Category: MAPF

The fund was approximately even with the index in May, as outperformance in high-coupon GWO issues and BNA.PR.C was offset by weakness in the low-coupon SLF and MFC issues.

The fund’s Net Asset Value per Unit as of the close May 31, 2012, was 10.3798.

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.

In cases such as this it is often possible to explain deviations through a change in the Implied Volatility of the embedded call option in StraightPerpetuals – as was the case in June 2008. Accordingly, we compare the month’s performance of individual DeemedRetractible issues with their Dividend Rate:

This actually works quite well, in sharp distinction to the situation last month – there is a clear correlation (44%) between dividend rate and May 2012 performance (about 290bp over the range of the chart).

This is illustrative of a problem that has bedevilled the market over the past year – 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. 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 unavailable (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.

The behaviour of the SLF DeemedRetractibles continues to be puzzling:

SLF.PR.A and SLF.PR.B are incorporated in the index; SLF.PR.C, SLF.PR.D and SLF.PR.E are in the fund. As may be seen from the following chart, the relationship between Current Yield and Annual Dividend Rate is quite different for GWO and SLF:

SLF DeemedRetractibles may be compared with PWF and GWO:

It is quite apparent that that the market continues to treat regulated issues (SLF, GWO) no differently from unregulated issues (PWF).

Those of you who have been paying attention will remember that in a “normal” market (which we have not seen in 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’. 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 May 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 eight such issues of investment grade, from only four issuer groups. Additionally, the fund has no holdings of these issues.

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 constant 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 picked up in May, to about 11%

Sectoral distribution of the MAPF portfolio on May 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) as of August 31, 2011, and published in the October, 2011, 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 April, for reasons that remain unclear – see the discussion below.

The fund’s Net Asset Value per Unit as of the close April 30, 2012, was 10.4438.

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.

The underperformance of MAPF during the month is difficult to understand given the relative index total returns in April:

The biggest component of the fund – by far – is DeemedRetractibles, while the biggest component ofthe index – also by far – is FixedResets. Even allowing for the index to have outperformed due to its higher weighting in the Floating Rate Sector and PerpetualDiscounts, the gap seems too large to be explicable in this manner – and it also seems that the fund return of +0.48% is lower than it should have been.

In cases such as this it is often possible to explain deviations through a change in the Implied Volatility of the embedded call option in StraightPerpetuals – as was the case in June 2008. Accordingly, the first step is to compare the month’s performance of individual DeemedRetractible issues with their Dividend Rate:

Well, that didn’t work at all – perhaps there will be a correlation with end-price (the closing bid on April 30)?

Nope. Current Yield?

Nope. This is getting serious – we need to try some weirder stuff. How about “Ending YTW”?

Nope. Next ex-Date?

Try as I might, I am unable to to come up with a simple relationship between instrument attributes. To illustrate the effect of the performance distribution on the fund’s relative performance, I prepared the following chart which divides DeemedRetractibles into four groups, depending on their incorporation into the index and the fund’s portfolio:

Clearly, the fund’s securities did worse than the index’s securities. But I can figure out why! This is particularly bizarre in the case of the SLF preferreds:

SLF.PR.A and SLF.PR.B are incorporated in the index; SLF.PR.C, SLF.PR.D and SLF.PR.E are in the fund.
SLF

SLF DeemedRetractibles may be compared with PWF and GWO:

It is quite apparent that that the market continues to treat regulated issues (SLF, GWO) no differently from unregulated issues (PWF). It will also be noted that the slope of the regression line did not change significantly over the month: 0.0243 in March vs. 0.0247 in April.

Those of you who have been paying attention will remember that in a “normal” market (which we have not seen in 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.

In short, the underperformance of the fund in April appears to be due to random factors. When these random factors work in the fund’s favour, trades are generated as issues that are held become expensive relative to issues not held. This month, unfortunately, things worked the other way. However, I am pleased to observe that a large chunk of the underperformance of SLF.PR.C/D/E relative to SLF.PR.A/B has been recovered in the first four days of May.

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’. 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 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. This presents another complication in the calculation of sustainable yield. The fund also holds a position in SplitShare issues (BNA.PR.C) 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 eight such issues of investment grade, from only four issuer groups. Additionally, the fund has only negligible holdings of these issues.

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 constant 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 declined sharply in April, to about 5%.

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:

The increase in holdings of issue with Average Daily Trading Values(ADTVs) of 50,000-100,000 is due mostly to migration, rather than trading: IAG.PR.A, for instance, had an ADTV of about 54,000 last month and only 44,000 this month.

Similarly, the increase in the 200,000-300,000 bracket is due to migration: MFC.PR.B, for example, had an ADTV of 318,000 last month, which has now declined to 240,000.

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) as of August 31, 2011, and published in the October, 2011, 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 March, as DeemedRetractibles issued by insurers underperformed the rest of market.

The fund’s Net Asset Value per Unit as of the close March 30, 2012, was 10.3944, after giving effect to a dividend distribution of $0.112796.

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.

SLF DeemedRetractibles may be compared with PWF and GWO:

It is quite apparent that that the market continues to treat regulated issues (SLF, GWO) no differently from unregulated issues (PWF). What is not quite so apparent from these charts is that the slope of the relationship between dividend rates and current yields has flattened considerably over the month – the slope of the regression line has changed from 0.0277 in February to 0.0243 in March.

Those of you who have been paying attention will remember that in a “normal” market (which we have not seen in 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. Despite the current month’s flattening, however, 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.

However, the trading that began in February (swapping low-coupon GWO issues for the higher-coupon ones) which was continued in March, has yielded very favourable results since trade-time:

As may be seen, the trade mitigated the loss. It’s a shame that SLF hasn’t got any high-coupon issues; if they had, I suspect similar trades would have been executable for this issuer!

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’. 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 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. This presents another complication in the calculation of sustainable yield. The fund also holds a position in SplitShare issues (BNA.PR.C) which also have their yields calculated with the expectation of a maturity at par.

The decline in the calculated sustainable yield is due to a significant shortening of term in the year to date, together with the elimination of expected dividends from the YLO issues – January’s run-up in the prices of longer-term issues has made it prudent to increase the investment in shorter-term, better-credit, lower-yielding FixedResets, although the weighting in this asset class remains well below index levels.

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

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 constant 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 steady in March, at about 21%.

Most of the trading involved shuffling in between DeemedRetractibles, with an overall movement from the lower-coupon GWO issues to their higher-coupon counterparts, GWO.PR.L and GWO.PR.P. Additionally, trading was done among the MFC issues, MFC.PR.B and MFC.PR.C, as well as the usual smaller trades that defy generalization.

Sectoral distribution of the MAPF portfolio on March 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:

The increase in holdings of issue with Average Daily Trading Values(ADTVs) of 50,000-100,000 is due mostly to migration, rather than trading: BNA.PR.C, for instance, had an ADTV of about 116,000 last month and only 94,000 this month.

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) as of August 31, 2011, and published in the October, 2011, 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 2011 Audited Financial Statements and the 2011 Portfolio Transaction Record have been released and are available for download via the Malachite Aggressive Preferred Fund web page.

The fund underperformed in February as the extremely poor performance of the YLO preferreds reduced returns by slightly over 100bp.

The fund’s Net Asset Value per Unit as of the close February, 2012, was 10.6167.

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.

The horrible performance of the YLO preferreds over the month (losses of between 60% (YLO.PR.A) and 76% (YLO.PR.D)) can be ascribed to the suspension of dividends on these issues, followed by sharp downgrades from DBRS and S&P. Unitholders and casual readers will know that these issues have been a nightmare for me since the renegotiation of their bank credit facilities in September. With the benefit of hindsight, it is easy to say I should have sold everything then – or at least stopped purchases after the credit downgrades in August – but … I didn’t. While I have been quite cognizant of the fact that credit quality of YLO has been deteriorating, I have also considered the decline to be more than fully reflected in the market price of these issues – and why sell for less than there estimated value?

One question that springs to mind is: just why, exactly, did the company suspend preferred dividends? This is a drastic measure to take and most companies maintain payouts until the very day they file for CCCA protection; in addition, YLO is both profitable and cash-flow positive. It is my belief that the board looked at the price their public securities – common, preferreds and bonds – were trading at and decided that since the public was of the view that bankruptcy was imminent they ‘might as well have the game as the name’.

Note that the calculation assumes that all issues remain outstanding, but the company can convert YLO.PR.A to common at the end of March, and YLO.PR.B to common at the end of June. The suspension of dividends means that such conversions will no longer have a cash-flow benefit, but conversions would halt the accrual of dividends, which are cumulative for all issues.

But one may say that a little over $10-million per quarter can now go towards paying down debt rather than paying out dividends – every little bit helps and, with luck, the relatively improved balance sheet will assist them to make a deal.

There was a large gyration in relative prices of bank and insurer DeemedRetractibles during the month, due to some long-awaited (by me, anyway!) issuance of Straight Perpetuals: GWO.PR.P, PWF.PR.R and POW.PR.G. The following chart shows the difference in bid price between CM.PR.J and GWO.PR.I, which pay the same annual dividend. No correction has been made for the difference in ex-Dividend dates:

SLF DeemedRetractibles performed quite well over the month and may be compared with PWF and GWO:

It is quite apparent that the pricing difference between SLF and similar issues has narrowed – and also that the market continues to treat regulated issues (SLF, GWO) no differently from unregulated issues (PWF).

The extent of the remaining SLF exceptionalism is better illustrated by a chart showing the current yield against the bid price:

Amazingly, SLF now trades comparably to WN, instead of cheaper!:

In order to rationalize the relationship between the Current Yields we are asked to believe:

• That the additional credit quality of SLF is worthless
  • It is possible, of course, to argue that WN is actually a better credit than SLF, or that the scarcity value of a non-financial preferred outweighs the difference in credit. I have not yet heard these arguments being made
• The option value of the issuer’s call is worthless
  • This can be phrased as ‘The potential capital gain for the SLF issues prior to a call, relative to that of the WN issues, is worthless’
• The potential of a regulatory inspired call for the SLF issues is worthless
  • the SLF issues are currently Tier 1 Capital at the holding company level, but do not have an NVCC clause

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’. 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 February 29; all of the former and most of the latter 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 in SplitShare issues (mainly BNA.PR.C) which also have their yields calculated with the expectation of a maturity at par.

The decline in the calculated sustainable yield is due to a significant shortening of term in the year to date, together with the elimination of expected dividends from the YLO issues – the recent run-up in the prices of longer-term issues has made it prudent to increase the investment in shorter-term, better-credit, lower-yielding FixedResets, although the weighting in this asset class remains well below index levels.

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

Different assumptions lead to different results from the calculation, but the overall positive trend is apparent. I’m very pleased with the 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 constant 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 picked up again in February, to about 20%.

Most of the trading involved shuffling in between DeemedRetractibles, with an overall movement from the lower-coupon GWO issues to their higher-coupon counterparts, GWO.PR.L, GWO.PR.M and GWO.PR.P. Additionally, some trading was done among the SLF issues.

Sectoral distribution of the MAPF portfolio on February 29 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) as of August 31, 2011, and published in the October, 2011, 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 higher
• 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 strongly outperformed in January as the fund’s long-standing overweighting in insurance company Straight Perpetuals finally paid off.

The fund’s Net Asset Value per Unit as of the close January 31, 2012, was 10.6827.

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.

Fund returns in January were helped substantially by a very dramatic narrowing of the difference between bank-issued Straight Perpetuals and those issued by insurers and others. The following chart shows the difference in bid price between CM.PR.J and GWO.PR.I, which pay the same annual dividend. No correction has been made for the difference in ex-Dividend dates:

SLF, in particular, has been afflicted in recent months by relatively poor financial results and bouts of selling (see Who’s Selling all the SLF Preferreds? and Moody’s puts SLF on Review-Negative) but is showing signs of recovery.

SLF issues may be compared with PWF and GWO:

It is quite apparent that the pricing difference between SLF and similar issues has narrowed – and also that the market continues to treat regulated issues (SLF, GWO) no differently from unregulated issues (PWF).

The extent of the remaining SLF exceptionalism is better illustrated by a chart showing the current yield against the bid price:

Now, I certainly agree that GWO is a better credit than SLF and deserves a little bit of premium pricing – but the current situation goes far beyond what I consider reasonable.

Amazingly, SLF continues to trade cheaper than WN:

In order to rationalize the relationship between the Current Yields we are asked to believe:

• That the additional credit quality of SLF is worthless
  • It is possible, of course, to argue that WN is actually a better credit than SLF, or that the scarcity value of a non-financial preferred outweighs the difference in credit. I have not yet heard these arguments being made
• The option value of the issuer’s call is worthless
  • This can be phrased as ‘The potential capital gain for the SLF issues prior to a call, relative to that of the WN issues, is worthless’
• The potential of a regulatory inspired call for the SLF issues is worthless
  • the SLF issues are currently Tier 1 Capital at the holding company level, but do not have an NVCC clause

Sometimes everything works … sometimes the trading works, but sectoral shifts overwhelm the increment … sometimes nothing works – and in 2011 circumstances were closer to the third possibility than they have generally been in the past. 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’. 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 January 31; all of the former and most of the latter 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 in SplitShare issues (mainly BNA.PR.C) and an OperatingRetractible Scrap (YLO.PR.B) which also have their yields calculated with the expectation of a maturity at par (capped at 10% for the latter issue), a somewhat dubious assumption in the latter case.

The decline in the calculated sustainable yield is due to a significant shortening of term over the month – the recent run-up in the prices of longer-term issues has made it prudent to increase the investment in shorter-term, better-credit, lower-yielding FixedResets, although the weighting in this asset class remains well below index levels.

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 issues. Additionally, the fund has substantially reduced its holdings of these issues.

Different assumptions lead to different results from the calculation, but the overall positive trend is apparent. I’m very pleased with the 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 constant 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.