PrefBlog

Malachite Aggressive Preferred Fund’s Net Asset Value per Unit as of the close September 29, 2023, was $7.9922 after a dividend distribution of 0.120186 per Unit.

Performance was affected by MIC.PR.A underperforming at +1.44% , BN.PR.R at +2.36% [repeating last month’s underperformance] and several low-weight, junk-rated issues underperforming at -4.95% to -0.58%. This was more than compensated for by good performance from TRP.PR.D (+6.44%), TD.PF.C (+6.36%, recovering from last month’s underperformance) and NA.PR.W (+5.66)[small holdings are not considered for individual mention here].

I feel it is only a matter of time before investors start paying attention to the fundamental risk of these instruments compared to their eye-popping interest-equivalent yields. In addition, the market appears to be giving considerable weight to Current Yield as a measure of valuation, ignoring or strongly deprecating the potential for large dividend increases on the next few years of resets.

FixedResets continue to yield more, in general, than PerpetualDiscounts; on September 29, I reported median YTWs of 9.18% and 7.07%, respectively, for these two indices; compare with mean Current Yields of 5.97% and 6.87%, respectively. RY.PR.J, to take a representative example, is calculated by HIMIPref™ as having a yield-to-worst of 9.35% at monthend (Current Yield of 4.49%); bid at 17.80, resetting 2025-5-24 at a spread of 274bp over GOC-5 (assumed to be constant at 4.31%) and currently paying 0.80 p.a. (3.20% annually). The next pay-date is 2023-11-24; it is trading cum-dividend.

If we plug the above data into the yield calculator for resets (which is discussed here and has recently been slightly modified), we arrive at a annualized (compounded semi-annually) yield of 9.24% for RY.PR.J . To take this up 11bp (the difference between the spreadsheets and HIMIPref™) above the PerpetualDiscount median index yield of 7.07% (to account for the calculation methodological differences), which is to say 7.18%, requires the assumption that GOC-5 will be 2.57% forever, as opposed the ‘constant rate’ assumption of 4.31%. Well … pays yer money and takes yer chances, gents! Assiduous Readers with long memories will liken this to all the calculations of Break-even Rate Shock when the puzzle represented the same problem with a different sign! Note that even if the unfavourable scenario of GOC-5 = 2.57% is realized, this has only reduced the yield of RY.PR.J to that of the median PerpetualDiscount yield, which isn’t the worst outcome one might fear from one’s investments!

The five-year Canada yield increased, with the five-year Canada yield (“GOC-5”) rising from 4.08% at August month-end to 4.31% at September month-end.

The Seniority Spread (between long-term corporate bonds and interest-equivalent PerpetualDiscounts) was 390bp as of 2023-9-27 (although this is based on suspect data from BMO) (chart end-date 2023-9-8) :

The situation with FixedResets is interesting, with the spread between GOC-5 and the interest-adjusted FixedReset (Discount) rate widening significantly from its 2021-11-10 low of 344bp to its current level of 762bp (as of 2023-9-27) … (chart end-date 2023-9-8):

…while at the same time the interest-equivalent spread between FixedReset (Discounts) and PerpetualDiscounts has narrowed to -274bp (as of 2023-9-29) from its 2021-7-28 level of +170bp (chart end-date 2023-8-11):

There is no significant correlation between the Issue Reset Spread and 1-month performance for discounted FixedResets for either the Pfd-2 or Pfd-3 Group issues, which is normal because there is a lot of noise in this inefficient market.

However, the normally moderate correlations between Issue Reset Spread and three-month performance have disappeared again in this month’s check:

Results for the regressions of performance against term-to-reset echo those found last month. I interpret this as implying that the market is using the FixedReset market as a proxy to make interest rate forecasting bets, but I am at a loss to discern any coherent vision to results in the year to date.

There was a correlation of 21% for the Pfd-2 Group and the same value for the Pfd-3 (21%) Group for 1-Month performance against term-to-reset; there seems to be some additional effect of a less than one-year term to reset:

… and for three-month performance against term-to-reset, there were significant correlations for both the Pfd-2 Group (32%) and the Pfd-3 Group (39%):

It should be noted that to some extent such a dependence (of performance on term-to-reset) can be justified as the nearer-term issues will receive the benefit of higher projected dividend rates sooner as a result of higher GOC-5 yields and therefore, perhaps, for longer. Equations for the relationship between correlation slope and change in GOC-5 were derived in the August 2022 PrefLetter. In the three months from June 30 to September 29, the GOC-5 rate increased from 3.74% to 4.31%. There may have well have been an effect from the surprise redemption of TD.PF.K, if enough investors thought this signalled the return of waves of redemptions.

I keep talking about ‘Sustainable Income’ and nowadays it’s far higher than the dividends that are currently being distributed. This is because Sustainable Income is the average yield-to-worst (YTW) of the portfolio when the YTW is calculated to perpetuity (or to redemption, of course, if the yield to redemption is lower), including resets at the current GOC-5 rate. The sharp increase in GOC-5 in the past year-odd has caused the difference between YTW and Current Yield to skyrocket, but one way or another I expect that these two values will become much closer – slowly at first, but quickening in about two years. We have to wait for the reset date of the MAPF portfolio securities before we see a change in actual cash receipts – and, of course, there is no guarantee whatsoever that the rate used for estimation purposes now will be used for the actual calculation in the future (chart prepared as of 2023-9-8).

These calculations were performed assuming constant contemporary GOC-5 and 3-Month Bill rates, as follows:

Turnover remained surprisingly high at 10% in September, saved from ignominy by a burst of activity following the surprise redemption of TD.PF.K and subsequent market movement.

Sectoral distribution of the MAPF portfolio on September 29, 2023, were:

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 distribution of Issue Reset Spreads is:

Distribution of Floating Rate Start Dates is shown in the table below. This is the date of the next adjustment to the dividend rate, if the issue is currently paying a fixed rate for a limited time; which in practice is successive terms of 5 years. Issues that adjust quarterly are considered “Currently Floating”.

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 directly from Hymas Investment Management. A “unit trust” is like a regular mutual fund, but are not sold with a prospectus This is cheaper, but means subscription is restricted to “accredited investors” (as defined by the Ontario Securities Commission). Fund past performances are not a guarantee of future performance. You can lose money investing in MAPF or any other fund.