PIM: Diversified Income Portfolio - November Update

Paul Borisoff - Dec 03, 2019
The Diversified Income Portfolio* was up 4.5% in November – and is now up 15.6% in 2019. In comparison our benchmark was up 1.9% in November – and is now up 14.4% year-to-date. Over the last twelve-month period the portfolio is up 12.6%..

The Diversified Income Portfolio* was up 4.5% in November – and is now up 15.6% in 2019. In comparison our benchmark was up 1.9% in November – and is now up 14.4% year-to-date. Over the last twelve-month period the portfolio is up 12.6% compared to our benchmark which was up 12.8%. Note, all long-term performance numbers for the Diversified Income Portfolio (3-year, 5-year, 10-year, and since inception) remain significantly above our benchmark.

* These returns are reported as a composite, time-weighted, rate-of-return (gross of fees, net of transaction charges) for all accounts in this mandate. Long-Term Returns/Benchmark Numbers will be reported in our Quarterly Updates. Past performance may not be repeated.

Market Update

After correcting slightly in October, the Canadian bond market (FTSE/TMX Canada Universe Bond Index – 60% of our benchmark) moved 0.5% higher in November – leaving it now up 8.2% in 2019 and up 9.6% over the last twelve-month period. Note, at month-end the 10-year Government of Canada Benchmark Bond was yielding 1.47% - and the iShares Core Canadian Universe Bond Index ETF had an average weighted yield-to-maturity of 2.10% (2.0% after deducting the ETFs management expense ratio). As pointed out in the past, bond yields will have to move significantly lower again – from current levels - for returns to approach recent historic returns. If yields move higher from current levels bond prices will be moving in the opposite direction – lower.

The S&P/TSX Composite High-Dividend Total Return Index (40% of our benchmark) had another good month in November – returning 4.0% - which left it up 24.1% 2019 and up 17.0% over the last twelve-month period.

The Bank of Canada will be making a rate policy statement on December 4th – followed by the US. Fed on December 11th. Consensus expectations seem to be that both Central Banks will now remain “on-pause” for the time being - regarding any near-term policy rate cuts. Note, any potential rate hikes are fully off the table for the foreseeable future in our opinion.

We continue to believe that the current low rate environment is becoming entrenched in developed economies around the world, and as a result, quality “income positions” should continue to be in demand and deliver attractive returns.

Portfolio Update

As per our November 6th update FuelCell Energy (FCEL) announced a new agreement with ExxonMobil that day to further develop their joint carbon capture technology (expected to be worth up to $60 million) and also a new 8-year Strategic Corporate Loan Facility with Orion Energy Partners for $200 million. Regarding our FCEL Preferred “B” shares, we received in USD $37.97 per share in cash into client accounts on November 15th – and the company is now fully caught-up on all outstanding dividend obligations . On November 25th, FCEL announced that they had completed the initial $80 million draw of their new Orion facility – with the funds to be used to support the execution of certain projects within their $2 billion project backlog. The $120 million balance of the Orion facility will be available over the next 18 months to invested in strategic growth, and to provide working capital as needed: “Our investment in FuelCell has been grounded in an extensive due diligence process,” said Gerrit Nicholas, Co-Founder and Managing Partner of Orion Energy Partners. “Over the past several weeks, we have gone deeper on the Company’s business strategy, operating plans, various projects, and extensive, $2 billion backlog. Coming out of this review, we are optimistic about FuelCell’s future and look forward to our continued close partnership as FuelCell Energy’s strategic transformation takes hold.”

The “B” shares closed the month at USD $239.00 per share – up from USD $114.95 on October 31st – which is still a little lower than where they started the year (they closed at $260.00 per share on December 31st, 2018). Going forward this investment is expected to deliver ~21% per year in cash ($50 dividend/$239 per share) – with the next $12.50 dividend expected to be paid out on February 15th - for shareholders on record as of February 1st, 2020. Note, significant additional upside on the “B” share price is also expected – as even at $500 per share the “Bs” still yield 10% per year - in perpetuity. Originally issued at $1,000 per share in 2004 the “Bs” traded in the $450 to $650 per share range as recently as 2014 – and in our opinion, the company is in much better shape today – than at any point in its history.

Recent Portfolio Changes

We made a number of changes to the portfolio in November – including taking advantage of various fixed income debenture opportunities (convertible and non-convertible) - which left our model portfolio with a significant increase in cash – now a little over 15% a month-end:

  1. On October 31st, CargoJet Inc. announced the early redemption of their 4.65% 31DEC21 $58.65 convertible debenture (they would be redeeming it at par value (100) on December 31st, 2019 – unless holders sold or converted it to stock prior to that date). This was an ~ 4% portfolio position as of October 31st – that we last added to in March 2018 at a price of 125.50 – and had an average cost of 111.64 in the model portfolio. Due to this “forced conversion” we sold 2/3rds of our position at 169.71 on November 4th – which locked-in a ~52% gain on this portion of the position - excluding coupon interest payments. We then converted the remaining 1/3rd of our position to CargoJet shares at $58.65 – which was a 1.3% portfolio position at $99.61 per share at month-end. Note, we also continue own a 0.8% position in a CargoJet 5.75% 30APR25 debenture (non-convertible) which we added to the portfolio in April this year at par value (100) – bought because we like the company’s outlook, credit quality, etc. – which closed the month at 102.78. This non-convertible debenture is similar to our new AG Growth International Inc. 5.25% 31DEC25 debenture highlighted below.
  2. We bought a new 0.8% position in an AG Growth International Inc. 5.25% 31DEC25 debenture on the market on November 28th at 99.65 – which worked out to a 5.33% semi-annual yield-to-maturity. AG Growth is a Canadian-based manufacturer of seed, fertilizer, grain, feed and food handling, blending, storage and conditioning equipment and has a market capitalization of ~$860 million. This $75 million debenture issue was recently listed onto the TSX on November 19th (issued at par value 100.00) – and closed the month 100.10.
  3. We increased our Tidewater Midstream and Infrastructure Ltd. 5.50% 30SEP24 convertible debenture from 2.3% of the portfolio to 3.0% at a price of 98.36 on November 20th (a 5.89% semi-annual yield-to-maturity) – which closed the month at 99.50.
  4. We increased our Just Energy 6.75% 31DEC21 convertible debenture to 4.8% of the portfolio from 4.2% at 78.37 (a 19.8% semi-annual yield-to-maturity) – which closed the month at 80.01. continue to believe the company will be sold at some point over the next few months.
  5. On the “sell side” we sold our small (1.2%) position in Vermillion Energy Trust at $19.03 in November (our cost was $27.74 per share) – off-set a little by $2.53 of dividends received over the last twelve-months. The proceeds were directed into the convertibles highlighted above – which have a higher degree of certainty regarding their expected returns.
  6. We also sold our equity position in the American Hotel Income Properties REIT at various prices in November – which resulted in a slight positive net return (including distributions) for most clients - after holding it for a number of years. This has definitely been one our more disappointing and frustrating investments in the portfolio. Recently, we have grown increasingly concerned that the company may cut their distribution at some point over the next few quarters - if there is not a significant improvement in their financial results - soon. While a distribution cut would actually be good for the company – and may attract institutional – we fear that it could result in a significant move lower in the unit price as most of the company’s equity is currently held by retail investors – in large part due to the large distribution yield it provides. do though continue to like the outlook for their short-term June 30, 2022 5.00% USD convertible debentures – and increased the portfolio’s position to ~4.0% from 2.0% at a price of 98.53 – which equates to a 5.61% yield-to-maturity. Also, we are looking at trying to secure a new position in the NHT Hospitality Trust which is currently in the market to raise $50 million USD via a public financing (expected to provide a dividend yield in the 6.0% to 6.7% range) – with the sponsoring company planning to invest $126 million USD into the company on the same terms via a private placement – to own ~77% of the company. Similar to American Hotel Income Properties the NHT Hospitality Trust owns and is planning to acquire hotel properties – but with an emphasis on renovating and repositioning properties to significantly improve their returns. Note, the sponsoring company also manages the $1.2 billion NYSE listed NexPoint Residential Trust- which has performed very well since its 2015 IPO.

Summary

At month-end we had ~15.3% in cash and our convertible debenture exposure was approximately 37.3%. Total Cash and Fixed Income exposure including our two 3rd party specialty fixed income manager position at month-end was ~73.0%.

We continue to strongly believe that the portfolio’s composition and flexibility offers a substantially improved risk/reward trade-off compared to an “income portfolio” relying only on government bonds and pure stock market exposure to drive returns and income.

As always, please do not hesitate to contact me if you have any questions.

Sincerely,

Paul J. Borisoff BBA, CIM, FCSI, AIFPTM, RIAC
Senior Vice President, Portfolio Manager
Senior Investment Advisor