Pender Corporate Bond Fund – Manager’s Commentary – May 2018
The Pender Corporate Bond Fund returned 0.8% in May, delivering steady progression amidst a somewhat turbulent market picture.
Strong performers for the Fund in May included our position in debt units of Gran Colombia Gold, which rallied strongly on good earnings results and the company’s successful completion of an anti-dilutive exchange of old convertible notes into new units of notes and warrants. In addition, Aceto Corp convertible notes, acquired in April, gained over 10% in the month as market participants viewed more positively the prospects for the pharma ingredients company’s deleveraging effort. Our recently added position in bonds of Eldorado Gold also performed well as progress was made relating to permitting for Eldorado’s proposed mining development in Greece. Toward the end of May, we saw a rally in a number of US Municipal bond closed-end funds that were acquired earlier in 2018.
The gains above were offset, to a degree, by weakness in a few select high yield issues, such as PHI Inc, as the helicopter operator disappointed investors on the timing of a debt refinancing, allowing its 2019 notes to become a current liability. We are confident in the asset value underpinning PHI and believe this strength, combined with improving operating performance, will result in a successful refinancing of our 2019 bonds in due course. Other areas of weakness included our small (1.5%) exposure to closed-end funds in emerging markets debt, where an ongoing sell-off appears to have created a fairly good risk-reward situation and large closed-end fund discounts.
Yes, Virginia, There IS an Alternative
In the aftermath of the financial crisis of 2008-09, investors without much tolerance for short-term losses – call them ‘savers’ – were faced with a rather unappetizing menu of choices. They could either accept extraordinarily small yields on deposit instruments or short term high-quality credit, or they could explore a suite of much more uncertain alternatives. Principal among the options that savers considered under the low interest rate regime were: a) much longer duration government bonds offering marginally higher yields, b) lower quality credit, or c) dividend paying equities. The trade became so common as to pick up a nickname, ‘TINA’, short for “There Is No Alternative,” because the usual alternative to risk-bearing positions, cash or near cash securities, paid effectively nothing.
Times have changed. In early 2016 the 30 year Government of Canada bond yielded over six times the Canadian T-bill rate, now its advantage is less than two times. In early 2016 the S&P 500 dividend yield was over eight times the US T-bill yield, now both yields are approximately equal. In early 2016 US high yield credit’s advantage over T-bill yields was more than 30 times, now it is just more than three times. Compared to extending duration, accepting equity risk, or accepting credit risk, the alternative of just rolling cash-like instruments stands as a far more competitive alternative than it was. Cash is trash no more.
We are not calling a market collapse. However, it may not be unreasonable to expect that some of the more difficult-to-justify prices in the credit markets may re-adjust in order to align with the newly competitive levels of the risk-free cash interest rate, as savers return to the lower risk territory. And so, we have been applying a much more stringent standard in accepting credit risk. And where new “yieldy” credit positions may not be justified through copious excess liquidation value protection, we have been happy to add weight to the least risky issuers in the Fund, or even into the shorter term obligations of the Government of Canada.
It may be months, perhaps years, before we see fat pitches in riskier credit such as were abundant in 2015-16. In the meantime, running relatively low risk, relatively short duration should allow us to earn a reasonable return while protecting capital. Our strategy, beyond this simple core, continues to favour well-protected positions with a degree of “room to run” upside in areas such as discounted closed-end funds, currently out-of-the-money convertible notes and credit positions that we believe to be unfairly discounted.
In May, we added a significant new position in the 2022 notes of anti-virus software producer Symantec Corp. Symantec shares and debt securities have been under pressure recently due to a controversy relating to management’s preparation of certain non-GAAP financial disclosure items. While these items may indeed affect, on the margin, Symantec’s $12 billion equity valuation, we find little change in the company’s very solid credit profile. The company enjoys a consistent and largely recurring base of customers, a healthy cash balance and strong underlying cash generation. Consequently, Symantec notes bearing a yield in excess of 4.5% seem attractive in the context of a one-year default probability that we estimate at being less than 0.2%.
Also in May, we continued to add Municipal credit to the portfolio, establishing a position in the December 2019 notes of the City of Vancouver. We like the credit profile of our home city, due to its low leverage, growing tax base and, in the unlikely event that credit deteriorates within this rather short maturity window, the City’s ready supply of potentially disposable property. Recently rated “AAA” by S&P and “Aaa” by Moody’s, we view the nearer term maturities of Vancouver as relatively safe yield “pickups” with spreads more than 30 basis points above the Government of Canada.
On the somewhat more aggressive side, we added a position in the discounted January 2019 USD notes of Bermuda-based shipping operator Golden Ocean Group Ltd, yielding approximately 6%. We believe the full cash repayment of this small front-end maturity (under $200 million), which has already been subject to significant recent repurchases by the company, and which sits atop more than $1 billion of equity market capitalization, to be a high probability event. Ample cash balances of more than $325 million further support the credit.
The Fund yield to maturity at May 31 was 6.2% with current yield of 5.0% and average duration of maturity‐based instruments of 2.5 years. There is a 1.4% weight in distressed securities purchased for workout value whose notional yield is not included in the foregoing calculation. Cash represented 1.7% of the total portfolio at May 31.
Geoff Castle, June 5, 2018