Category: MAPF

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.

Turnover picked up in January, to about 10%.

Portfolio composition changed in several ways this month, but the major effects are due to the sale of nearly the entire ELF.PR.F and ELF.PR.G, with proceeds used to purchase higher-rated, more liquid, lower yielding FixedResets.

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) 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 probably underperformed in December, although comparators are not yet available.

The fund’s Net Asset Value per Unit as of the close December 30 was $10.0793 after distribution of $0.162247 dividends and $0.299965 capital gains.

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.

My assumption that the fund underperformed in December is based on the performance of the S&P/TSX Preferred Share Index (TXPR) Total Return Index, for which preliminary figures show a return of +1.37% for the month (although the quarter was OK, with the fund gaining 2.63%, vs. +2.35% for TXPR). However, this return is based on the closing price, not the closing bid, and these figures were significantly different this year.

In all, the difference in valuation for the whole fund is about $25,000, or about 0.5% of fund value.

Naturally, this is not a full explanation – ideally, we would know what the difference was at November month-end and compare the two differences. I will say, however, that in the course of valuing the fund I was surprised at the size of the discrepency, which is a number I usually just glance at and discard, since it has no real meaning.

Fund returns in December were dragged down by poor performance in low-coupon DeemedRetractibles. 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) and has not yet shown significant signs of recovery.

SLF issues may be compared with PWF and GWO:

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. What is also very interesting is the observation that the market is sharply differentiating between SLF and GWO, but not between GWO and its unregulated parent, PWF.

The import of the above charts becomes more clear when we examine the December performance for the same issues:

While the SLF issues did fairly well when compared against other insurance and insurance-related Straight Perpetuals, there was a clear bias towards higher returns for the higher coupon issues – and the fund is concentrated in the low-coupon issues.

Further, I consider the comparison between SLF and WN to be absolutely fascinating:

Aside from the outlier WN.PR.A, which is currently redeemable at 25.00, it is clear that the WN issues are trading at lower Current Yields than the SLF issues (there’s minimal jiggery-pokery regarding the next dividend; the SLF issues go ex-dividend on about February 21, while WN.PR.A is at the end of February and the other WN issues go ex in mid-March).

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

All in all, this is a good indication of what I don’t understand about what the market has been doing this year and a big factor in the fund’s underperformance.

Another factor, for the year and for December, has been the performance of the YLO issues. These performed poorly in December and reduced the fund’s return for the month by about 36bp. I continue to be surprised at just how poorly these issues are surprising: I will certainly agree that YLO was never the best of all possible credits, and will also agree that their financial position has deteriorated over the year – but the company remains significantly profitable (on an operating basis) and cash-flow positive; but the preferreds are trading as if they are on the steps of bankruptcy court.

According to me, the worst-case realistic scenario for YLO is not bankruptcy court, but a reorganization in which the bond holders take over the company. This will be bad news for the common shareholders, and for holders of the two issues which can be converted by the company into common (YLO.PR.A and YLO.PR.B), but the prospects for the two FixedResets (YLO.PR.C and YLO.PR.D) are much less clear even given further financial deterioration and angry bondholders.

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 December 30; 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, a somewhat dubious assumption in the latter case.

However, if the entire portfolio except for the PerpetualDiscounts were to be sold and reinvested in these issues, the yield of the portfolio would be the 5.69% shown in the MAPF Portfolio Composition: December 2011 analysis (which is greater than the 5.12% index yield on November 30). Given such reinvestment, the sustainable yield would be ($10.0793 + 0.162247) * 0.0569 = $0.5827 (note the adjustment for the dividend distribution, which makes the figure more comparable to November’s), down somewhat from the $10.4511 * 0.0579 / 1.0298 = 0.5876 (note the adjustment for capital gains reinvestment) reported for November.

Still, I am pleased that although the market value of the portfolio has not kept up with expectations, the sustainable income per unit (adjusted for capital gains) did increase by $0.02 over the year … do that often enough and eventually market value will reflect the underlying performance!

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 remained low in December, at about 4%.

Sectoral distribution of the MAPF portfolio on December 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.

The increase in cash is due to client subscriptions for year end which have not yet been invested.

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 underperformed in November, largely due to a steep decline in the prices of SLF issues, which form a significant part of the fund’s holdings.

The fund’s Net Asset Value per Unit as of the close November 30 was $10.4511.

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 fund’s returns in November were hurt by a steep decline in the price of SLF preferreds, which have 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).

For example, the difference in the YTWs of GWO.PR.I and SLF.PR.E (which have the same annual dividend of 1.125) are shown below since the OSFI announcement that extant issues without the NVCC clause would not be grandfathered (note that this announcement applied only to banks; there is still no official word on the status of preferreds issued by insurance holding companies, although I continue to expect that the bank rules will eventually apply).

Similarly, we can look at the difference in prices between the two issues:

The charts Yield Difference and Bid Price Difference are available in PDF format.

Another way to look at the situation is compare the SLF issues with PWF and GWO, as was done in the post Who’s Selling All the SLF Preferred?.

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. What is also very interesting is the observation that the market is sharply differentiating between SLF and GWO, but not between GWO and its unregulated parent, PWF.

Sometimes everything works … sometimes the trading works, but sectoral shifts overwhelm the increment … 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 November 30; 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 a SplitShare (BNA.PR.C) and an OperatingRetractible Scrap (YLO.PR.B) which also have their yields calculated with the expectation of a maturity at par, a somewhat dubious assumption in the latter case.

However, if the entire portfolio except for the PerpetualDiscounts were to be sold and reinvested in these issues, the yield of the portfolio would be the 5.79% shown in the MAPF Portfolio Composition: November 2011 analysis (which is greater than the 5.32% index yield on November 30). Given such reinvestment, the sustainable yield would be $10.4511 * 0.0579 = $0.6051, down from the $10.4924 * 0.0598 = $0.6274 reported for October, but an increase from the $10.2709 * 0.0584 = $0.5998 reported in September.

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 remained low in November, at about 2%.

Sectoral distribution of the MAPF portfolio on November 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) 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 had a good month in October, making up some of the ground lost in September.

The fund’s Net Asset Value per Unit as of the close October 31 was $10.4924.

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 fund’s returns in October were aided by a small bounce in the value of the YLO preferreds:

However, there was a drag on performance due to a holding in CZP.PR.A. The bulk of this position was purchased in February and March of this year, when this PerpetualDiscount issue was rated three notches higher than BBD.PR.C, but yielded about the same:

The spread widened in June, 2011, following S&P’s announcemnet that CZP was on review-negative, but gradually returned to more usual levels … until the details of the take-over by Atlantic Power (ATP) were announced! DBRS warned of a three-notch downgrade (which would make the credit ratings of BBD and CZP equal) and … there was a lot of selling in late October.

The problem with the ATP take-over is that it is being structured, effectively, as a complete acquisition, rather than keeping Capital Power as a wholly-owned subsidiary. While the structure retains the wholly-owned subsidiary legal structure, the subsidiary is guaranteeing the senior debt of the holding company (the same way in which the attempted Teachers / BCE deal was structured), so CZP has lost its credit advantage of being “closer to the money” than the holding company.

The position in CZP.PR.A as of October 31 amounted to about 2.6% of fund value. It is my current intention to maintain the position until such time as the yield is again comparable with BBD.PR.C – as it now “should” be, given that a three-notch downgrade will make the credit ratings identical.

Sometimes everything works … sometimes the trading works, but sectoral shifts overwhelm the increment … 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 August 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 a SplitShare (BNA.PR.C) and an OperatingRetractible Scrap (YLO.PR.B) which also have their yields calculated with the expectation of a maturity at par, a somewhat dubious assumption in the latter case.

However, if the entire portfolio except for the PerpetualDiscounts were to be sold and reinvested in these issues, the yield of the portfolio would be the 5.98% shown in the MAPF Portfolio Composition: October 2011 analysis (which is greater than the 5.37% index yield on October). Given such reinvestment, the sustainable yield would be $10.4924 * 0.0598 = $0.6274, an increase from the $10.2709 * 0.0584 = $0.5998 reported in September.

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.