As noted in MAPF Portfolio Composition: March 2015, the fund now has a fairly large allocation to FixedResets, mostly of relatively low spread.
Many of these were largely purchased with proceeds of sales of DeemedRetractibles from the same issuer, it is interesting to look at the price trend of some of the Straight/FixedReset pairs. We’ll start with GWO.PR.N / GWO.PR.I; the fund sold the latter to buy the former at a takeout of about $1.00 in mid-June, 2014; relative prices over the past year are plotted as:
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Given that the March month-end take-out was $5.74, this is clearly a trade that has not worked out very well.
In July, 2014, I reported sales of SLF.PR.D to purchase SLF.PR.G at a take-out of about $0.15:
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There were similar trades in August, 2014 (from SLF.PR.C) at a take-out of $0.35. The February month-end take-out (bid price SLF.PR.D less bid price SLF.PR.G) was $6.16, so that hasn’t worked very well either.
November saw the third insurer-based sector swap, as the fund sold MFC.PR.C to buy the FixedReset MFC.PR.F at a post-dividend-adjusted take-out of about $0.85 … given a February month-end take-out of about $5.29, that’s another regrettable trade, although another piece executed in December at a take-out of $1.57 has less badly.
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This trend is not restricted to the insurance sector, which I expect will become subject to NVCC rules in the relatively near future and are thus subject to the same redemption assumptions I make for DeemedRetractibles. Other pairs of interest are BAM.PR.X / BAM.PR.N:
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… and FTS.PR.H / FTS.PR.J:
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… and PWF.PR.P / PWF.PR.S:
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I will agree that the fund’s trades highlighted in this post may be decried as cases of monumental bad timing, but I should point out that in May, 2014, the fund was 63.9% Straight / 9.5% FixedReset
while in February 2015 the fund was 22% Straight / 64% FixedReset & FloatingReset (The latter figures include allocations from those usually grouped as ‘Scraps’). Given that the indices are roughly 30% Straight / 60% FixedReset & FloatingReset, it is apparent that the fund was extremely overweighted in Straights / underweighted in FixedResets in May 2014 but is now approximately index-weighted in FixedResets and underweighted in Straights (the balance being mostly SplitShares in the fund). HIMIPref™ analytics have been heavily favouring low-spread issues and the fund’s holdings are overwhelmingly of this type.
Summarizing the charts above in tabular form, we see:
| FixedReset | Straight | Take-out December 2013 |
Take-out MAPF Trade |
Take-out December 2014 |
Take-out February 2015 |
Take-out March 2015 |
| GWO.PR.N 3.65%+130 |
GWO.PR.I 4.5% |
($0.04) | $1.00 | $2.95 | $6.25 | $5.74 |
| SLF.PR.G 4.35%+141 |
SLF.PR.D 4.45% |
($1.29) | $0.25 | $2.16 | $6.45 | $6.16 |
| MFC.PR.F 4.20%+141 |
MFC.PR.C 4.50% |
($1.29) | $0.86 | $1.20 | $5.29 | $5.46 |
| BAM.PR.X 4.60%+180 |
BAM.PR.N 4.75% |
($2.06) | $0.17 | $5.39 | $4.76 | |
| FTS.PR.H 4.25%+145 |
FTS.PR.J 4.75% |
$0.60 | $5.68 | $8.47 | $8.86 | |
| PWF.PR.P 4.40%+160 |
PWF.PR.S 4.80% |
($0.67) | $3.00 | $6.63 | $6.43 | |
| The ‘Take-Out’ is the bid price of the Straight less the bid price of the FixedReset; approximate execution prices are used for the “MAPF Trade” column. Bracketted figures in the ‘Take-Out’ columns indicate a ‘Pay-Up’ | ||||||
So why is all this happening? One should take care in explaining market movements, but it is my belief that in the latter half of 2013 we were dealing with the ‘taper tantrum’ – the market’s fears that Fed tapering and subsequent tapering would lead to massive spikes in yields; this led to a great preference for FixedResets over Straights. Now, with the economic news getting less inflationary with every news story and Europe and Japan desperately trying to reflate their sluggish economies, the market seems to think that these rate increases are still a long way off … leading to a great preference for Straights over FixedResets.
In addition, the graphs show a sharp spike in early December, during which the low-spread FixedResets were very badly hurt; I believe this to be due to a combination of tax-loss selling and a panicky response to the 29% reduction in the TRP.PR.A dividend.
And in January it just got worse with Canada yields plummeting after the Bank of Canada rate cut with speculation rife about future cuts although this has recently become less emphatic.
There was some good discussion about what is going on in the comments to the January 29 market action report. I take the view that we’ve seen this show before: during the Credit Crunch, Floaters got hit extremely badly (to the point at which their fifteen year total return was negative) because (as far as I can make out) their dividend rate was dropping (as it was linked to Prime) while the yields on other perpetual preferred instruments were skyrocketing (due to credit concerns). Thus, at least some investors insisted on getting long term corporate yields from rates based (indirectly and with a lag, in the case of FixedResets) on short-term government policy rates. And it’s happening again!
Here’s the March performance for FixedResets that had a YTW Scenario of ‘To Perptuity’ at mid-month. The correlations for both the Pfd-2 Group and the Pfd-3 Group improved this month: 12% and 25%, respectively:
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I don’t think anyone should panic over the dramatic shift of low spread fixed resets vs straights. I see this as a temporary aberration that may last 6 months or even a year. Once the yield curve turns, so will the low spread fixed resets vs straights. I actually see the potential for an incredible buying opportunity on these cheap resets.
Example: If FTS.PR.H resets at 2.15% yield (GoC5 @ 0.7%), and one buys it today at $16, then that provides a yield of 3.36% for the next 5 years, after which time it could reset at 3.45% in 2020 (GoC5 @2%) or 5.39% at cost. That low spread reset is unlikely to be called and if it is called at par in 2020, there is a huge cap gain involved.
I agree with AltaRed that this represents an excellent opportunity for new purchasers since the odds are good that the GoC5 will be higher in 5 years than it is today. However, over the past few weeks, I (and undoubtedly many other PrefBlog aficianodos) have already accumulated a considerable number of low-spread FRs at what I thought were “bargain-basement” prices. This was certainly true until the last couple of days (particularly today – what a disaster!!), when new rumours about the BoC announcing, or at least unambiguously “signaling”, an imminent rate cut seem to be going around. The prices of several of my low-spread FR holdings fell below their ACB today. (Funnily enough, while the low-spread FR market was in turmoil, the actual GoC5 rate didn’t really change much today.)
The problem is that if a rate cut is announced or otherwise clearly “signaled” shortly before May 2 (for FTS.PR.H) or May 31 (for TRP.PR.B), etc., there will likely be a precipitous overshoot in the GoC5 rate, without time for it to recover to a more reasonable steady-state value before being locked in. The prices of these FRs, purchased a few weeks earlier, will hence drop further with the rate cut. (Now THAT would be a good buying opportunity, if you have any spare cash left – I don’t….)
Personally, I don’t know if I want to wait several years to potentially recover my purchase price (I am not a long-term pref investor, unless forced to be…). Of course, one could decide to convert to the floater in the few days following the determination of the reset GoC90 value, in order to more rapidly “benefit” from any subsequently rising GoC90 rates, but these rates would have to rise a lot just to overcome the inherently big relative difference between the dividends of the (low-spread-reset) floater and fixed-reset prefs.
Ah, the joys and perils of short-term pref investing!