Alternative Absolute Return – November 2022
The Pender Alternative Absolute Return Fund finished November with a return of 0.3%, bringing year-to-date performance to 5.1%.
November was one of the more difficult market environments for the Fund to navigate, as a market that is historically not cheap experienced sharp rallies. The high yield market was up for a second consecutive month, with the ICE BofA US High Yield Index returning 1.9%. All of these returns were driven by duration, as spreads compressed by only 8bp, with the “excess” return relative to government securities being -0.1%. The high yield market finished the month with an Option Adjusted Spread of 455bp and a yield to worst of 8.6%. Year to date, the market has returned -10.5%. Our view that the investment grade market offered better value than high yield was borne out by market performance in November, with Investment Grade spreads tightening by 24bp, while generating an excess return of 1.8% relative to government securities.
The Fund’s positioning did not change significantly in November. The Fund added several new investment grade and high yield exposures in both primary and secondary markets. High-quality high yield inched closer to presenting an attractive entry point before the US October CPI report was released, and we therefore made purchases in bonds backed by Hilton World Wide Holdings Ltd. (NYSE: HLT) and Videotron Ltd., a subsidiary of Quebecor Inc. (TSX: QBR.B), but did not significantly increase market exposure. In several instances, following significant capital appreciation, we accepted offers to sell as the securities moved from cheap to fully valued in our judgement.
The Fund participated in new issues in the high yield, investment grade and leveraged loan markets in November, adding positions in TransAlta Corporation (TSX: TA), Nielsen (private), Open Text Holdings, Inc. (TSX: OTEX) and Formula One (private.), among others. With the market now pricing five-year rates more than 100bp below the expected peak of the hiking cycle in Canada and the United States, floating rate loans are looking more attractive to us. There is a possibility that the market is not accurately reflecting the potential for rates to be higher for longer. Additionally, in some instances like Open Text, the floating rate loan priced at a significantly higher spread than the fixed coupon bond that was issued at the same time. We added a position in Four Seasons Term Loan (private), which recently priced a new seven-year loan at a spread of 325bp, which is greater than the bond spreads of their best comparable hotel management companies. We believe that Four Seasons occupies a particularly valuable market segment and has the support of a strong long-term sponsor since being taken private in 2007.
In the Fund’s Event Driven strategy, our holdings in Twitter, Inc. 5% 2030 notes paid out late in the month, and we also received a call notice for our holdings in Switch, Inc. 2028 bonds, which will be redeemed in early December. We identified some interesting combinations of credit and equity event driven positions in November that we look forward to actively trading in the months ahead. The combination of regulatory risk, rising rates and special mandatory redemption features have created some compelling arbitrage opportunities. Overall, our exposure to Event Driven opportunities declined significantly in November, but we suspect that volatility will likely increase our opportunity set in the months ahead.
The Fund’s short positions barely changed in November, as almost all our trading was on the long side of the portfolio. If the market continues to rally into December, we may look to top up our macro hedges.
The Fund finished November with long positions of 126.5%. 22.3% of these positions are in our Current Income strategy, 91.8% in Relative Value and 12.4% in Event Driven positions. The Fund had a -68.8% short exposure that included -25.3% in government bonds, -30.9% in credit and -12.6% in equities. The Option Adjusted Duration was 1.8 years.
Excluding positions that trade at spreads of more than 500bp and positions that trade to call dates that are 2024 and earlier, Option Adjusted Duration declined to 1.2 years. The duration figure includes several Event Driven positions where bonds we expect to be redeemed in the next five months are assigned durations of five years or longer.
The Fund’s current yield was 6.0% while yield to maturity was 7.2%.
November was a month that featured some violent macro moves, with the market clearly eager to accept a narrative that inflation is rolling over and a Fed pivot is coming. While the lower-than-expected CPI print in the US certainly was unambiguously good news, the market reaction appeared excessive to us. The market went even further at the end of November with a stunning rally following Federal Reserve Chair Jerome Powell’s event at the Brookings Institution. While Powell certainly made some comments that could have been interpreted as dovish, overall, the messaging was balanced and included commentary on the labour market that could have been construed as hawkish. Ultimately, the market only heard what it wanted to hear and ripped higher into month-end.
With high yield spreads about average compared to the past decade, despite a heightened risk of a recession over the near term, we see no reason to chase market momentum. If the market rallies in December, we would expect to lower our market exposure into strength.
It is the time of year when many sell side strategists and economists publish forecasts. We have been struck by how much consensus there is on the path of policy rates in 2023. What is particularly remarkable is how many forecasts match exactly what is priced into markets, with 50bp of cuts expected from the Federal Reserve in the second half of 2023. Strategists are validating market pricing despite the Fed itself stating that it does not expect to cut policy rates over the near term. A year ago, the market was pricing in a policy rate of just over 0.5% following the November 2022 FOMC meeting. While we would not expect another year where market pricing ends up being more than 300bp off, the chance that market pricing turns out to be exactly correct is unlikely in our view. Our best guess is that if there are 50bp of rate cuts in late 2023, it will be due to a weak economy, and risk premiums will be higher than they are today.
We will adjust our positioning in response to both prices and incoming information. Despite a market that is not cheap at a high level, there are individual pockets of value where securities are mispriced compared to their fundamentals and peer group.
Justin Jacobsen, CFA
December 7, 2022
 Class F of the Fund. Other classes are available. Fees and performance may differ in those other classes.
 Based on figures from the ICE BofA US Corporate Index