PIM: Diversified Income Portfolio

Paul Borisoff - Oct 02, 2018

PIM: Diversified Income Portfolio – October 2nd, 2018

 

The Diversified Income Portfolio* was down 0.4% in September – leaving the portfolio up 2.0% in 2018 – and 5.7% higher over the last twelve months. September was generally disappointing for income investors with our benchmark down 1.1% in the month - leaving this comparable down 1.0% in 2018 – and up 1.6% over the last twelve month rolling period.

 

* 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.

 

Canadian bond market (FTSE/TMX Canada Universe Bond Index) dropped 1.0% in September – keeping with its recent zig zag pattern of quickly giving up gains after positive advances - and is now negative in 2018 again – down 0.4%. Over the last twelve months bonds are now up 1.7% – in-line with the three-year average return of 1.6% per year. We still do not see much room for improvement going forward on this asset class – with the possibility of negative returns over certain periods if rates move sharply higher.

 

S&P/TSX Composite High Dividend Index (40% of our benchmark) was impacted by both the difficult bond market conditions in September – and the uncertainty around the NAFTA trade negotiations which didn’t get resolved until after the last trading day in September – and impacted several sectors. This index was down 1.7% in September – and is now down 4.2% in 2018. Over the last twelve months it is up 4.1%.

 

While 2018 has been a frustrating year return wise so far, we continue to believe that we have good visibility to a significant expected return pick-up over the balance of the year based on expectations for specific security positions in the portfolio. One example is highlighted below, with more in our quarterly commentary in a few days.

 

Recent Portfolio Changes – and Highlights:

 

On August 30th Tricon Capital Group announced that they would redeem their 5.60% 31MAR20 convertible debenture on October 9th, 2018 at par value (100) – forcing us to make a change to this position to avoid seeing our gains evaporate. We had a 2.7% position in this name bought at an average cost of 106.50 – and decided to sell 2/3rd of it at 113.25 locking-in our gain. We converted our remaining position to shares at $9.80 as per our conversion right - as we continue to like the outlook for this company. Note, we continue to hold a 3.1% position in the Tricon Capital Group USD 5.75% 31MAR22 convertible. Tricon is one of the largest owners of single family homes in the U.S. – and additionally manages real estate portfolios on behalf of third party institutional and high-net worth accredited investors. Tricon’s shares closed the quarter at $10.88 – and the current average twelve-month price target is $13.77 per share (Bloomberg).

 

We increased our FuelCell Energy (FCEL) Preferred B position to ~4.0% from ~3.5% in September at USD $297.18 per share (16.8% yield)– lowering our average cost slightly. The company raised net proceeds of $25 million in August which strengthened their balance sheet once again - providing additional safety for Preferred B holders. Management maintains that the company is on track to convert ~$793 million of “awards” won via a Long Island Power Authority Fuel Cell RFP just over a year ago to backlog by the end of their fiscal year - which ends on October 31st, 2018. Important updates are also expected shortly from FCEL on: their Fuel Cell Carbon Capture project(s) with ExxonMobil; Distributed Hydrogen project(s) with Toyota; Solid Oxide Fuel Cell (SOFC) Commercialization Strategy including Energy Storage & 1st SOFC system delivered to NRG Energy; and their 1st SureSource 4000 (Triangle Project) starting-up commercial operations after certification (this new “Higher Electrically Efficient” Fuel Cell Power Plant is the basis of recent RFP wins – and is expected to allow FCEL to compete directly for the large data server market where Bloom Energy continues to win significant business). If FCEL delivers significant news on award conversions and/or significant news in one of these other areas I would expect to see these Prefs trade back to the $350 - $500 range very quickly. Note, the FCEL Preferred B’s were issued at $1,000 per share in 2004 - and are current on all annual dividend payments of $50 per year. FCEL Preferred B’s have a liquidation preference of $64 million ($1,000 per share) over common shareholders in a worst-case scenario – which can also be triggered if an entity acquires 50% or more of the company. Unlike common shareholders, FCEL Preferred B holders are not at risk of being diluted via additional equity raises.

 

Summary:

 

While large investors often face size and liquidity constraints in sourcing income investments there are many attractive income opportunities which retail investors and small institutional investors can incorporate into their portfolio if they know where to look – and complete the detailed due diligence required.

 

At quarter-end the portfolio’s cash position was sitting at ~8.7% and our convertible debenture exposure was approximately 33.8%. Total Cash and Fixed Income exposure including our four 3rd party specialty fixed income manager positions was ~68.7% 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.

 

Our next quarterly summary and commentary will be available by Friday, October 12th. In the and 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