The fund underperformed in June, due largely to being over-weight in DeemedRetractible issues, more particularly insurance DeemedRetractibles which didn’t just underperform – these issues actually underperformed PerpetualDiscounts, something I cannot explain.
The Canadian preferred share market performed poorly in July, with a few new twists.
ZPR, is a relatively new ETF comprised of FixedResets and Floating Rate issues, with a very high proportion of junk issues, which returned -1.48% for the month, and -3.59% 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 returns for the TXPL index of -1.42% and -3.49%, respectively. The fund has been able to attract assets of about $830.8-million in the eight and a half months since inception, even adding $18.0-million in June despite the market downturn but – and this is important – losing 12.6-million in assets in July. The change in assets is roughly equal to the return of the fund, meaning that although ZPR has not yet experienced any redemptions over a full month, the flow of money into the fund has stopped – at least temporarily. I feel that the flows into and out of this fund are very important in determining the performance of its constituents.
TXPR had returns over one- and three-months of -0.98% and -3.40%, respectively
Returns for the HIMIPref™ investment grade sub-indices for May were as follows:
HIMIPref™ Indices Performance to July 31, 2013 |
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Sub-Index | 1-Month | 3-month |
Ratchet | N/A | N/A |
FixFloat | +2.84% | -1.24% |
Floater | +1.78% | +0.35% |
OpRet | +0.85% | +0.59% |
SplitShare | -0.10% | +0.06% |
Interest | N/A | N/A |
PerpetualPremium | +0.51% | -3.98% |
PerpetualDiscount | +0.19% | -11.15% |
FixedReset | -0.44% | -1.64% |
DeemedRetractible | -0.63% | -3.55% |
Malachite Aggressive Preferred Fund’s Net Asset Value per Unit as of the close July 31, 2013, was 10.1673.
Returns to July 31, 2013 | ||||
Period | MAPF | BMO-CM “50” Index | TXPR Total Return |
CPD – according to Blackrock |
One Month | -1.54% | -0.48% | -0.98% | -0.98% |
Three Months | -5.06% | -2.13% | -3.40% | -3.48% |
One Year | +1.95% | +1.76% | +0.43% | -0.08% |
Two Years (annualized) | +2.39% | +3.11% | +2.33% | N/A |
Three Years (annualized) | +6.68% | +6.34% | +4.97% | +4.34% |
Four Years (annualized) | +8.81% | +7.21% | +5.71% | N/A |
Five Years (annualized) | +17.02% | +7.07% | +5.74% | +5.07% |
Six Years (annualized) | +12.61% | +4.48% | +3.26% | |
Seven Years (annualized) | +11.58% | +3.92% | ||
Eight Years (annualized) | +10.68% | +3.82% | ||
Nine Years (annualized) | +10.30% | +3.96% | ||
Ten Years (annualized) | +11.16% | +4.16% | ||
Eleven Years (annualized) | +11.36% | +4.35% | ||
Twelve Years (annualized) | +11.36% | +4.33% | ||
MAPF returns assume reinvestment of distributions, and are shown after expenses but before fees. | ||||
CPD Returns are for the NAV and are after all fees and expenses. | ||||
* CPD does not directly report its two- or four-year returns. | ||||
Figures for Omega Preferred Equity (which are after all fees and expenses) for 1-, 3- and 12-months are -0.19%, -2.47% and +1.36%, respectively, according to Morningstar after all fees & expenses. Three year performance is +5.19%; five year is +5.83% | ||||
Figures for Jov Leon Frazer Preferred Equity Fund Class I Units (which are after all fees and expenses) for 1-, 3- and 12-months are -0.46%, -2.50% and -0.05% respectively, according to Morningstar. Three Year performance is +2.56% | ||||
Figures for Manulife Preferred Income Fund (formerly AIC Preferred Income Fund) (which are after all fees and expenses) for 1-, 3- and 12-months are -0.88%, -5.14% & -1.12%, respectively. Three Year performance is +3.17% | ||||
Figures for Horizons AlphaPro Preferred Share ETF (which are after all fees and expenses) for 1-, 3- and 12-months are -0.42%, -2.43% & +1.54%, respectively. | ||||
Figures for Altamira Preferred Equity Fund are -1.12% and -3.68% for one- and three- months, respectively. | ||||
The figure for BMO S&P/TSX Laddered Preferred Share Index ETF is -1.48% and -3.59% for one- and three-months. [calculation by JH] |
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 particularly in May, 2013, when the three lowest-coupon SLF DeemedRetractibles (SLF.PR.C, SLF.PR.D and SLF.PR.E) were the worst performing DeemedRetractibles in the sub-index!
I have pointed out in the past that the market continues to treat regulated insurance issues (SLF, GWO) in much the same way unregulated issues (PWF); this was dramatically illustrated in June but the July results are even more dramatic.
The first observation is that insurance issued DeemedRetractibles continued to behave much more like Straight Perpetuals than bank-issued DeemedRetractibles; the second is that the insurance issues actually underperformed Straights in July.
As the fund holds a high proportion of insurer-issued DeemedRetractibles, fund performance was hurt by this phenomenon.
A side effect of the downdraft was the return of measurable Implied Volatility:
Implied Volatility of Two Series of Issues July 31, 2013 |
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Issuer | Pure Yield | Implied Volatility |
GWO | 3.85% (+0.55) | 25% (-3) |
PWF | 4.30% (+0.30) | 24% (-1) |
Bracketted figures are changes since June month-end |
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. As has been previously noted, very high levels of Implied Volatility (in the 40% range) imply a very strong expectation of directionality in future prices – i.e, an expectation that all issues will be redeemed at par. The decline in Implied Volatility – which is still at very high levels – implies more uncertainty regarding this prediction.
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.
Calculation of MAPF Sustainable Income Per Unit | ||||||
Month | NAVPU | Portfolio Average YTW |
Leverage Divisor |
Securities Average YTW |
Capital Gains Multiplier |
Sustainable Income per current Unit |
June, 2007 | 9.3114 | 5.16% | 1.03 | 5.01% | 1.3240 | 0.3524 |
September | 9.1489 | 5.35% | 0.98 | 5.46% | 1.3240 | 0.3773 |
December, 2007 | 9.0070 | 5.53% | 0.942 | 5.87% | 1.3240 | 0.3993 |
March, 2008 | 8.8512 | 6.17% | 1.047 | 5.89% | 1.3240 | 0.3938 |
June | 8.3419 | 6.034% | 0.952 | 6.338% | 1.3240 | $0.3993 |
September | 8.1886 | 7.108% | 0.969 | 7.335% | 1.3240 | $0.4537 |
December, 2008 | 8.0464 | 9.24% | 1.008 | 9.166% | 1.3240 | $0.5571 |
March 2009 | $8.8317 | 8.60% | 0.995 | 8.802% | 1.3240 | $0.5872 |
June | 10.9846 | 7.05% | 0.999 | 7.057% | 1.3240 | $0.5855 |
September | 12.3462 | 6.03% | 0.998 | 6.042% | 1.3240 | $0.5634 |
December 2009 | 10.5662 | 5.74% | 0.981 | 5.851% | 1.1141 | $0.5549 |
March 2010 | 10.2497 | 6.03% | 0.992 | 6.079% | 1.1141 | $0.5593 |
June | 10.5770 | 5.96% | 0.996 | 5.984% | 1.1141 | $0.5681 |
September | 11.3901 | 5.43% | 0.980 | 5.540% | 1.1141 | $0.5664 |
December 2010 | 10.7659 | 5.37% | 0.993 | 5.408% | 1.0298 | $0.5654 |
March, 2011 | 11.0560 | 6.00% | 0.994 | 5.964% | 1.0298 | $0.6403 |
June | 11.1194 | 5.87% | 1.018 | 5.976% | 1.0298 | $0.6453 |
September | 10.2709 | 6.10% Note |
1.001 | 6.106% | 1.0298 | $0.6090 |
December, 2011 | 10.0793 | 5.63% Note |
1.031 | 5.805% | 1.0000 | $0.5851 |
March, 2012 | 10.3944 | 5.13% Note |
0.996 | 5.109% | 1.0000 | $0.5310 |
June | 10.2151 | 5.32% Note |
1.012 | 5.384% | 1.0000 | $0.5500 |
September | 10.6703 | 4.61% Note |
0.997 | 4.624% | 1.0000 | $0.4934 |
December, 2012 | 10.8307 | 4.24% | 0.989 | 4.287% | 1.0000 | $0.4643 |
March, 2013 | 10.9033 | 3.87% | 0.996 | 3.886% | 1.0000 | $0.4237 |
June | 10.3261 | 4.81% | 0.998 | 4.80% | 1.0000 | $0.4957 |
July, 2013 | 10.1673 | 5.13% | 1.000 | 5.13% | 1.0000 | $0.5216 |
NAVPU is shown after quarterly distributions of dividend income and annual distribution of capital gains. Portfolio YTW includes cash (or margin borrowing), with an assumed interest rate of 0.00% The Leverage Divisor indicates the level of cash in the account: if the portfolio is 1% in cash, the Leverage Divisor will be 0.99 Securities YTW divides “Portfolio YTW” by the “Leverage Divisor” to show the average YTW on the securities held; this assumes that the cash is invested in (or raised from) all securities held, in proportion to their holdings. The Capital Gains Multiplier adjusts for the effects of Capital Gains Dividends. On 2009-12-31, there was a capital gains distribution of $1.989262 which is assumed for this purpose to have been reinvested at the final price of $10.5662. Thus, a holder of one unit pre-distribution would have held 1.1883 units post-distribution; the CG Multiplier reflects this to make the time-series comparable. Note that Dividend Distributions are not assumed to be reinvested. Sustainable Income is the resultant estimate of the fund’s dividend income per current unit, before fees and expenses. Note that a “current unit” includes reinvestment of prior capital gains; a unitholder would have had the calculated sustainable income with only, say, 0.9 units in the past which, with reinvestment of capital gains, would become 1.0 current units. |
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DeemedRetractibles are comprised of all Straight Perpetuals (both PerpetualDiscount and PerpetualPremium) issued by BMO, BNS, CM, ELF, GWO, HSB, IAG, MFC, NA, RY, SLF and TD, which are not exchangable into common at the option of the company (definition refined in May, 2011). These issues are analyzed as if their prospectuses included a requirement to redeem at par on or prior to 2022-1-31 (banks) or 2025-1-31 (insurers and insurance holding companies), in addition to the call schedule explicitly defined. See OSFI Does Not Grandfather Extant Tier 1 Capital, CM.PR.D, CM.PR.E, CM.PR.G: Seeking NVCC Status and the January, February, March and June, 2011, editions of PrefLetter for the rationale behind this analysis. | ||||||
Yields for September, 2011, to January, 2012, were calculated by imposing a cap of 10% on the yields of YLO issues held, in order to avoid their extremely high calculated yields distorting the calculation and to reflect the uncertainty in the marketplace that these yields will be realized. From February to September 2012, yields on these issues have been set to zero. All YLO issues held were sold in October 2012. |
Significant positions were held in DeemedRetractible and FixedReset issues on July 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 (banks) or 2025-1-31 (insurers and insurance holding companies). This presents another complication in the calculation of sustainable yield. The fund also holds positions in various SplitShare issues which also have their yields calculated with the expectation of a maturity at par.
I no longer show calculations that assume the conversion of the entire portfolio into PerpetualDiscounts, as 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 1.31% for the May 31 calculation) to estimate dividends after reset for FixedResets.
Most funds report Current Yield. For instance, ZPR reports a “Portfolio Yield” of 4.90% as of July 31, 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 5.32%, 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 $0.5216 per unit in July, 2013, 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.
LFE.PR.B: 13H1 Report, Dividend Policy Announced For Capital Units
August 5th, 2013On July 8, Quadravest announced:
On July 23, Quadravest announced:
According to the company, the undiluted NAV was 14.33 on July 31, and 13.69 fully diluted.
They have also released the 13H1 Financials for LFE, whence the following information can be extracted:
MER: The “Base Management Expense Ratio”, which excludes issuance costs and dividends paid on preferreds, is 1.05%.
Average Net Assets: Calculation of this figure is complicated by the exercise of warrants. Assets were 148.3-million at May 31 and 103.7-million at November 30. Giving the latter figure double weight (as the big warrant exercise was at the end of March) provides an average of 118.6-million. Considering dividends paid on the preferreds were $3.342-million and the preferreds pay 0.625 p.a., this implies an average of 10.69-million units outstanding, with an average NAVPU of (13.56 + 12.48) / 2 = 13.02, for a total of 13.02 x 10.69-million = 139.2-million. Taking the average of these two estimates provides a guess of Average Net Assets = 128.9-million.
Underlying Portfolio Yield: Dividends received of 2.178-million time 2 (semi-annual) divided by average net assets of 128.9-million is 3.38%. The main holdings of the fund are the Big Four Insurers:
The agreement is astonishing (there have to be compensating errors in there somewhere) and justifies the use of 3.36% portfolio yield.
Income Coverage: Net Investment Income of 1,424,271 divided by Preferred Share Distributions of 3,342,072 is 42%. This figure is undoubtedly brought down by delays in investing the proceeds of the warrant exercise, and therefore of earning dividend income. If we say that the fully diluted NAV is 13.69 (as at 7/31) and the portfolio earns 3.36% (calculated above), that’s $0.4600 p.a. before about 0.10 expenses to pay 0.625 preferred dividends, is about 58%, which sounds like a better guess.
Given all this computation, we can now take a stab at estimated credit quality:
9.96 bid on 8/2
Note that there are some problems with the above calculation, beyond all the estimates discussed above: Capital Unit dividends will be paid based on the undiluted NAV and hence will generally be more than estimated by the credit quality calculator, which is based on diluted NAV.
Update: Assiduous Reader prefhound asks in the comments about the sensitivity of the Expected Default Loss to the expected total return. Actually it’s surprisingly little:
Click for Big
The above chart is taken from the December, 2010, edition of PrefLetter, in which the model is discussed in detail. This is part of the PrefLetter 2010 Collection, sold on the PrefLetter website for the low, low price of only $50. That’s right, only $50! Click on PrefLetter right now to purchase the 2010 Collection for only $50! My server is standing by!
Since there is a cash drag, the big problem is sensitivity to return distribution assumptions; see Split Share Credit Quality; as might be expected, sensitivity to everything increases as the NAV declines; see It’s All About Sequence.
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