of you who have been paying attention will remember that in a “normal” market (which we have not seen in well over a year) the slope of this line is related to the implied volatility of yields in Black-Scholes theory, as discussed in the January, 2010, edition of PrefLetter. The relationship is still far too large to be explained by Implied Volatility – the numbers still indicate an overwhelming degree of directionality in the market’s price expectations.

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. 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. A large chunk of the month’s trading was triggered by a market participant whose poorly executed portfolio rebalancing roiled the market mid-month.

There’s plenty of room for new money left in the fund. I have shown in recent issues of PrefLetter that market pricing for FixedResets is demonstrably stupid 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.

Significant positions were held in DeemedRetractible and FixedReset issues on January 31; 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. This presents another complication in the calculation of sustainable yield. The fund also holds a position various SplitShare issues which also have their yields calculated with the expectation of a maturity at par.

I will no longer show calculations that assume the conversion of the entire portfolio into PerpetualDiscounts, as there are currently only four such issues of investment grade, from only two issuer groups. Additionally, the fund has no holdings of these issues.

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:

The difference is because the bond’s yield calculation includes the amortization of the discount; therefore, so does the Sustainable Income estimate.

Thus, the decline in the MAPF Sustainable Income from $0.5500 per unit in June to $0.4606 per unit in January should be looked at as a simple consequence of the fund’s holdings; virtually all of which have their yields calculated in a manner closer to bonds than to Perpetual Annuities.

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 is 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.

Turnover remained above 2012 averages in January, at about 11%.

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 has been the migration of PerpetualDiscounts into PerpetualPremiums (due to price increases) – many of the PerpetualPremiums have negative Yields-to-Worst and those that don’t aren’t particularly thrilling; speaking very generally, PerpetualPremiums are to be avoided, not traded! This effect has caused the first of the three segments noted above to be untradeable for most practical purposes.

To make this more clear, since I’ve been asked the question recently, 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 its peers, I also have to check its peer group. This cuts down on the potential for trading.

However, there have been some hopeful signs: trading picked up a little in December and has remained at this elevated level in January; there was some frenzied trading on January 14; and the low-reset FixedResets are showing good volatility. Additionally, the long promised OSFI Draft Definition of Capital for Insurers may clarify the status of the Insurer-issued DeemedRetractibles and make them homogeneous with Bank-issued DeemedRetractibles (as I expect) or with unregulated Straight Perpetuals (which would surprise me … but a lot of things happen that surprise me).

Sectoral distribution of the MAPF portfolio on January 31 was as follows:

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.

Credit distribution is:

Liquidity Distribution is:

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 lower
• MAPF Yield is higher
• Weightings in
  • 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

The fund outperformed in December, boosted by good performance by the MFC and SLF DeemedRetractibles. DeemedRetractibles as a group outperformed FixedResets, +96bp vs. +76bp respectively.

The fund’s Net Asset Value per Unit as of the close December 31, 2012, was 10.8307 after a dividend distribution of 0.129831. There was no capital gains distribution.

2012 was a fine year for the fund, as it returned +12.76% (after expenses, before fees) against +5.50% for its benchmark … leaving me once again to ponder the question: ‘Why am I not running every dollar there is?’

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 year 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. The fund has done well by trading between GWO issues, which have a good range of annual coupons, but is “stuck” in the MFC and SLF issues, which have a much narrower range of coupon, while the IAG DeemedRetractibles are quite illiquid. Until the market became so grossly segmented, this was not so much of a problem – 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). The fund’s portfolio is, in effect ‘locked in’ to the MFC & SLF issues due to projected gains from a future OSFI decision, to the detriment of trading gains.

SLF DeemedRetractibles may be compared with PWF and GWO:

It is quite apparent that that the market continues to treat regulated insurance issues (SLF, GWO) no differently from unregulated issues (PWF) – despite the fact that the PWF issues are much more subject to unfavourable calls in the near term and should, logically, be deprecated on those grounds alone without any fancy-pants arguments about imposition of the NVCC rule!

Those of you who have been paying attention will remember that in a “normal” market (which we have not seen in well over a year) the slope of this line is related to the implied volatility of yields in Black-Scholes theory, as discussed in the January, 2010, edition of PrefLetter. The relationship is still far too large to be explained by Implied Volatility – the numbers still indicate an overwhelming degree of directionality in the market’s price expectations.

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. 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 recent issues of PrefLetter that market pricing for FixedResets is demonstrably stupid 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.

Significant positions were held in DeemedRetractible and FixedReset issues on December 31; 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. This presents another complication in the calculation of sustainable yield. The fund also holds a position various SplitShare issues which also have their yields calculated with the expectation of a maturity at par.

I will no longer show calculations that assume the conversion of the entire portfolio into PerpetualDiscounts, as there are currently only four such issues of investment grade, from only two issuer groups. Additionally, the fund has no holdings of these issues.

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:

The difference is because the bond’s yield calculation includes the amortization of the discount; therefore, so does the Sustainable Income estimate.

Thus, the decline in the MAPF Sustainable Income from $0.5500 per unit in June to $0.4643 per unit in December should be looked at as a simple consequence of the fund’s holdings; virtually all of which have their yields calculated in a manner closer to bonds than to Perpetual Annuities.

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 is 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.