PrefBlog

The fund had another good month in November.

The fund’s Net Asset Value per Unit as of the close November 30 was $11.8495.

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.

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, whether that implies monthly turnover of 10% or 100%.

The fund’s returns were helped along by the overweighting in deeply discounted PerpetualDiscounts in which the fund is still overweighted (see MAPF Portfolio Composition: November 2010) although not as overweighted as it has been. While this type of issue generally outperformed, the effect is nowhere near as marked as was reported in October.

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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 Fixed-Reset issues on November 30; all of which (with the exception of the two YLO issues) currently have their yields calculated with the presumption that they will be called by the issuers at par at the first possible opportunity. This presents another complication in the calculation of sustainable yield. The fund also holds a position in a SplitShare (BNA.PR.C) which also has its yield calculated with the expectation of a maturity.

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 5.51% shown in the MAPF Portfolio Composition: November 2010 analysis (which is in excess of the 5.41% index yield on November 30). Given such reinvestment, the sustainable yield would be $11.8495 * 0.0551 = $0.6529, a nice increase from the $0.6474 reported last month.

Note that there will be a drag on the calculation in up-markets due to presence of shorter-term issues (or, at least, presumed shorter term issues!); the question is whether the positive effect of these issues in down markets will outweight their negative effect in up-markets – all I can say is … it has in the past!

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 fairly constant in November, at just under 30%.

Trades were, as ever, triggered by a desire to exploit transient mispricing in the preferred share market (which may be 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.

The increase in PerpetualPremium holdings at the expense of PerpetualDiscounts is related to a shift in credit quality from the Pfd-1(low) bucket to the Pfd-2(high) bucket and will be discussed below.

As reported in the post HIMIPref™ Index Performance, November 2010, PerpetualDiscounts significantly outperformed PerpetualPremiums over the month; unfortunately, heterogeniety of the data set does not allow us to conclude that Implied Volatility increased. In fact, for the three issuers with a sufficient sample of dividend rates, volatility was relatively constant, although it became more homogeneous between these specific issuers.

Analysis of the data using the Straight Perpetual Implied Volatility Calculator produces the following table:

As discussed in the October edition of PrefLetter, the implied volatility calculated for GWO is very high and implies a questionable assessment of the probability distribution of future yields, but it looks like the market is finding a level for Implied Volatility in the mid- to high-twenties.

Graphs from the Straight Perpetual Volatility Calculator for November 30 are:

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The yield pick-up for holding high-coupon Straights is such one should no longer automatically buy the deepest-discount issue in a series!

Credit distribution is:

As noted earlier, the shift in holdings weight from Pfd-1(low) to Pfd-2(high) is related to the shift from PerpetualDiscounts to PerpetualPremiums. Most of the move is explained by the following trades:

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) 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 31, 2010, and published in the September, 2010, PrefLetter. When comparing CPD and MAPF:

• MAPF credit quality is better
• MAPF liquidity is a higher
• MAPF Yield is higher
• Weightings in
  • MAPF is much more exposed to Straight Perpetuals
  • MAPF is much less exposed to Operating Retractibles
  • MAPF is slightly more exposed to SplitShares
  • MAPF is less exposed to FixFloat / Floater / Ratchet
  • MAPF weighting in FixedResets is much lower