PIM: Diversified Income Portfolio
Paul Borisoff - Apr 04, 2018
PIM: Diversified Income Portfolio – April 3rd, 2018
The Diversified Income Portfolio* was up 0.3% in March - leaving the portfolio down 1.5% in 2018. Our benchmark was also up 0.3% in March – but is down 2.5% in 2018. Over the most recent 12-month rolling period the portfolio is up 3.8% compared to our benchmark which is up 0.2%.
* 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.
March was another difficult month for most Canadian “income” portfolios – along with the last twelve months. While the Canadian bond market (FTSE/TMX Canada Universe Bond Index) moved higher last month - up 0.8% – it is up just 0.1% in 2018 – and up 1.4% over the last twelve months. The S&P/TSX Composite High Dividend Index (40% of our benchmark) was down another 0.4% in March though – leaving it down 6.4% in 2018 – and down 1.6% over the last twelve months.
In a repeat of what we said last month – while the bond market is showing signs of stabilizing – most “high-yield” Canadian equity names look increasingly oversold to us as they have continued to weaken. In an environment of increased volatility our primary concern is always preserving capital – followed by trying to improve the portfolio by taking advantage of attractive investment opportunities. In March we did both. Note, the transactions outlined below left the portfolio with increased cash and fixed income positions at 71.8% of the portfolio at quarter-end – an increase from the end of February:
Recent Portfolio Changes
- We locked-in the gain on the portfolio’s 1.2% position in Cargojet Inc. at $67.70 per share (1.2% yield) – realizing a 135% gain.We originally acquired this position via a 5-year 5.50% 30JUN19 $28.75 convertible debenture – which we decided to convert to shares when the company elected to invoke their “Soft-Call” and forced conversion in June of 2017.We continue to like the outlook for Cargojet – and used the proceeds to increase our exposure to the Cargojet 31DEC21 4.65% $58.65 convertible debenture in the portfolio at 125.50 (current yield 3.70%) – leaving us with a ~3.0% position with an average cost of 111.64.This move increased the portfolio’s yield – and reduced risk in case of a significant pullback.The current consensus twelve-month price target for Cargojet is $72.60 (Bloomberg).
- We sold the portfolio’s ~3.2% position in Pure Industrial REIT at ~$8.06 – locking-in an approximate 100% gain as many clients have cost bases in the low $4.00 range.Our first purchase was at $3.50 per unit back in May of 2010 – and with the dividends paid out since then it has been one of our most successful positions.However, with the acquisition of Pure Industrial REIT at $8.10 per unit by Blackstone approved by unitholders this month little remaining upside was left on the table.
- We sold the portfolio’s ~2.5% position in Dream Global REIT at an average price of ~$13.37.This position had moved up sharply since our reacquisition in July 2017 at $10.39 per unit.Note, we acquired our original position at $9.00 per unit in August of 2016 – which we sold at $11.01 in June of 2017. This is a company which we will continue to monitor closely - and likely purchase again at some point if a compelling buying opportunity comes along.
- We increased our position in the IBI Group 5.50% 31DEC21 $8.35 convertible debenture from 2.6% to ~4.1% at 105.80 – moving our average cost to 104.55.IBG Group’s share price recently traded as high as $9.00 in January – and a recent “soft” earnings report on March 8th provided a buying opportunity on the convertible.IBI Group Inc. is an architecture, planning, engineering and technology company – and provides a range of professional services focused on the physical development of cities. The company is currently forecasting 2018 revenue of $366 million, and has approximately $331 million of work that is committed and under contract for the next three years. The current consensus twelve-month price target is $8.88 (Bloomberg).
- We increased our exposure to Tricon Capital’s 5.60% 31MAR20 $9.80 CDN convertible debenture at 109.00 (new adjusted cost base 106.50) and reduced the portfolio’s ~4.2% position in the Tricon Capital 5.75% 31MAR22 USD $10.46 convertible debenture to ~3.2% at 103.00 USD.This change gives us a little more direct exposure to Tricon’s share price - which we expect to move back up closer to the $12 - $13 range over the next year or so from where it closed the quarter at ($9.85 per share) – and a little less USD exposure.Our 5.75% 31MAR22 USD $10.46 convertible would have to see the underlying shares move up to ~$13.48 CDN (~37% higher) prior to directly participating in further upside based on the quarter-end exchange rate – while the 5.60% 31MAR20 $9.80 CDN convertible is currently “in-the-money.” Based on our original cost – and currency conversion in March of 2017 – the reduction of our 5.75% 31MAR22 USD $10.46 convertible debenture resulted in a slight loss (0.3%) – but net gain since acquiring it including interest. Note, if Tricon Capital elects to redeem the 5.60% 31MAR20 $9.80 CDN convertible debenture at par value prior to maturity - and force an early conversion as per their Call feature - our inclination will be to convert to shares at $9.80 (2.86% dividend yield) if share are trading above the conversion price – and we expect them to stay there. Bottom-line: we would not mind holding a direct equity position in this growing company (one of the largest owners of single family rental homes in the U.S). The current consensus twelve-month average price target is $13.18 (Bloomberg).
- American Hotel Income Properties REIT posted a “soft” quarter in March – which sent the units down to a level which looks extremely oversold.In this case we took advantage of the sell-off by increasing our direct equity exposure to the company at $8.01 per unit from 3.9% to 4.9% of the portfolio – and reducing our American Hotel Income Properties REIT 5.00% 30JUN22 USD $9.25 convertible debenture from ~3.0% of the portfolio to ~2.0% at 96.48 (realizing a ~5.1% loss which was offset by interest received since acquired last June).Our average cost is now ~$9.13 per unit.This position closed the quarter at $7.91 per unit (10.6% yield) and the current consensus twelve-month price target is $10.19 (Bloomberg) – implying a potential total return of close to 40% over the next year. Note, on December 13th, 2017, the company reported that the CEO had just recently purchased 164,000 units of the company on the open market (December unit price range was $8.99 to $9.38 per unit) and requested to take 100% of his 2018 compensation in the form of additional equity. Additionally, Canaccord Genuity’s Real Estate analyst estimated on March 8th that the company’s Net Asset Value was $8.78 USD per unit ($11.32 CDN) based on the quarter-end exchange rate -which should draw support and interest to the company.
- We also increased our exposure to the FuelCell Energy Cumulative Perpetual “B” Preferred Shares at $379 USD (13.2% current yield) from 3.0% of the portfolio to 3.8% (matching the U.S. dollars received from the sale of the American Hotel Income Properties REIT USD convertible debenture). Our average cost is now $300.49 USD (~$378 CDN in client accounts) – leaving the position up ~23% based on the quarter-end price of $361 USD and taking into consideration the exchange rate. In a March 12th update on the company (available if you have not seen it) we outlined a number of significant positive developments for the company – including the recent reinstatement of the U.S. Federal Fuel Cell Investment Tax Credit, a substantial improvement in the company’s balance sheet – and what looks likes the highest degree of visibility in the company’s history regarding a clear near-term path to breakeven - and then profitability as the company converts over $1 billion of recent project awards to backlog.Note, these Preferred “B” shares have a liquidation preference of $64 million ($1,000 per share) over the common shareholders in the event the company is wound up at some point in the future in a worst-case scenario (which we do not expect). However, if an entity acquires 50% or more of the total voting power of all classes of capital stock (directly or indirectly) the Series B Preferred shareholders can require the company to redeem the shares at $1,000 – which we believe is a possibility given ExxonMobil’s previously detailed and increasing interest in the company. Additionally, FuelCell Energy is now working on a Global Deployment Strategy with Toyota Motor Company (the largest automotive company in the world – and #1 Fuel Cell Vehicle proponent) for their Distributed Hydrogen Solution – which they claim is technologically, operationally and financially superior to conventional hydrogen generation technologies – and will help facilitate the required build-out of hydrogen infrastructure for fuel cell electric vehicles (FCEVs).
- Finally, we added a new 1.2% position to the portfolio in Chorus Aviation Inc. at an average cost of $8.35 per share (5.7% yield).We originally bought a 0.6% position at $8.60 via a financing which closed on March 13th which raised ~$100 million to fund the company’s rapidly growing aircraft leasing division.We doubled the position prior to the transaction closing at $8.10. Note, Chorus Aviation is the largest regional airline in Canada based on fleet size and number of routes operated. Chorus and Air Canada are parties to a capacity purchase agreement under which Air Canada purchases Chorus’s capacity based on fixed fee per aircraft proving a high degree of stability and predictability. Chorus is seeing substantial growth though in its growing regional aircraft leasing division which seems to have significant further growth opportunities in front of it. This new position closed March at $8.30 – and the current consensus twelve-month price target is $10.68 (Bloomberg).
At month-end the portfolio’s cash position was sitting at ~8.6% 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 ~71.8% 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 that our next summary and quarterly commentary will be available by Wednesday, April 11th, 2018. In the meantime, please do not hesitate to contact me if you have any question or concerns.
Paul J. Borisoff
Senior Vice President
Portfolio Manager, Senior Investment Advisor