The Manager's Commentary - March 31, 2010
The current debate amongst investors, both equity and fixed income, is around the timing and magnitude of central bank interest rate hikes. The last time interest rates rose in the U.S. was when the federal funds rate went from 1% in June 2003 to 5.25% in June 2006. While we don’t necessarily believe that interest rates are set to embark on this type of trajectory (i.e. there is still significant slack in the economy) the Pender Corporate Bond Fund is positioned for this outcome.
Overall, the portfolio is under three years in duration. However, the bonds in the fund that are greater than three years in duration either have an above average coupon, which helps to protect the bond investor from rising interest rates, or possess a catalyst with upside / downside protection. As always, let’s point to an example to highlight this.
A bond currently positioned in the Top 10 of the fund is the Linn Energy 11.75% bond, due May 2017. Linn Energy was created seven years ago by oil & gas veteran Michael Linn. He saw the opportunity, which was driven by the increase in oil prices, to purchase stable long-term producing oil & gas reserves from companies that were becoming more focused on exploring their unconventional (i.e. costly) reserves. Call Michael boring, but this is exactly the kind of mindset we like to see a CEO, operating in a capital intensive industry, possess. Linn has a reserve life in excess of 20 years and cash flow that covers the interest on the debt almost four times.
The 11.75% bonds were the first bonds the company issued and were issued during a period, the spring of 2009, when corporate bond spreads had never been higher. The combination of being a first time issuer during the worst credit market in a generation resulted in this attractive bond being issued.
The majority of Linn’s production is hedged over the next three years which takes you beyond the first call date of the 11.75% bonds. Due to its high coupon the company may want to refinance. So while on the surface these bonds appear to be of “longer duration”, the higher coupon, potentially higher oil prices and credit ratings three years down the road make an early call a strong possibility. While we don’t necessarily want this outcome, it certainly helps you sleep at night knowing this bond has lots of forces working in its favour.
Matthew Shandro
March 31st, 2010