PrefBlog

Malachite Aggressive Preferred Fund’s Net Asset Value per Unit as of the close June 30, 2017, was $9.5313 after a distribution of $0.089495.

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.

Obviously, the last twelve months have been superb for both preferred shares in general and the fund in particular, but I think that there is still room for outsized gains. The Seniority Spread (the interest-equivalent yield on reasonably liquid, investment-grade PerpetualDiscounts less the yield on long term corporate bonds) is still quite elevated (chart end-date 2017-6-9):

… and the relationship between five-year Canada yields and yields on investment-grade FixedResets is also well within what I consider ‘decoupled panic’ territory (chart end-date 2017-6-9):

In addition, I feel that the yield on five-year Canadas is unsustainably low (it should be the inflation rate plus an increment of … 1%? 1.5%? 2.0%?),and a return to sustainable levels is likely over the medium term.

The performance gap between FixedResets and PerpetualDiscounts, remarked on last month, narrowed sharply in June but, amazingly, PerpetualDiscounts still managed to outperform over the quarter:

Of course, it’s one thing to say that ‘spreads are unsustainable and so are government yields’ and it’s quite another to forecast just how and when a more economically sustainable environment will take effect. It could be years. There could be a reversal, particularly if Trump’s international trade policies cause a severe recession or even a depression. And, of course, I could be just plain wrong about the sustainability of the current environment. However, the increasingly hawkish tilt among global central banks has been widely remarked:

Two weeks of rhetoric from policy makers in Europe and North America has rewritten the outlook for markets, with the Bank of England and the Bank of Canada now seen as more likely than not to join the Federal Reserve in raising rates before the year is out, based on overnight index swap rates. Even the possibility of a European Central Bank hike, once seen as all but impossible, is slowly growing.

The prospect of four of the world’s five largest central banks moving to tighten policy at the same time is shocking traders after years of easing, with the dislocations in money markets also rippling through global bonds.

I think that a broad, sustainable rally in FixedResets will require higher five-year Canada yields (or a widespread expectation of them) … and although I’m sure this will happen eventually, it would be foolish to speculate on just when it will happen!

These calculations were performed assuming constant contemporary GOC-5 and 3-Month Bill rates, as follows:

Significant positions were held in NVCC non-compliant regulated FixedReset issues on March 31, 2017; 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. It will also be noted that my analysis of likely insurance industry regulation as recently updated is not given much weight by the market.

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.

This entry was posted on Tuesday, July 4th, 2017 at 1:38 am and is filed under MAPF. 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.