PrefBlog

The fund performed well as the preferred share recovery now looks pretty solid. As noted in the report of Index Performance, July 2009, both the FixedReset and PerpetualDiscount posted strong gains, particularly in the latter half of the month following the TXPR Revision.

The fund’s performance was helped by its overweighting in PerpetualDiscount issues, as discussed in the post MAPF Portfolio Composition, but managed to outperform even the pure measure of PerpetualDiscount total return due to security selection and frequent trading. This has been accomplished while remaining fully invested in a portfolio with an overall composition that did not change much through the month – which is exactly what I seek to accomplish in managing the fund.

The fund’s Net Asset Value per Unit as of the close July 31 was $11.8181.

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.

I am very pleased with the returns, but implore Assiduous Readers not to project this level of outperformance for the indefinite future. The past year in the preferred share market has been filled with episodes of panic and euphoria, together with many new entrants who do not appear to know what they are doing; perfect conditions for a disciplined quantitative approach.

All I can say about the fund’s relative returns in the past year is … sometimes everything 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 have been a lot of strongly motivated market participants in the past year, generating a lot of noise! Things won’t always be this good … but for as long as it lasts the fund will attempt to make hay while the sun shines.

A good example of “selling liquidity” is the fund’s accumulation of a position in SLF.PR.B during the month.

It may also be noted that SLF.PR.B still has an elevated yield relative to the average level for the Sun Life PerpetualDiscount issues:

I believe that the trading opportunities amongst the SLF PerpetualDiscounts were triggered by a major seller of SLF.PR.A, which had an influence on the other issues that propogated at different rates while also influenced by a broad general demand for PerpetualDiscounts. In support of this hypothisis, I have uploaded three graphs (prepared by my firm’s analytical software, HIMIPref™):

• The daily volume in SLF.PR.A exploded towards the end of the month
• This was so extreme that it had a significant effect on calculated average volume
• And I say it was driven by a major seller because of the pattern in bid-Yield-to-Worst

This is mere explanation after the fact, however. At the time of trade, all that really mattered was that the fund could pick up yield by swapping between issues with identical credit quality and almost identical terms.

Another example of profitable trading was discussed as part of the post on portfolio composition.

There’s plenty of room for new money left in the fund. Just don’t expect the current level of outperformance every year, OK? While I will continue to exert utmost efforts to outperform, it should be borne in mind that beating the index by 500bp represents a good year, and 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.

As discussed in the post MAPF Portfolio Composition: July 2009, the fund has positions in splitShares (almost all BNA.PR.C) and an operating retractible, both of which have high yields that are not sustainable: at some point they will be called or mature and the funds will have to be reinvested. Therefore, both of these positions skew the calculation upwards.. Since the yield on these positions is higher than that of the perpetuals despite the fact that the term is limited, the sustainability of the calculated “sustainable yield” is suspect, as discussed in August, 2008.

Significant positions were also held in Fixed-Reset issues on July 31; all of which currently have their yields calculated with the presumption that they will be called by the issuers at par at the first possible opportunity. It is the increase in exposure to the lower-yielding Fixed-Reset class that accounts for the apparent stall in the increase of sustainable income per unit in the past seven months. In December 2008, FixedReset exposure was zero; it is now 11.3%. Exposure to the extraordinarily high-yielding SplitShare class has also been reduced since December due to credit concerns.

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 6.14% shown in the July 31 Portfolio Composition analysis (which is in excess of the 6.06% index yield on July 31). Given such reinvestment, the sustainable yield would be 11.8181 * 0.0614 = $0.7256, an increase from the $0.7228 derived by a similar calculation last month.

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.

Trading activity eased slightly in July, with portfolio turnover of about 100%, while the market extended its gains.

Trades were, as ever, triggered by a desire to exploit transient mispricing in the preferred share market (which may the thought of as “selling liquidity”), rather than any particular view being taken on market direction, sectoral performance or credit anticipation.

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.

Not much change in the sectoral distribution!

Credit distribution is:

The shift from Pfd-2(high) to Pfd-1(low) is attributable to sale of some POW issues (Pfd-2(high)) in the PerpetualDiscount sector to fund the purchase of GWO PerpetualDiscounts (Pfd-1(low)):

The fund does not set any targets for overall credit quality; trades are executed one by one. Variances in overall credit will be constant as opportunistic trades are executed. The overall credit quality of the portfolio is now superior to the credit quality of CPD at August month-end (when adjusted for the downgrades of BCE and the banks).

Claymore provides the following ratings breakdown:

Three events have occurred since the Dec. 31 calculation date of CPD’s credit quality:

• Rebalancing of TXPR index with only a slight change in quality
  • January
  • July
• Downgrade of BCE: CPD holds about 4.3% of its portfolio in BCE issues
• Downgrade of Banks: HSB & NA are no longer in the “Pfd-1” class.

Liquidity Distribution is:

There is no real pattern to the increase in liquidity experienced this month. For instance, a positions in SLF.PR.C (ATV = 167,986) and SLF.PR.E (ATV = 185,774) were swapped into SLF.PR.B (ATV = 239,639). The trades from POW to GWO (partially noted above) also contributed to the increase, as did trades from BPO into YPG.

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. 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) and 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 29. When comparing CPD and MAPF:

• MAPF credit quality is better
• MAPF liquidity is similar (although CPD now has a lot of entries in the ‘super-heavy’ >300,000 class)
• MAPF Yield is higher
• Weightings in
  • MAPF is more exposed to PerpetualDiscounts
  • MAPF is much less exposed to Operating Retractibles
  • MAPF is more exposed to SplitShares
  • MAPF is less exposed to FixFloat / Floater / Ratchet
  • MAPF weighting in FixedResets is much lower