The Manager's Commentary - June 2011
The following are returns for various financial instruments during the 2nd quarter of 2011:
| Instrument | Q2 Performance |
|---|---|
| S&P 500 | -0.40% |
| S&P/TSX | -5.20% |
| US High Yield Corporates | 1.00% |
| US Inv Grade Corporates | 2.30% |
| 10 Year Treasuries | 3.60% |
| 10 Year Gov't of Canada's | 3.70% |
As the table highlights, being invested in longer duration risk free assets in Q2 was generally the best trade going. In fact, if you looked at returns to the end of the 3rd week in June, 10 year Treasuries would have been up over 6 percent for the quarter. With 10 year Treasury bonds yielding under 3%, the “tag team” drivers of risk – Euro Sovereign default and stagnant U.S. employment growth are clearly dominating investors psyche. As a reference point, the 10 year Treasury bond yield today is at the same level as the first quarter of 2009 when the S&P 500 index was in the 700 to 800 zip code.
Despite the obvious drags on economic growth from unemployment, sovereign risks as well as high personal debt levels, we don't think deflation is a near term risk. The global economy was close to passing through deaths door a few years back and the Federal Reserve with that experience scorched indelibly on its mind will use its abilities, through quantitative easing and the capacity to print an unlimited amount of dollars, to fight off any deflationary concerns.
Nevertheless, the various outcomes of the global economy, as a result of the aforementioned risks, is decidedly unclear. The bulk of the portfolio, however, is positioned in shorter duration securities as we believe that it is not a matter of “if” but “when” yields on all fixed income securities increase. The Pender Corporate Bond Fund as of the end of June had a duration of 2.3 years.
As credit investors we are on the lookout for opportunities where there is little or no interest rate risk. We recently purchased a bond due in December of this year with a 7.5% yield. This bond is the next piece of debt due on the company's balance sheet and has cash coverage greater than 3 times; as well as having a market cap that is 5 times the size of all debt outstanding.
Over the first half of 2011 we have purchased bonds of four companies going through restructurings. While we believe each will provide strong results over a one to three year time horizon, an ancillary benefit is that they should express little correlation with the rest of the portfolio. One of these positions is the 11.375% secured bonds of Great Atlantic and Pacific, a grocery chain operator in the North Eastern US. While management is focused on maximizing profitability through rationalizing its store network and renegotiating key contracts the owned real estate which on average has been on the books for several decades provides the “great” cover for our bonds.
Matthew Shandro
June 30, 2011