MAPF Performance: September 2011

Well, there’s no sense trying to put a gloss on it: the fund had a horrible month in September.

The fund’s Net Asset Value per Unit as of the close September 30 was $10.2709 after a dividend distribution of $0.151168.

Returns to September 30, 2011
Period MAPF Index CPD
according to
One Month -6.52% -0.29% -0.82%
Three Months -6.27% -0.13% -0.72%
One Year +2.81% +7.94% +4.56%
Two Years (annualized) +8.96% +8.92% N/A
Three Years (annualized) +24.33% +9.35% +6.95%
Four Years (annualized) +16.63% +5.12%  
Five Years (annualized) +13.36% +3.65%  
Six Years (annualized) +12.09% +3.71%  
Seven Years (annualized) +11.36% +3.93%  
Eight Years (annualized) +11.87% +4.06%  
Nine Years (annualized) +13.94% +4.41%  
Ten Years (annualized) +11.91% +4.30%  
The Index is the BMO-CM “50”
MAPF returns assume reinvestment of distributions, and are shown after expenses but before fees.
CPD Returns are for the NAV and are after all fees and expenses.
* CPD does not directly report its two-year returns.
Figures for Omega Preferred Equity (which are after all fees and expenses) for 1-, 3- and 12-months are -0.63%, -0.63% and +5.29%, respectively, according to Morningstar after all fees & expenses. Three year performance is +7.73%.
Figures for Jov Leon Frazer Preferred Equity Fund Class I Units (which are after all fees and expenses) for 1-, 3- and 12-months are -0.40%, -0.18% and +2.40% respectively, according to Morningstar
Figures for Manulife Preferred Income Fund (formerly AIC Preferred Income Fund) (which are after all fees and expenses) for 1-, 3- and 12-months are -0.29%, -0.03% & +4.34%, respectively
Figures for Horizons AlphaPro Preferred Share ETF are not yet available (inception date 2010-11-23)

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.

The fund’s poor return for the month is basically due to the following:

MAPF Performance Attribution
September, 2011
Factor Contribution Note
YLO Preferreds -5.0% Topped up during month.
YLO.PR.A -90%
YLO.PR.B -85%
YLO.PR.C -84%
YLO.PR.D -82%
Overall Market -0.8% TXPR Total Return -0.77%
(Mainly underperformance of
Insurance Preferreds)
-0.7% e.g., CM.PR.J +1.20%
GWO.PR.I -0.22%
MFC.PR.C -2.79%
SLF.PR.C -4.20%
Total -6.52%  

The precipituous decline in YLO preferreds may in turn be attributed to their September 28 Press Release (discussed on PrefBlog) in which they announced, among other things:

  • Elimination of the common dividend
  • Stringent new rules for their sharply reduced bank credit line

Reaction from the rating agencies was mixed: DBRS went into hysterics, slashing the preferred rating four notches to Pfd-4(low); S&P merely yawned, maintaining their rating at P-4(high) and stating that they’d be looking forward to the next quarterly report with more interest than usual.

The price of the common and the preferreds, which had been sharply declining, promptly cratered.

Click for Big

I don’t get it. The company still has about $1.5-billion in revenue and estimated free cash flow in excess of $200-million per year. Yes, of course both these figures are going to decline somewhat in the future, and yes, you at the back of the room, I know you haven’t looked at the Yellow Pages in three years, but the question is – how fast?

In the August edition of PrefLetter I made a spreadsheet available at which attempted to quantify the effects on cash-flow and debt of various user-specified assumptions regarding the rate of print revenue decline and digital substitution; you have to make some assumptions that I consider quite extreme before you start getting seriously scared. The baseline assumptions – which I consider a little on the gloomy side, if anything – indicate that the targetted Debt:EBITDA ratio falls to 2:1 in about six years. Interestingly, reflecting the elimination of common dividends in the spreadsheet and applying these savings to debt reduction reduces the time for this target to be met to three years.

Is this a guarantee? No, of course, not. Ain’t nothing guaranteed. But my point is that awfully severe assumptions have to be made in order to show a bankrupt company and it is my judgement that these awfully severe assumptions have a low probability.

I had an illuminating conversation over dinner with another investment manager recently. We don’t really talk about investments much, but this time I was bemoaning the horror of the YLO carnage, while he said with satisfaction that he’d just sold his last YLO bonds at forty cents on the dollar. So I said (his paraphrased comments in brackets) something like … “Look, when I look at the company’s financials and apply a 15% annual rate of decline in print revenue forever (‘Could be more.’) and assume a 50% digital substitution rate (‘Could be less.’) at a 40% profit margin (‘Could be less.’), I just don’t understand the hysteria.”

But his comments illustrate, boys and girls, how investment management is usually done. You can project bankruptcy for any company in the world by making your assumptions severe enough – there’s no skill in that. Investment management involves making judgements about the future while at all times remembering that you might be wrong – which is why the fund will no longer top up its YLO holdings (the new credit agreement carries with it a partial loss of access to capital markets). Whatever your “gut reaction”, it can be justified. When I look at YLO, I see a company that is in decline, certainly, but I also see it spinning off cash like crazy in the meantime – much like one of those gold mines that is the latest Big Investment Idea around now – and becoming a smaller digital media company. The company has always made more sense as private equity rather than a public company; and at current prices I wouldn’t be surprised if Google, Microsoft and Yahoo! weren’t wondering if it would be cheaper to buy than build.

We have seen something like this before: in September 2002 the fund underperformed by a stunning 8.01%. Why? Much the same reason – the fund held Bombardier preferreds, which were engulfed by a wave of market sentiment very similar qualitatively to the sentiment which now surrounds Yellow Media. The relative price drop of the BBD preferreds was smaller, but the fund’s holdings were larger.

In the end, BBD recovered and the fund eventually exited its position with a small profit. I can’t, of course, guarantee that the same thing will happen in this episode – but I can’t, at this point, see why not. In the meantime, we will remember one of the ways in which the liquidity premium can be captured:

The spread on corporate bonds over the liquid risk-free rate (for example, government bonds) represents compensation for several different factors:

A Expected default losses
B Unexpected default risk, such as default and recovery rate risk
C Mark-to-market risk, such as the risk of a fall in the market price of the bond
D Liquidity risk, such as the risk of not finding a ready buyer at the theoretical market price.

Investors concerned with the realisable value of their investment in the short-term require compensation for all these risks.

However, investors who can hold bonds to maturity need compensation only for A and B. Such investors can enjoy the premiums for C and D, and we refer to these collectively as a ‘liquidity premium’

Right now we’re seeing mark-to-market risk with a vengeance!

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, without worrying about the level of monthly turnover.

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.

Calculation of MAPF Sustainable Income Per Unit
Month NAVPU Portfolio
June, 2007 9.3114 5.16% 1.03 5.01% 1.2857 0.3628
September 9.1489 5.35% 0.98 5.46% 1.2857 0.3885
December, 2007 9.0070 5.53% 0.942 5.87% 1.2857 0.4112
March, 2008 8.8512 6.17% 1.047 5.89% 1.2857 0.4672
June 8.3419 6.034% 0.952 6.338% 1.2857 $0.4112
September 8.1886 7.108% 0.969 7.335% 1.2857 $0.4672
December, 2008 8.0464 9.24% 1.008 9.166% 1.2857 $0.5737
March 2009 $8.8317 8.60% 0.995 8.802% 1.2857 $0.6046
June 10.9846 7.05% 0.999 7.057% 1.2857 $0.6029
September 12.3462 6.03% 0.998 6.042% 1.2857 $0.5802
December 2009 10.5662 5.74% 0.981 5.851% 1.0819 $0.5714
March 2010 10.2497 6.03% 0.992 6.079% 1.0819 $0.5759
June 10.5770 5.96% 0.996 5.984% 1.0819 $0.5850
September 11.3901 5.43% 0.980 5.540% 1.0819 $0.5832
December 2010 10.7659 5.37% 0.993 5.408% 1.0000 $0.5822
March, 2011 11.0560 6.00% 0.994 5.964% 1.0000 $0.6594
June 11.1194 5.87% 1.018 5.976% 1.0000 $0.6645
September, 2011 10.2709 6.10%
1.001 6.106% 1.0000 $0.6271
NAVPU is shown after quarterly distributions of dividend income and annual distribution of capital gains.
Portfolio YTW includes cash (or margin borrowing), with an assumed interest rate of 0.00%
The Leverage Divisor indicates the level of cash in the account: if the portfolio is 1% in cash, the Leverage Divisor will be 0.99
Securities YTW divides “Portfolio YTW” by the “Leverage Divisor” to show the average YTW on the securities held; this assumes that the cash is invested in (or raised from) all securities held, in proportion to their holdings.
The Capital Gains Multiplier adjusts for the effects of Capital Gains Dividends. On 2009-12-31, there was a capital gains distribution of $1.989262 which is assumed for this purpose to have been reinvested at the final price of $10.5662. Thus, a holder of one unit pre-distribution would have held 1.1883 units post-distribution; the CG Multiplier reflects this to make the time-series comparable. Note that Dividend Distributions are not assumed to be reinvested.
Sustainable Income is the resultant estimate of the fund’s dividend income per current unit, before fees and expenses. Note that a “current unit” includes reinvestment of prior capital gains; a unitholder would have had the calculated sustainable income with only, say, 0.9 units in the past which, with reinvestment of capital gains, would become 1.0 current units.
DeemedRetractibles are comprised of all Straight Perpetuals (both PerpetualDiscount and PerpetualPremium) issued by BMO, BNS, CM, ELF, GWO, HSB, IAG, MFC, NA, RY, SLF and TD, which are not exchangable into common at the option of the company (definition refined in May). These issues are analyzed as if their prospectuses included a requirement to redeem at par on or prior to 2022-1-31, in addition to the call schedule explicitly defined. See OSFI Does Not Grandfather Extant Tier 1 Capital, CM.PR.D, CM.PR.E, CM.PR.G: Seeking NVCC Status and the January, February, March and June, 2011, editions of PrefLetter for the rationale behind this analysis.
Yields for September 30, 2011, were calculated by imposing a cap of 10% on the yields of YLO issues held, in order to avoid their extremely high calculated yields distorting the calculation and to reflect the uncertainty in the marketplace that these yields will be realized.

Significant positions were held in DeemedRetractible and FixedReset issues on August 31; all of the former and most of the latter currently have their yields calculated with the presumption that they will be called by the issuers at par prior to 2022-1-31. This presents another complication in the calculation of sustainable yield. The fund also holds a position in a SplitShare (BNA.PR.C) and an OperatingRetractible Scrap (YLO.PR.B) which also have their yields calculated with the expectation of a maturity at par, a somewhat dubious assumption in the latter case.

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 5.84% shown in the MAPF Portfolio Composition: September 2011 analysis (which is greater than the 5.35% index yield on September 30). Given such reinvestment, the sustainable yield would be $10.2709 * 0.0584 = $0.5998 a decrease from the $11.1492 * 0.0580 = $0.6467 reported in August.

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.

7 Responses to “MAPF Performance: September 2011”

  1. grant says:

    “All are tracked by HIMIPref™; all are relegated to the Scraps index on credit concerns.”

    Why did your fund buy YLO prefs if they were ‘scraps’?

  2. jiHymas says:

    Issues are relegated to the “Scraps” index if, due to either credit or volume concerns, they are considered to be poorly correlated with other issues of the same structure which comprise the reported indices. See my article OSFI & the Bond Indices for more discussion of what makes a good index.

    Inclusion in the Scraps index does not mean that the issue is considered a poor investment regardless of price.

  3. grant says:

    Thank you for the clarification.

    It appears they were at least 1/17th of the fund at some point. Is this a normal weighting for a single company? Or did you, at the time, feel like overweighting them was the right decision?

  4. jiHymas says:

    I fear that in your calculation you missed the phrase “Topped up during month.”

    For periodic disclosures on the fund’s holdings, see the fund’s main web page.

  5. grant says:

    Good info, thanks. Hopefully at least your “C” shares recover in time. I expect your “B”s to be exchanged into ugly common.

  6. jiHymas says:

    I expect your “B”s to be exchanged into ugly common.

    Maybe … but while that is currently a prudent assumption, it is by no means assured even at the current price of the common. This game still has a while to play!

  7. […] 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 5.79% shown in the MAPF Portfolio Composition: November 2011 analysis (which is greater than the 5.32% index yield on November 30). Given such reinvestment, the sustainable yield would be $10.4511 * 0.0579 = $0.6051, down from the $10.4924 * 0.0598 = $0.6274 reported for October, but an increase from the $10.2709 * 0.0584 = $0.5998 reported in September. […]

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