PrefBlog

The fund had a sub-par, but hardly disastrous, month in December, due mostly to its large holdings in deeply discounted Straight Perpetuals, which underperformed. Results for the quarter and the year look pretty good.

The fund’s Net Asset Value per Unit as of the close December 31 was $10.7659 after a Capital Gains distribution of $0.882239 and a Dividend Distribution of $0.159708.

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 diminished this month by the overweighting in deeply discounted PerpetualDiscounts in which the fund is still overweighted (see MAPF Portfolio Composition: December 2010) although not as overweighted as it has been for much of the year.

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The relative performances are interesting. SLF.PR.E had the worst performance of the selected issues (in fact, it had the worst performance of all the HIMIPref™ index constituents), clocking in at -4.05% – and the fund had a 7.0% weighting in this issue as of November 30. The position was not traded during the month, so we can estimate that all by itself this position cost the fund 28bp of performance. Even if we say the position “should have” returned -2.00%, in line with comparable issues, that’s still 14bp of underperformance, a significant chunk of the fund’s relative performance.

Even worse, the last bid price on this issue declined from 20.52 on December 30 to 19.91 on December 31, a decline of 2.97% on the day; and the last quote was 19.91-20.60. Its bid yield on 12/31 was significantly above its peers, so this is is almost certainly a glitch – albeith not certainly enough and not significant enough for me to take the rather awesome step of substituting a different price for fund valuation purposes.

It’s not really a big deal – the issue still pays 1.125 and still has exactly the same credit quality as the other SLF issues. Its undervaluation relative to its peers provides the fund with something of a tailwind for January!

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 December 31; all of which (with the exception of YLO.PR.C) 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 5.60% shown in the MAPF Portfolio Composition: December 2010 analysis (which is in excess of the 5.46% index yield on December 31). Given such reinvestment, the sustainable yield would be $10.7659 * 0.0560 = $0.6029, basically unchanged from the (adjusted for capital gains) $0.6034 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.

Update: The SLF.PR.E is a legitimate closing quote, although it does mean that the market-maker fell down on the job.

I have sent the following eMail to info@tsx.com:

According to information reported by DataLinx for December 31, the closing quotation for SLF.PR.E was 19.91-60, 2×27.

I have four questions that arise from the closing quotation:

i) Who is the market-maker for this security?

ii) Will the TMX be investigating the circumstances that led to the wide spread on this closing quotation?

iii) Will the TMX be announcing the results of such an investigation?

iv) Will the TMX be implementing any sanctions against the market maker for this security?

Update, 2011-01-13: The TMX response to the eMail, and my follow-up, are reported in the post TMX: Close, Schmose!.

Turnover remained fairly constant in December, at about 27%.

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 PerpetualDiscount holdings at the expense of PerpetualPremiums is largely due to migration of two positions, CM.PR.P and GWO.PR.M, from the latter class to the former. Both accrued dividends during the month.

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

The decline in volatility is interesting and probably reflects a market view on the future direction of market yields. Given the high level of uninformed emotion in the preferred share market – particularly the Straight Preferred sector – this could be a fruitful area of research.

Graphs from the Straight Perpetual Volatility Calculator for December 31 are:

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

Credit distribution is:

Liquidity Distribution is:

As was the case with the sector distribution, the large shift from the $300,000+ liquidity bucket to the $200,000-$300,000 was not due to trading, but rather to migration, as positions were held in BAM.PR.N, SLF.PR.B and YLO.PR.C which all experienced declines in Average Trading Value over the month.

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) or 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