Manager’s Commentary – Geoff Castle – January 2016
The Pender Corporate Bond Fund ended the month of January with a decline of 0.78%*. While this performance was better than most funds in the category, the negative performance was nevertheless disappointing, coming on the heels of a difficult 2015. A gradual lower drift across all classes of holdings was observed, with particular weakness in the bonds of Niska Gas Storage and Millar Western Forest Products, which are two of the longer-dated maturities held in the Fund (although we expect Niska’s acquisition by Brookfield to be completed before the end of 2016, which should result in repayment of the bond principal at par). Partially offsetting these declines was strength in a few credits such as SpeedyCash, Toys R Us and our holding of short maturity Teck Resources notes. Our closed-end fund holdings were also weak in January, although they have rebounded recently.
Big Picture – Challenge and Opportunity
The downdraft in prices of high yield bonds continued unabated through the first month of the year. In addition to the much discussed impact of falling commodity prices on bonds of resource company issuers, we observe several other forces at play that create challenges. The first of these forces is a continuing cycle of downgrades from rating agencies that result in mandate-driven selling of bonds out of investment-grade funds. Another factor has been industry-wide net redemptions from high yield credit funds and ETF’s. A third factor has been the effective closure of the high yield market to new debt issuance. Actual operating performance of issuers was fairly steady outside of the commodity complex, but this did not prevent many bonds from being impacted by the factors above.
Our weighting of approximately 15% in cash at month-end, given the context of the market, did not hurt us as bond prices fell in general. However we have been very active in the beginning of February in deploying capital in attractive risk/reward situations. We are focussing on near maturities where we do not need to rely on the bond market for liquidity.
Volkswagen was one recent example of a case where we saw an immediate and clear path to principal repayment. Punished back in November when the automaker’s emissions scandal blew up, short-term Volkswagen notes have since traded with a spread of more than 2.5% over Canada bonds. The wide spread has persisted despite strong credit supports such as more than $50B equity market cap under the credit, and a large available credit line to fund repayment of short maturities. In normal circumstances, the VW issue’s spread would have collapsed as maturity approached but, in the current market, wide spreads sometimes hold right to the day of maturity. Our February 1 Volkswagen bond matured on schedule and we continue to invest in other near-term Volkswagen maturities.
A higher-yielding example is our $5 million investment in the March 15, 2016 maturity of Chesapeake Energy. We believe Chesapeake management has ample available resources, and compelling institutional reasons, to repay this bond on maturity. That this bond traded at approximately 93 per cent of par value less than 45 days from maturity is more a function of the paralysis of the credit market at present than a statement of real default risk for this security. In all our conversations with the company and Wall Street credit analysts who cover the company closely, no one is expecting any other outcome than full repayment at maturity. The company has a total of $5 billion in cash and available liquidity, and this maturity is only $500 million. Nevertheless the bond is priced at such a level that its full payment at maturity (March 15) would imply a return of 1% per week.
Another recent investment was made in the prospectively called bonds of Corus Entertainment. Due to covenant restrictions in Corus Senior Notes, the closing of Corus’ recent purchase of Shaw Media requires a redemption of this issue at a “make whole” price. Although there is some uncertainty regarding the precise timing of the redemption, a call completed in the first half of 2016 would make our return on this investment more than 10% annualised.
A final example of a new holding is our position in bonds of Fage International. This company is the maker of one of the most popular brands of Greek yogurt in the United States and Europe. The company is growing strongly, and is adding capacity to meet demand in the United States. Its financial metrics are very sound, with comfortable 4x interest coverage, low debt factors and a healthy cash balance. We expect future rating upgrades on this credit from its current single B status. Consequently we expect our holding of this 2020 maturity to be called by the company sometime in 2017 and, in that event, the yield would be in the range of 8%.
We are finding many similar examples in the market. There are a great many companies whose short maturities are priced at very interesting yields despite their overwhelmingly strong ability to pay.
Positioning at Month-End
At month-end, the Fund sits with ample liquidity. Cash and bonds maturing in less than one year stand at 44% of total holdings. Yield to maturity in the Fund averages 8.2%. Current yield is somewhat lower at 5.1%. Average duration is less than two years. In a nervous market, we feel increasingly confident of delivering solid returns.
Geoff Castle
February 5, 2016
* F Class
* FTSE TMX Canada Bond Universe. Given the composition of the Fund at present this index, or other similar US high yield indices, are more reflective of the underlying pool of potential investments than the formal benchmark, the FTSE TMX Canada Bond Universe, with its significant weightings in Canadian and provincial government issues. The appropriate benchmark index for the Fund is currently under review.
