PrefBlog

Malachite Aggressive Preferred Fund’s Net Asset Value per Unit as of the close December 31, 2018, was $8.6875 after a dividend distribution of 0.101427 per unit.

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 preferred share market has suffered a sharp reverse in the past three months, leaving a lot of 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 extremely elevated (chart end-date 2018-12-14)

Note that the Seniority Spread was a breathtaking 370bp on December 19. As a good practical example of the spreads between markets, consider that on November 19, CIU issued $385-million of 30-year bonds yielding 3.95%, at a time when issuing Straight Perpetuals would have cost them about 5.75% – a very wide spread even before considering the tax effect.

… 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 2018-12-14):

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.

FixedReset (Discount) performance on the month was -2.69% vs. PerpetualDiscounts of +1.95% in November; the two classes finally decoupled in mid-November after months of moving in lockstep.:

Floaters took another hit over the month, as they returned -5.71% for December and -4.86% for the past twelve months. But look at the long-term performance:

Some Assiduous Readers will be interested to observe that the ‘Quantitative Easing’ decline was not as bad as the ‘Credit Crunch’ decline, which took the sector down to the point where the 15-year cumulative total return was negative. I wrote about that at the time and still can’t get over it. Fifteen years!

As for the future, 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 sharp declines of the past two months clarify the market’s fears, which were unclear on October 29: the market is behaving more as if it fears falling interest rates rather than rising ones – although this does not explain the very high value of the Seniority Spread, discussed above.

Yields on preferred shares of all stripes are extremely high compared to those available from other investments of similar quality. A I told John Heinzl in an eMail interview in late November, the best advice I can offer investors remains Shut up and clip your coupons!

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 December 31, 2018; 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 2030-1-31 (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 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 Wednesday, January 2nd, 2019 at 12:12 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.