September 7, 2021

The Manager’s Monthly Commentary – August 2021

Written by Geoff Castle

The Pender Corporate Bond Fund returned 0.7%[1] in August in a mixed market environment in which credit spreads tightened in the face of somewhat higher sovereign yields.

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The Fund’s return was bolstered by particularly strong performance of some credits in the shipping industry, as persistently high charter rates helped optimism return to this once moribund sector. Our positions in credits of Eagle Bulk Shipping Inc., Seaspan Corporation and SFL Corporation Ltd. all posted gains. August also saw a good rebound in some work-out positions which had suffered through the summer doldrums, including FTS International Inc., McDermott International, Inc., and the helicopter fleet operator PHI Group, Inc.

The Fund was also favourably impacted by our participation in a balance sheet restructuring involving Intercept Pharmaceuticals, Inc. In exchanging our deeply discounted senior unsecured convertible notes for more attractive first lien convertible notes, we were able to post a double-digit percentage gain in the value of this position. Moreover, we were also able to lower significantly our strike price for potential future conversion into the deeply oversold stock. We like Intercept’s chances of surprising pessimistic investors as this liver therapy company approaches a catalyst rich 2022.

Offsetting the above strength, to a degree, were a few weaker positions including the first lien bonds of National CineMedia LLC, which declined on fears relating to the Delta variant’s impact on re-opening activity. We also saw a decline in the convertible notes of Esperion Therapeutics, Inc. Despite fairly robust growth in revenue from its recently approved cardiovascular drug, Esperion’s 4% convertible notes fell to the mid 60’s percent of face value, implying a greater than 15% yield to a 2025 maturity. We view Esperion’s capital structure as being significantly undervalued and used the sell-off to add weight in this position.

Portfolio Construction – Raising a Glass to the Red Lion

In 1933, Albert Tarling, the innovative head bartender at London’s popular Café Royal, conducted an experiment. Starting with a bottle of sugary sweet Grand Marnier, Tarling mixed two parts of the liqueur with one part each of fresh lemon juice and orange juice. To his delight, the tartness of the juices offset the excessive sweetness of the Grand Marnier. He then topped his concoction with another two parts of Booth’s Gin and shook the mix over ice.

The resulting cocktail, dubbed the Red Lion, was a sensation! Can the drink be fairly credited with bringing Britain out of the depths of the Great Depression? Well, that is perhaps an exaggeration. However, the judges at that year’s British Empire Cocktail Competition were sold, recognizing Tarling’s Red Lion with the coveted 1st Prize.

Now the jobs of bartending and managing a portfolio are rather different. A top bartender needs to possess a ready knowledge of hundreds of drink recipes, all the while maintaining the demeanor of a charming and chatty everyman. This is hardly the resume of a modern capital allocating whiz kid. However, with respect to the blending of ingredients and the mixing of securities, we do tip our hat to the genius of Tarling for his essential insight. In seeking to improve his product, he found a way to oppose an extreme trait of an ingredient without negating its more pleasant qualities.

In the same way, this Fund has sought to combine various elements of credit markets for the purpose of enhancing the overall user experience. At the base of this Fund is a group of wide-spread credits which appear to be “on the rails” to near-term repayment. To these “cream puff” -type opportunities we add many securities that are likely to follow more winding price paths. But the winding paths need not all be the same. Floating rate securities blend to counter fixed rate. Technology company convertible bonds walk a different path from those of precious metals miners. Distressed bonds offset, but do not negate, investment grade bonds.

The art of portfolio construction, as Harry Markowitz laid out in his 1959 work, Portfolio Selection:  Efficient Diversification of Investments, involves understanding the risk-reducing value of offsetting investment drivers. “To reduce risk,” said Markowitz, “it is necessary to avoid a portfolio whose securities are all highly correlated with each other.” For this line of thinking, Markowitz ultimately received the Nobel Prize in economics.

So, are we disciples of the Nobel laureate, Markowitz, or simply mates of Tarling, the talented barkeep? Either way, we will raise a glass to the ameliorating effect that multiple asset classes can have within an income portfolio. And cheers to both of our heroes!

New Positions

In August we added significantly to our position in the first lien bonds of Ayr Wellness Inc., priced to yield over 8% to a 2024 maturity. A purveyor of medical marijuana in five US states, Ayr has a wonderful credit profile, with more net working capital than total debt. Debt-to-EBITDA is a skinny 1.8x and the company’s market cap of $1.5B dwarfs this $137M bond issue. We estimate one year default probability for Ayr at less than 0.05%.

Also in August, we established a position in the secured credit of widely followed AMC Entertainment Holdings, Inc. While the equity part of this capital structure has reached “meme” status, some equity investors might be surprised to see AMC’s 1st lien term loan priced near 88¢ on the dollar to yield over 6% and AMC’s 2nd lien 12% notes priced to yield 13% to a 2026 maturity. AMC management has taken advantage of recent extraordinary equity valuations to issue over $2B of equity, giving the company enough fresh capital, in our opinion, to see the company through to free cash break-even in the post-pandemic world. Valuing the company based on an eventual recovery to 2019 activity levels, we see an ample valuation cushion below AMC’s secured debt.

Finally, we established a position in the 2028 “green” bonds of Atlantica Sustainable Infrastructure PLC. Atlantica is a UK-based operator of a portfolio of renewable energy assets located around the world. We like the strong cash generation profile of Atlantica’s diverse asset base, as well as the implicit credit support that comes from Atlantica’s over 40% ownership by Algonquin Power & Utilities Corp. Atlantica’s BB+ rated notes were priced recently to yield approximately 3.3%.

Fund Positioning

The Pender Corporate Bond Fund yield to maturity at August 31 was 5.1% with current yield of 4.9% and average duration of maturity‐based instruments of 3.9 years. There is a 2.0% weight in distressed securities held for workout value whose notional yield is not included in the foregoing calculation. Cash represented 1.1% of the total portfolio at August 31.

Geoff Castle
September 7, 2021

[1] All Pender performance data points are for Class F of the Fund. Other classes are available. Fees and performance may differ in those other classes.