PIM: Diversified Income Portfolio

Paul Borisoff - Jul 05, 2018
The Diversified Income Portfolio* was down 0.8% in June – leaving the portfolio up 1.3% in 2018 – and 6.3% higher over the last twelve months. In comparison, our benchmark was up 1.2% in June –  leaving it down 0.4% in 2018 – and 2.1% higher over the

PIM: Diversified Income Portfolio – July 5th, 2018

 

The Diversified Income Portfolio* was down 0.8% in June – leaving the portfolio up 1.3% in 2018 – and 6.3% higher over the last twelve months. In comparison, our benchmark was up 1.2% in June –  leaving it down 0.4% in 2018 – and 2.1% higher over the twelve months.

 

* 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.

 

The Canadian bond market (FTSE/TMX Canada Universe Bond Index) was up 0.6% in June - pushing it back into positive territory in 2018 (up 0.6%) – and leaving it up 0.8% over the last year. The S&P/TSX Composite High Dividend Index (40% of our benchmark) moved up 2.2% in June as it benefited from both stronger bond prices and higher energy prices. While this index is still down 2.0% in 2018 it is now up 4.0% over the last twelve months.  

 

The Trump administration’s decision to engage in trade wars with most of the country’s major trading partners led to increased volatility in June – and growing concern about what the ramifications will eventually be for the U.S. – and the countries targeted by them. In this environment of increasing uncertainty, it was therefore not surprising to see defensive investments gain favour in June – as “safety” and “liquidity” became more important to investors.

 

With the increased level of “jitteriness” last month a few portfolio positions moved lower on what we believe will be short-term pullbacks. A few positions also moved higher on company specific positive news. Overall, we expect to see solid returns over the balance of 2018 as many positions firm-up off what we believe are “over-sold” levels. A few highlights below:

 

Recent Portfolio Changes – and Highlights:

 

We added a new convertible debenture position to the portfolio in June – a new 0.8% position in a Crown Capital Partners Inc. 30JUN23 6.00% $13.70 issue we purchased at par value (100) via a financing transaction. Crown is a Canadian based specialty finance company that originates, structures and provides tailored special situation and long-term financing solutions to a diversified group of private and public mid-market companies in the form of loans, royalties and other structures.

 

Our Enbridge position moved up 16.7% in June on recovering energy prices, and an important ruling from the Minnesota Public Utilities Commission on June 28th approving their Line 3 Replacement program. At quarter-end Enbridge closed at $47.00 per share (5.7% yield) and still offers considerable further upside over the next year in our opinion. The current consensus one-year price target was $52.29 as of month-end (Bloomberg).

Moving in the opposite direction our Crius Energy Trust position was down 13.0% in June on a downgrade from the Canaccord Genuity analyst on increased concerns related to margin pressure (he lowered his price target to $7.50 - down from $9.00 per unit). Note, there has been no change from the other four analysts that cover the company. RBC Capital Market and National Bank Financial currently both have a $10 price target on Crius, while Desjardin Securities and Raymond James are still at $11. As mentioned last month Crius has recently been under pressure from activist shareholders to make changes required to drive the company’s valuation higher. The Board of Directors subsequently formed a Strategic Operating Committee - which we believe may result in the company’s solar business being sold shortly – and possibly the entire company. At quarter-end the units were yielding 12.4% via monthly distributions – and we would not be surprised if the current weakness accelerates some strategic changes at the company.  

 

Back to positive surprises. Our largest convertible debenture exposure in the portfolio is to our two Tricon Capital Group positions. On June 27th Tricon announced a $2 billion joint venture with two leading institutional investors (one of the largest sovereign wealth funds in the world and one of the largest state pension plans in the U.S.) to acquire over 10,000 single family rental homes in the U.S. sunbelt. Note, as this announcement happened near the end of the month Tricon’s share price ended June at $11.03 per share – down slightly from $11.06 at the end of May (but significantly higher than where the shares were trading at prior to this news). While our 31MAR22 5.75% USD $10.46 convert closed June at $105.51 – down from 107.20 – at the end of May – our 31MAR20 5.60% $9.80 convert moved slightly higher to 116.00 from 115.42 the month prior. In our opinion there are several significant “positives” for Tricon’s outlook because of this development - which we expect to see reflected in a significantly higher share price over the next few years – and translated into further gains on our convertible debenture positions.   

 

Note, Tricon traded down to $10.40 earlier in June - prior to firming up on the news outlined above near month-end. The weakness in the first part of June was somewhat typical for many Canadian mid-cap dividend paying companies last month– many which continue to trade near the low-end of recent ranges.

 

Our FuelCell Energy B Preferred position also did not help our return in June closing at $340 USD per share down from $397 at the end of May (-13% including currency). At quarter-end this position was up 13.8% from our adjusted cost based and was yielding ~14.7% – and we fully expect to see the prefs back in the $400+ range shortly (face value $1,000 - which can be triggered via redemption in certain circumstances). The market reactively negatively when the company announced an At the Money “ATM” financing registration on June 14th right after being awarded 22.2 MW of fuel cell projects in Connecticut (which took their contracted and “awarded” backlog to ~$1.9 billion). FCEL’s $50 million ATM allows the company increased flexibility to quickly raise additional cash, possibly on share price strength, to support the expected growth of the business over the next few quarters as “awards” are converted to “backlog.”  While common shareholders might have misplaced concern regarding shareholder dilution – it is hard to see how these developments can be interpreted negatively for the preferred shares. In the same light, FCEL announced on June 20th that POSCO Energy (their Asian distribution partner) has decided to exit the fuel cell business in 2018 – which the market took as another reason to sell down FCEL in the market. This should not have been a surprise as a decision has been pending since late 2016 – and FCEL previously took over the direct marketing of their fuel cell products in the Asian market in March of 2017. When this issue gets settled FCEL will either have a new partner to serve the Asian market (FCEL has consent rights) - or the company will end up with the service contracts for POSCO Energy’s current 180 MW installed base with 15 utilities.   These service contracts include 300 MW of fuel cell module replacements over the next fifteen years (for perspective FCEL has been currently producing fuel cell modules at a 25 MW per year run-rate in the U.S.– which I expect to move to a higher level once recent “awards” move to “backlog”). Note, I continue to also like the outlook for the common shares – which rank behind the Preferred Shares regarding security. Of interest FCEL reported on June 28th the largest Insider purchase of common shares in approximately three years (FCEL’s Chairman of the Board bought 152,000 common shares).  

Finally, we highlight Insider Buying again – this time on our American Hotel Income Properties position - which moved down to $8.32 per unit at month-end – from $8.46 the month prior.     We recently attended a management corporate update and were significantly encouraged that the company’s financial results are on track to look a lot better over the next few quarters - which we expect to translate into a much higher unit price. We highlight that the CEO elected to take all his 2018 compensation in the form of equity in the company – and purchased a significant number of units on the open market near the end of last year. Additionally, since mid-May 2018 the CEO has bought a significant number of additional units on the market via a few different transactions (67,000 units, 24,900 units, 12,000 units and 5,000 units) - a very encouraging sign. While, this position has been one of our weaker performing REITs in recent periods we believe that it could turn into one of our best performing positions over the next year.  At quarter-end this position was yielding 10.3% via monthly expected distributions – with a current consensus price target of $9.64 per unit (Bloomberg).

 

Summary:

At month-end the portfolio’s cash position was sitting at ~5.9% and our convertible debenture exposure was approximately 36.3%. Total Cash and Fixed Income exposure including our four 3rd party specialty fixed income manager positions was ~68.6% at month-end.  

 

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. 

 

Please note our next Quarterly Summary and Quarterly Commentary will be available by next Friday, July 13th.

In the meantime, please do not hesitate to contact me if you have any question or concerns. 

 

Sincerely,

 

Paul J. Borisoff

Senior Vice President

Portfolio Manager, Senior Investment Advisor