Manager’s Commentary – Geoff Castle – February 2017
The Pender Corporate Bond Fund returned 0.8% in February. We view this return as reasonable for the period, given the lower credit spread environment, combined with our own more cautious risk positioning. Our February returns were roughly evenly split between interest accrual and capital appreciation. On the capital side of things, positive moves by our positions in the discounted bonds of Grupo Famsa, Jakk’s Pacific Holdings and Restoration Hardware were offset, to a degree, by a decline in Global Brokerage Inc. notes (formerly FXCM), as that company was impacted by regulatory action.
February saw a change in the direction of some key long-term government interest rates, with both longer-dated US Treasuries and Government of Canada bonds trading to slightly lower yields. Credit markets were a little stronger as the major high yield indices continued to tighten their spreads to US Treasuries. In general, we view North American credit markets as now having moved towards the expensive side of the range. In response, we have begun to add more high quality credit to the portfolio mix, while maintaining relatively short duration.
The downside of higher credit quality is lower expected return, and we may be foregoing some short term earning opportunities with this stodgier stance. Ignoring any expected gains from workout or equity securities held by the fund, yield to maturity has dropped to 6.1%, down from a level of 7.5%-8.5% where we were positioned for most of the past 18 months. The shift in emphasis is intentional as we transition from a “grow and protect” orientation towards “protect and grow.”
The upside in reduced risk positioning is the potential to revert to a more risk accepting stance at a future point when spreads are wider and when we believe the odds for outsized returns are once again heavily in our favour. This may happen on a company-by-company basis, or it may be a market-wide event. However, we are building our reserves of dry powder to capitalize on opportunities as they arise. When you have ample cash and near-cash securities, volatility is your friend.
We recently added small weights in the credit positions of Orexigen Therapeutics, which markets a novel weight loss drug, and Novavax Inc, which is relatively far along in developing vaccines for preventing respiratory illnesses that are linked to significant levels of morbidity in the United States and around the world. Once balance sheet cash is taken into consideration, we believe there to be much less capital risk in the debt of these issuers than is implied by credit prices, which places the notes of these issuers at less than half of par. The outcome in these cases is uncertain, which is why these positions are rather small in the context of the Fund, but we see plenty of scenarios for materially higher workout.
As commodity-related credit has gained materially over the past year, we view our investments in depressed life sciences issuers as attractive replacements for distressed oil bonds that have performed so well within the higher risk band of the Fund. Energy and materials, a big driver of returns in 2016 for the Fund, now represents just over 10% of our assets.
For full standard performance information, please visit: http://www.penderfund.com/funds