There was a very gratifying exchange on FWF about Malachite Aggressive Preferred Fund that (so far!) has included the following concerns about the fund:
The outperformance of Malachite fund is indeed commendable and tempting for a newbie like myself currently investing in CPD. However turnover is very high, about 250 transactions for last year. We invest our non-registered fixed income in preferreds due to dividend tax credit advantage. Malachite’s high turnover seems highly tax inefficient, which would erode its outperformance. While its expense capped at 0.5% and fee of 1% for investment up to $0.5m is reasonable for a well managed active product, passive CPD’s MER is 0.45%. It may be interesting to work out the net outperformance after taking into consideration overall tax considerations and MER for such active versus passive products.
Fair enough. Let’s take the concerns in order:
However turnover is very high, about 250 transactions for last year.
The high turnover is a direct consequence of my philosophy as an active manager. I do not believe it is possible, in the long term, to make excess risk-adjusted returns by making macro-economic market-timing calls. So, for instance, I don’t think it possible that somebody can say “Oil will be going up for the next five years, therefore I’m going to invest in oil stocks” and have a reasonable expectation of making money.
As I never tire of saying, it’s a chaotic world we live in and even if you are able to analyze the world situation perfectly as of TODAY, there is every likelihood that the world will change tomorrow and mess up all your analysis.
There is, however, money to be made by selling liquidity … a rather arcane concept, but I’ll do the best I can.
How does a used car dealer make money? By and large, he’s not actually improving the cars … he’s just buying at one price and selling at another. Which is the key point. If you want to sell your car – you’ll go to him with a car “worth” $7,500 and accept $7,000 for it, because it’s convenient and probably cheaper than taking an ad out in the paper and spending time with potential buyers. If you want to buy a used car “worth” $7,500, you may well be happy to pay him $8,000 because of that same convenience and cost factor. So the dealer has, in this case, made $1,000 by “selling liquidity” – all he’s done is kept a parking lot in operation and been available at his place of business.
It’s the same thing with securities. There are always shifts in supply and demand that change the market price of a security without affecting the “fair” price. HIMIPref™, the proprietary software developed by my firm seeks to determine the fair value of each security in the preferred share universe it tracks. When the market value of something it doesn’t own becomes “sufficiently” cheaper than something it does – it trades. The word “sufficiently” is in quotes because solving that problem is just as hard as solving the “fair price” problem … at what point does the difference in value become so compelling that the possibility of gains outweighs the possibility of losses and the certainty of costs?
Not every trade will work – and I can’t, of course, provide any guarantees about the future – but the system has been sufficiently successful at this evaluation that returns over the first seven years of the fund’s existence have been very gratifying. As long as each trade meets the requirements and has a good potential profit … well, the more trades the better, I say!
Malachite’s high turnover seems highly tax inefficient, which would erode its outperformance.
Well … not really.
The concept of tax inefficiency is of major importance only with equities. An equity can easily double from its IPO price, for instance, while increasing its dividend. Given sufficient time, the price and the dividend can multiply by any amount you wish, with the unrealized capital gain giving rise to deferred tax, which is a lot nicer than having had to pay the tax earlier which would result from trading of the equities.
But preferred shares are fixed income instruments. A preferred share issued at $25 will, almost always, eventually be called at $25 (the exceptions are early calls, for which the issuer pays a slight premium, and defaults, for which a loss is expected which may be total). You do not make money from preferred shares from long term capital gains. Therefore, the concept of tax efficiency – at best – is limited to a few years’ deferral in a bull market.
While its expense capped at 0.5% and fee of 1% for investment up to $0.5m is reasonable for a well managed active product, passive CPD’s MER is 0.45%.
True enough. One generic advantage of MAPF – shared by most funds – is that you have a choice of whether to receive or to reinvest distributions. I’m not sure whether CPD offers a Dividend Reinvestment Plan at this point or not; or what the terms of such a plan might be.
More importantly, MAPF has historically beaten the index by more than the 1.05% difference in costs (the difference will decline as the amount invested gets larger).
An index product, for instance, will not sell a holding even when the yield-to-worst goes negative. An active fund can. An index product will not – usually – subscribe for a new issue, even when the issue has been priced at a substantial concession to extant issues. An active fund can.
I work hard to keep this track record going and have confidence that the fund will outperform in the future. Investors in the fund share that confidence, and I attempt to communicate to unitholders why I am confident. Just how convinced you are is up to you!
I hope this helps – please comment, eMail or call with any other questions you may have.
This entry was posted on Friday, April 11th, 2008 at 6:39 pm and is filed under MAPF, Reader Initiated Comments. You can follow any responses to this entry through the RSS 2.0 feed.
You can leave a response, or trackback from your own site.
MAPF: Response to a Potential Client's Concerns
There was a very gratifying exchange on FWF about Malachite Aggressive Preferred Fund that (so far!) has included the following concerns about the fund:
Fair enough. Let’s take the concerns in order:
However turnover is very high, about 250 transactions for last year.
The high turnover is a direct consequence of my philosophy as an active manager. I do not believe it is possible, in the long term, to make excess risk-adjusted returns by making macro-economic market-timing calls. So, for instance, I don’t think it possible that somebody can say “Oil will be going up for the next five years, therefore I’m going to invest in oil stocks” and have a reasonable expectation of making money.
As I never tire of saying, it’s a chaotic world we live in and even if you are able to analyze the world situation perfectly as of TODAY, there is every likelihood that the world will change tomorrow and mess up all your analysis.
There is, however, money to be made by selling liquidity … a rather arcane concept, but I’ll do the best I can.
How does a used car dealer make money? By and large, he’s not actually improving the cars … he’s just buying at one price and selling at another. Which is the key point. If you want to sell your car – you’ll go to him with a car “worth” $7,500 and accept $7,000 for it, because it’s convenient and probably cheaper than taking an ad out in the paper and spending time with potential buyers. If you want to buy a used car “worth” $7,500, you may well be happy to pay him $8,000 because of that same convenience and cost factor. So the dealer has, in this case, made $1,000 by “selling liquidity” – all he’s done is kept a parking lot in operation and been available at his place of business.
It’s the same thing with securities. There are always shifts in supply and demand that change the market price of a security without affecting the “fair” price. HIMIPref™, the proprietary software developed by my firm seeks to determine the fair value of each security in the preferred share universe it tracks. When the market value of something it doesn’t own becomes “sufficiently” cheaper than something it does – it trades. The word “sufficiently” is in quotes because solving that problem is just as hard as solving the “fair price” problem … at what point does the difference in value become so compelling that the possibility of gains outweighs the possibility of losses and the certainty of costs?
Not every trade will work – and I can’t, of course, provide any guarantees about the future – but the system has been sufficiently successful at this evaluation that returns over the first seven years of the fund’s existence have been very gratifying. As long as each trade meets the requirements and has a good potential profit … well, the more trades the better, I say!
Malachite’s high turnover seems highly tax inefficient, which would erode its outperformance.
Well … not really.
The concept of tax inefficiency is of major importance only with equities. An equity can easily double from its IPO price, for instance, while increasing its dividend. Given sufficient time, the price and the dividend can multiply by any amount you wish, with the unrealized capital gain giving rise to deferred tax, which is a lot nicer than having had to pay the tax earlier which would result from trading of the equities.
But preferred shares are fixed income instruments. A preferred share issued at $25 will, almost always, eventually be called at $25 (the exceptions are early calls, for which the issuer pays a slight premium, and defaults, for which a loss is expected which may be total). You do not make money from preferred shares from long term capital gains. Therefore, the concept of tax efficiency – at best – is limited to a few years’ deferral in a bull market.
While its expense capped at 0.5% and fee of 1% for investment up to $0.5m is reasonable for a well managed active product, passive CPD’s MER is 0.45%.
True enough. One generic advantage of MAPF – shared by most funds – is that you have a choice of whether to receive or to reinvest distributions. I’m not sure whether CPD offers a Dividend Reinvestment Plan at this point or not; or what the terms of such a plan might be.
More importantly, MAPF has historically beaten the index by more than the 1.05% difference in costs (the difference will decline as the amount invested gets larger).
An index product, for instance, will not sell a holding even when the yield-to-worst goes negative. An active fund can. An index product will not – usually – subscribe for a new issue, even when the issue has been priced at a substantial concession to extant issues. An active fund can.
I work hard to keep this track record going and have confidence that the fund will outperform in the future. Investors in the fund share that confidence, and I attempt to communicate to unitholders why I am confident. Just how convinced you are is up to you!
I hope this helps – please comment, eMail or call with any other questions you may have.
This entry was posted on Friday, April 11th, 2008 at 6:39 pm and is filed under MAPF, Reader Initiated Comments. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.