MAPF Performance: June, 2015

The fund underperformed the BMO-CM “50” in June.

ZPR, is an ETF comprised of FixedResets and Floating Rate issues and a very high proportion of junk issues, returned -3.77%, -4.37% and -12.61% over the past one-, three- and twelve-month periods, respectively (according to the fund’s data), versus returns for the TXPL index of -3.78%, -4.50% and -12.34% respectively. The fund has been able to attract assets of about $987.6-million since inception in November 2012; AUM declined by $112-million in June; given an index return of -3.78% a decrease of about $42-million was expected, so there was a significant cash outflow over the month. I feel that the flows into and out of this fund are very important in determining the performance of its constituents.

TXPR had returns over one-, three- and twelve-months of -3.10%, -3.93% and -7.40% respectively with CPD performance within expectations.

Returns for the HIMIPref™ investment grade sub-indices for the month were as follows:

HIMIPref™ Indices
Performance to June 30, 2015
Sub-Index 1-Month 3-month
Ratchet N/A N/A
FixFloat N/A N/A
Floater -0.58% -5.11%
OpRet -0.25% +0.24%
SplitShare -0.16% +1.05%
Interest N/A N/A
PerpetualPremium -0.27% -0.49%
PerpetualDiscount -3.61% -5.75%
FixedReset -2.60% -3.22%
DeemedRetractible -0.60% -1.48%
FloatingReset -0.39% -1.29%

Malachite Aggressive Preferred Fund’s Net Asset Value per Unit as of the close June 30, 2015, was $9.4181 after a dividend distribution of 0.128623

Returns to June 30, 2015
Period MAPF BMO-CM “50” Index TXPR
Total Return
CPD – according to Blackrock
One Month -3.56% -2.73% -3.10% N/A
Three Months -4.12% -3.44% -3.93% N/A
One Year -6.49% -7.44% -7.40% -7.61%
Two Years (annualized) +0.46% -2.17% -2.13% N/A
Three Years (annualized) +2.32% -0.47% -0.61% -1.05%
Four Years (annualized) +1.70% +0.77% +0.51% N/A
Five Years (annualized) +5.07% +3.33% +2.62% +2.08%
Six Years (annualized) +7.53% +4.83% +3.76%  
Seven Years (annualized) +11.91% +4.10% +3.24%  
Eight Years (annualized) +9.73% +3.01% +2.00%  
Nine Years (annualized) +9.22% +2.63%    
Ten Years (annualized) +8.74% +2.64%    
Eleven Years (annualized) +8.84% +2.99%    
Twelve Years (annualized) +9.76% +3.10%    
Thirteen Years (annualized) +9.55% +3.46%    
Fourteen Years (annualized) +9.96% +3.44%    
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.
Figures for National Bank Preferred Equity Income Fund (formerly Omega Preferred Equity) (which are after all fees and expenses) for 1-, 3- and 12-months are -2.51%, -2.95% and -4.25%, respectively, according to Morningstar after all fees & expenses. Three year performance is +0.82%; five year is +3.50%
Figures for Manulife Preferred Income Class Adv [into which was merged Manulife Preferred Income Fund (formerly AIC Preferred Income Fund)] (which are after all fees and expenses) for 1-, 3- and 12-months are -3.61%, -4.55% & N/A, respectively.
Figures for Horizons AlphaPro Preferred Share ETF (which are after all fees and expenses) for 1-, 3- and 12-months are -2.58%, -3.27% & -5.86%, respectively. Three year performance is +0.38%
Figures for National Bank Preferred Equity Fund (formerly Altamira Preferred Equity Fund) are -2.63%, -3.55% and -7.22% for one-, three- and twelve months, respectively.
The figure for BMO S&P/TSX Laddered Preferred Share Index ETF is -3.77%, -4.37% and -12.61% for one-, three- and twelve-months, respectively. Two year performance is -5.80%.
Figures for NexGen Canadian Preferred Share Tax Managed Fund (Dividend Tax Credit Class, the best performing) are -3.1%, -3.8% and -1.0% for one-, three- and twelve-months, respectively.
Figures for BMO Preferred Share Fund are -3.72% and -6.81% for the past three- and twelve-months, respectively.
Figures for PowerShares Canadian Preferred Share Index Class, Series Fare -3.32%, -4.45% and -8.76% for the past one, three and twelve months, respectively. The three- and five-year figures are -2.36% and +0.90%, respectively.
Figures for the First Asset Preferred Share Investment Trust (PSF.UN) are -3.47%, -5.32% and -9.19% for the past one, three and twelve months, respectively. The two-, three-, four- and five-year figures are -4.35%, -2.37%, -1.47% and +0.13, respectively.

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.

A problem that has bedevilled the market over the past four years has been the OSFI decision not to grandfather Straight Perpetuals as Tier 1 bank capital, and their continued foot-dragging regarding a decision on insurer Straight Perpetuals has segmented the market to the point where trading has become much more difficult. Until the market became so grossly segmented, there were many comparables for any given issue – but now banks are not available to swap into (because they are so expensive) and non-regulated companies are likewise deprecated (because they are not DeemedRetractibles; they should not participate in the increase in value that will follow the OSFI decision I anticipate and, in addition, are analyzed as perpetuals). The fund’s portfolio was, in effect ‘locked in’ to the low coupon DeemedRetractibles due to projected long-term gains from a future OSFI decision to the detriment of trading gains, particularly in May, 2013, when the three lowest-coupon SLF DeemedRetractibles (SLF.PR.C, SLF.PR.D and SLF.PR.E) were the worst performing DeemedRetractibles in the sub-index, and in June, 2013, when the insurance-issued DeemedRetractibles behaved like PerpetualDiscounts in a sharply negative market. Nowadays, the fund is ‘locked-in’ to the low-spread FixedResets from these companies: GWO.PR.N, MFC.PR.F, and SLF.PR.G.

In May, insurance DeemedRetractibles performed worse than bank DeemedRetractibles:

Click for Big

… but better than Unregulated Straight Perpetuals.

Click for Big

Correlations were very poor for banks (-1%; not shown), not much good for insurance (4%; not shown) but quite good for unregulated issues (67%).

A lingering effect of the downdraft of 2013 has been the return of measurable Implied Volatility but given my recent updates in recent daily market reports, I will not discuss them further in this post.

Sometimes everything works … sometimes it’s 50-50 … 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’ – although for quite some time, noise trading has taken a distant second place to the sectoral play on insurance DeemedRetractibles; something that dismays me, particularly given that the market does not yet agree with me regarding the insurance issues! 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 PrefLetter that market pricing for FixedResets is very often irrational 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% 1.3240 0.3524
September 9.1489 5.35% 0.98 5.46% 1.3240 0.3773
December, 2007 9.0070 5.53% 0.942 5.87% 1.3240 0.3993
March, 2008 8.8512 6.17% 1.047 5.89% 1.3240 0.3938
June 8.3419 6.034% 0.952 6.338% 1.3240 $0.3993
September 8.1886 7.108% 0.969 7.335% 1.3240 $0.4537
December, 2008 8.0464 9.24% 1.008 9.166% 1.3240 $0.5571
March 2009 $8.8317 8.60% 0.995 8.802% 1.3240 $0.5872
June 10.9846 7.05% 0.999 7.057% 1.3240 $0.5855
September 12.3462 6.03% 0.998 6.042% 1.3240 $0.5634
December 2009 10.5662 5.74% 0.981 5.851% 1.1141 $0.5549
March 2010 10.2497 6.03% 0.992 6.079% 1.1141 $0.5593
June 10.5770 5.96% 0.996 5.984% 1.1141 $0.5681
September 11.3901 5.43% 0.980 5.540% 1.1141 $0.5664
December 2010 10.7659 5.37% 0.993 5.408% 1.0298 $0.5654
March, 2011 11.0560 6.00% 0.994 5.964% 1.0298 $0.6403
June 11.1194 5.87% 1.018 5.976% 1.0298 $0.6453
September 10.2709 6.10%
1.001 6.106% 1.0298 $0.6090
December, 2011 10.0793 5.63%
1.031 5.805% 1.0000 $0.5851
March, 2012 10.3944 5.13%
0.996 5.109% 1.0000 $0.5310
June 10.2151 5.32%
1.012 5.384% 1.0000 $0.5500
September 10.6703 4.61%
0.997 4.624% 1.0000 $0.4934
December, 2012 10.8307 4.24% 0.989 4.287% 1.0000 $0.4643
March, 2013 10.9033 3.87% 0.996 3.886% 1.0000 $0.4237
June 10.3261 4.81% 0.998 4.80% 1.0000 $0.4957
September 10.0296 5.62% 0.996 5.643% 1.0000 $0.5660
December, 2013 9.8717 6.02% 1.008 5.972% 1.0000 $0.5895
March, 2014 10.2233 5.55% 0.998 5.561% 1.0000 $0.5685
June 10.5877 5.09% 0.998 5.100% 1.0000 $0.5395
September 10.4601 5.28% 0.997 5.296% 1.0000 $0.5540
December, 2014 10.5701 4.83% 1.009 4.787% 1.0000 $0.5060
March, 2015 9.9573 4.99% 1.001 4.985% 1.0000 $0.4964
June, 2015 9.4181 5.55% 1.002 5.539% 1.0000 $0.5217
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, 2011). These issues are analyzed as if their prospectuses included a requirement to redeem at par on or prior to 2022-1-31 (banks) or 2025-1-31 (insurers and insurance holding companies), 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.

The same reasoning is also applied to FixedResets from these issuers, other than explicitly defined NVCC from banks.

Yields for September, 2011, to January, 2012, 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. From February to September 2012, yields on these issues have been set to zero. All YLO issues held were sold in October 2012.
Calculations of resettable instruments are performed assuming constant contemporary GOC-5 and 3-Month Bill rates. For June 30, 2015, yields of 0.91% and 0.52%, respectively, were assumed.

Significant positions were held in DeemedRetractible, SplitShare and NVCC non-compliant regulated FixedReset issues on June 30; all of these currently have their yields calculated with the presumption that they will be called by the issuers at par prior to 2022-1-31 (banks) or 2025-1-31 (insurers and insurance holding companies) or on a different date (SplitShares) This presents another complication in the calculation of sustainable yield, which also assumes that redemption proceeds will be reinvested at the same rate.

I will also note that the sustainable yield calculated above is not directly comparable with any yield calculation currently reported by any other preferred share fund as far as I am aware. The Sustainable Yield depends on:
i) Calculating Yield-to-Worst for each instrument and using this yield for reporting purposes;
ii) Using the contemporary value of Five-Year Canadas to estimate dividends after reset for FixedResets. The assumption regarding the five-year Canada rate has become more important as the proportion of low-spread FixedResets in the portfolio has increased.
iii) Making the assumption that deeply discounted NVCC non-compliant issues from both banks and insurers, both Straight and FixedResets will be redeemed at par on their DeemedMaturity date as discussed above.

I no longer show calculations that assume the conversion of the entire portfolio into PerpetualDiscounts, as the fund has only a small position in these issues.

Most funds report Current Yield. For instance, ZPR reports a “Dividend Yield” of 4.5% as of August 29, 2014, but this is the Current Yield, a meaningless number. The Current Yield of MAPF was 4.89% as of August 29, but I will neither report that with any degree of prominence nor take any great pleasure in the fact that it’s a little higher than the ZPR number. It’s meaningless; to discuss it in the context of portfolio reporting is misleading.

However, BMO has taken a significant step forward in that they are no longer reporting the “Portfolio Yield” directly on their website; the information is taken from the “Enhanced Fund Profile” which is available only as a PDF link. CPD doesn’t report this metric on the CPD fact sheet or on their website. I may have one less thing to mock the fundcos about!

It should be noted that the concept of this Sustainable Income calculation was developed when the fund’s holdings were overwhelmingly PerpetualDiscounts – see, for instance, the bottom of the market in November 2008. It is easy to understand that for a PerpetualDiscount, the technique of multiplying yield by price will indeed result in the coupon – a PerpetualDiscount paying $1 annually will show a Sustainable Income of $1, regardless of whether the price is $24 or $17.

Things are not quite so neat when maturity dates and maturity prices that are different from the current price are thrown into the mix. If we take a notional Straight Perpetual paying $5 annually, the price is $100 when the yield is 5% (all this ignores option effects). As the yield increases to 6%, the price declines to 83.33; and 83.33 x 6% is the same $5. Good enough.

But a ten year bond, priced at 100 when the yield is equal to its coupon of 5%, will decline in price to 92.56; and 92.56 x 6% is 5.55; thus, the calculated Sustainable Income has increased as the price has declined as shown in the graph:

Click for Big

The difference is because the bond’s yield calculation includes the amortization of the discount; therefore, so does the Sustainable Income estimate.

Different assumptions lead to different results from the calculation, but the overall positive trend is apparent. I’m very pleased with the long-term 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 has generally been due to 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.

4 Responses to “MAPF Performance: June, 2015”

  1. David says:

    I understand how a mutual fund can have “outflows”. What circumstances would create an “outflow” from ZPR as you describe? I probably do not have a solid understanding of how ETF’s operate and apologize in advance. Thank you.

  2. jiHymas says:

    Say you own some shares of ZPR, and have decided you don’t want to own them any more.

    So you sell it on the exchange and three days later you get the price and the commission.

    But who did you sell it to? It could have been another investor, but it also might have been a market-maker, which is usually the preferred share desk at a major brokerage; for some of the larger ETFs, it might also be a hedge fund.

    Say a market-maker bought it. He has no interest in owning preferred shares as such, he’s only interested in buying something for less than what he gets when he sells it and minimizing his risk over a short period.

    So at the same time he bought your ZPR, he sold short one or more of its constituents, keeping his overall exposure to the preferred share market flat.

    One way to square his position is to sell those shares of ZPR to another investor (at the asking price, this time!) and buying back his short sale; if things work out properly, he’ll make a few dollars on the round trip.

    But another way to square his position is to end up owning a ‘creation block’ of ZPR. I think that’s 100,000 shares, but all the details are in the prospectus. These can be presented to the ETF and exchanged for the underlying securities … 1,007 shares of BMO.PR.S, 442 shares of BNS.PR.Y, etc. (numbers have been made up). At this point, he has no position at all in ZPR, he just has a big mass of individual preferred share positions, some long, some short, that, ideally, nets out to be worth about $0. Then he just continues on his merry way selling X at the offer, buying Y at the bid, doing a big block of Z at the midpoint but charging a commission … market-making stuff. Keeping his inventory turning over on a continuous basis and, hopefully, making some money.

    The best Canadian preferred share market-maker, EVER, was David Berry, who has been discussed quite often in this blog.

  3. SafetyinNumbers says:

    Mr. Hymas,

    Do you track the assets of all Canadian preferred share ETFs? There sure seems to be a lot of carnage out there so maybe a broader asset allocation decision ahead of higher expected rate while the market also worries about low rate resets!

  4. jiHymas says:

    No, I only look at the assets for ZPR. The other funds are either broadly based or actively managed; and therefore changes in total assets will not have a direct effect on the supply and demand for a known and particular sector. With ZPR, I know that all changes in AUM result in a direct effect on supply/demand for FixedResets.

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