Manager’s Commentary – Geoff Castle – March 2017

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The Pender Corporate Bond Fund returned 1.8% in March. This was a good result, especially given the general weakness in credit markets during the period. The Fund benefited from strength in a number of discounted credits including Restoration Hardware, whose bonds rallied on an improved earnings outlook. Also contributing were our position in Orexigen Therapeutics, whose weight loss drug showed significant growth in prescription activity, and Enernoc, with the demand-side management electricity firm announcing a strategic review that may result in the sale of the company.

Some New Positions
While markets, on average, have seen relatively tight spreads in 2017, the month of March saw a decent amount of volatility and good entry points in certain credits. In the lower risk, most liquid portion of the Fund, we were able to source a position in the 2023 bonds of Masonite International, yielding more than 5%. Masonite, which makes and distributes doors used in residential and commercial construction, is very well capitalized, with over a $3 Billion equity market cap sitting beneath its $600 Million bond obligations. The company’s one year Bloomberg default risk probability was recently 0.04%, a level similar to some of the highest investment grade credits.

We also continued to find opportunities in the Canadian preferred share market, adding some series of BCE rate-resets. We believe the BCE ‘Series O’ preferreds, with a recently reset yield of 4.6%, represent a far more attractive exposure to this issuer than its 2.5% yielding corporate 5 year bonds. On a tax-equivalent basis, dividend yields on BCE preferred O’s are more than twice the level of the company’s bonds. A par call for this issue seems possible in our view, which represents a potential opportunity for an additional 8% capital appreciation.

In the distressed area, we established a position in the convertible notes of Primero Mining Corp, which has endured numerous difficulties over the past year. We believe the company’s high grade orebody at San Dimas is an asset significantly undervalued by the market and that either a return to profitability or an acquisition of the company by a senior producer are highly possible outcomes. With convertible notes trading in the 50’s, we consider investors to have been too pessimistic on this credit which has the potential to be worth as much as par.

Where is the Puck Heading?
Now that we are approaching hockey playoff time, it is worth considering the Gretzky question for the bond market – where is the puck heading? Widespread opinion, if one believes investor surveys, has flipped. While last year the loudest voices in credit were declaring positive yields as an endangered species, now we are supposedly at the dawn of an age of reflation. We weren’t sure at the “bond bull” sentiment extreme in 2016 and we aren’t sure in 2017 now that sentiment is diametrically opposite.

While sentiment is not tangible, prices are very real. High quality bond prices, particularly in US dollar credit are much more attractive now than a year ago. The significant increase in the yields of high quality issuers through the 3-6 year tenors has surprised us. Issuers who had five year maturities yielding between two and three percent are now seeing those same bonds quoted at between four and five percent. Not a huge difference in the scheme of things, but the speed at which we have seen the market move strikes us as not being completely supported by the small degree to which the Yellen Fed has moved short term rates.

Our approach has been to edge slightly longer in duration as there has been better compensation for doing so. And where we have extended tenor, we have done so in generally higher quality issuers. We still occupy a relatively short-term positioning, curve-wise, but we need to consider where the puck may eventually go in the bond market. We don’t see such a high probability of rapid rate rises that we are willing to entirely forego the higher yields available in some 3-6 year maturities of high quality issuers.

There are certain markets we are watching to get a better sense of how business prospects are likely to develop through the balance of this year. Among these are residential housing in Canada and also automobile markets in the United States. It is not clear in either case that the generally benign trend of the past few years has reversed, but both of these are sending off potentially troublesome signs, with the recent negative credit watch placed on Canadian sub-prime mortgage lender Home Capital Group, and the sharp recent decline in American used car prices being examples. Our move to increased credit quality in the portfolio has been towards entities well-capitalized enough to easily withstand recessionary times. We may be unduly cautious in this move, but we find it better to be a few months or quarters early than a day late.

Portfolio Positioning
The Fund yield to maturity at March 31 was 6.5% with current yield of 4.8% and average duration of maturity‐based instruments of 2.2 years. There is a 4.1 % weight in distressed securities purchased for workout value whose notional yield is not included in the foregoing calculation. Cash, temporarily elevated due to month-end maturities, was 10.3% of the total portfolio at March 31 and has since returned to normal levels.

Geoff Castle
April 3, 2017

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