PrefBlog

Thornburg Mortgage has been a fascinating continuing saga and I have referred to it frequently in conversation over the past six months – it was last mentioned on PrefBlog on August 22. It is the only example I know of in which preferred shareholders were the target of a partial cram-down: reorganizations and bankruptcies are usually an all-or-nothing affair for preferred shareholders, but in this instance they got partial value.

All for naught! Thornburg Mortgage is going bust.

In a startling development some US investors in AIG have been able to figure out who the villains might be (assuming there are villains) when considering excessive bonuses (assuming bonuses are excessive) and are going after the chairman of the board’s compensation committee. A Nobel prize in economics can’t be far behind.

Another banner day for preferreds, with PerpetualDiscounts leading the way and FixedResets not far behind. PerpetualDiscounts now yield 7.26%, equivalent to 10.16% interest at the standard 1.4x equivalency factor; long corporates are now at 7.4% (maybe a tad higher) for a pre-tax interest-equivalent spread of 276bp.

Wouldn’t you know it! No sooner do I award plaudits to HOOPP and point out the wonderful thing about being an independent fund manager with a captive clientele (March 25) than the Ontario government comes up with a thoroughly lunatic scheme to make Teachers’ compete for clients:

The government is introducing legislation that, if passed, would expand the mandate of the Ontario Teachers’ Pension Plan (OTPP) Board if the government and the Ontario Teachers’ Federation (as Partners of the Plan) agree. The amendment would permit the OTPP Board to provide pension administration and investment services to other pension plans and institutional investors in the public sector.

• Benefits would include higher revenues for the OTPP Board, lower administrative costs and enhanced investment opportunities for future OTPP clients.
• This change is consistent with recommendations of the Expert Commission on Pensions that large pension plans be permitted to offer their services to smaller pension plans to improve investment returns for Ontario pension plans and others

The empire builders and salesmen-wannabes at Teachers’ are thrilled:

“The Ontario government’s proposed amendment to the Teachers’ Pension Act represents an encouraging step forward towards pension reform for thousands of Ontarians,” said Jim Leech, President and CEO of the Ontario Teachers’ Pension Plan (Teachers’). The amendment was introduced as part of the Ontario government’s 2009 budget.

“This move would allow us to help smaller pension plans and other institutions meet their beneficiaries’ needs,” he said. “We could pool significantly large amounts of capital and make our resources, such as our direct investing expertise, available to manage their funds. Their beneficiaries would benefit in gaining expertise, scope and scale.”

You can tell he’s been booking up for this opportunity. He’s using the same words every single investment manager that has ever existed in the history of the entire universe has used to flog his funds.

The report itself completely misses the point:

However, lower investment fees are but one of the many advantages enjoyed by large plans over smaller ones and over individual savers. In terms of income generation, large plans are in a position to hire expert staff to initiate and execute their investment strategies, to make attractive private placements of their investment funds, and to spread the investment risk by acquiring a wider range of investment vehicles. In terms of administrative expense, large plans are able to reduce their unit costs of administration by spreading them across a large plan membership, and they are typically able to offer members enhanced levels of information, education and service. Finally, large plans are more likely to survive than smaller ones, if only because the enterprises (or groups of enterprises) that sponsor them are likely to be more stable or resilient than those that sponsor small plans.

The cumulative effect of all of these advantages is extremely significant. It is so significant, in fact, that plan size may be a greater determinant of a member’s pension than plan design. Or, to make a more modest claim — holding plan design constant — large plans will generally perform better than small ones.

Modest claim, eh? There’s a very easy way to test this: look at the performance of investment managers by AUM and come up with a correlation between size and performance. After all, a large manager has the same ability to “hire expert staff”, “make attractive private placements” and “spread investment risk”. Sadly, the so-called expert commission does not appear to have thought of such a real-world test of their hypothesis.

Incredibly, there are still some people who believe that markets are efficient, notwithstanding the immense profitability of dealers’ proprietary trading and evidence that mutual fund investors have real difficulties getting their timing right. Correct me if I’m wrong, but shouldn’t it be true that if one clearly identifiable group is underperforming the market (pre-fees), then their should be another clearly identifiable group that is outperforming? Just wondering. Somebody has to, the Expert Commission isn’t.

In the investment business, sales isn’t simply a slight extra cost stuck on to the firm’s expenses. Sales is pervasive throughout the organization; from coming up with an interesting story to tell, through avoiding ‘fessing up to mistakes and all the way through to hiring good talkers in preference to good doers until, in the end, investment management is viewed as just another irritating expense rather than the organization’s raison d’etre. And that, ladies and gentlemen, is what costs the money; not piddly little management fees. Not transaction fees either, although transaction costs might.

Teachers can only hope that the proportion of external assets attracted by their manager will remain at less than 10% of the total – say another $10-billion. At that level, sales really will be simply an addendum to the real business of investment management. Any higher though, and there’s a real risk that investment management will become an addendum to the real business of sales.

March came in a lion and left like a lamb, with the PerpetualDiscount market having a great day on decent volume to close with a yield of 7.29%, equivalent to 10.21% at the standard equivalency factor of 1.4x. Long corporates continue to yield a BORING 7.5% (maybe just a hair under), having returned +2.74% over the month, so the pre-tax interest-equivalent spread is ending the quarter at 271bp … still elevated by all but recent standards.

Happy birthday, Malachite Aggressive Preferred Fund!