Portfolio manager says you have to look beyond Main Street for returns but there is potential for a better-than-average year
Fixed-income investors who want push beyond the prospect of meagre returns in 2021 will have to look further along the risk curve. Fear not, though. Geoff Castle, portfolio manager at PenderFund Capital Management, told WP there are still opportunities for reasonable returns.
With government bond yields below 1% as a result of central bank intervention and investor caution, savers have a choice. They can accept zero, which comes with a fair amount of protection through cash or short-term government bonds. Or for those with more of a saver disposition than investing (equities), corporate credit is a “nice halfway house”. Or for the more intrepid, the best opportunities in the fixed-income space are outside Main Street.
Castle said: “There is obviously potential for equities to do quite well in 2021 but from the point of view of a saver, looking at their other alternatives and thinking about moving a little bit along the risk spectrum, [fixed income] looks like a reasonably attractive place to go.”
While Pender don’t have any particular investments in the vaccine business, he expects some things to be affected by a return to something a bit more normal than the past nine months.
Castle said that in the long run, we might all be driving electric and hydrogen vehicles, but next year, most people who have gasoline powered cars are still going to be doing just that. And while there’s been a cessation of activity in the oil and gas sector, and inventories have come down a bit, we are on the cusp of seeing demand go up, at least relatively. He believes that’s not really been priced into the debt markets.
He added: “You still have companies that have a good financial position in the oil and gas sector, with double digit yields on their paper and that will probably help deliver a return during the year. There are other parts of the market, like the preferred-share market in Canada, where there is potential to earn double digit returns. When you put all that together, the outlook for 2021 is better than average.”
Castle picked out five ideas for investors for 2021.
1, Discounted Closed-End Funds
Castle said: “Benjamin Graham, the great teacher of Warren Buffett and other value investors, had a penchant for closed-end mutual funds trading at a discount of more than 15% to daily net asset value. Were Ben Graham to put together a holiday wish list, we would expect him to look fondly on some of the more deeply discounted closed-end credit funds in today’s market. Case in point, the Aberdeen Asia Pacific Income Fund (FAP.TO) which ended November at a 25% discount to daily net asset value, and which sports an 8.8% annual dividend. Here’s a double-play opportunity to close the discount whilst earning an attractive coupon.”
2, Secured Marijuana Credit
He said: “1st lien credit of Trulieve and Curaleaf should be on every holiday wish list in 2020. To be owned not merely for their delightfully high yields (over 7% for Trulieve and north of 10% for Curaleaf) but also for their comparatively mellow default probability. Both Trulieve ($4.9B mkt cap vs $169M debt) and Curaleaf ($9.3B mkt cap vs $390M debt) have large market capitalizations relative to tiny senior credit obligations. This equity-heavy capital stack in both cases drives our estimates of 1-year default probability below 0.2%. With improving profitability and possible legalization of marijuana banking in the United States, we see more tailwinds for the sector in 2021.”
Rate-Reset Preferred Shares
“No fixed income holiday wish list in Canada can leave out the extraordinarily cheap value proposition of rate reset preferreds,” Castle said. “Consider the Bell Canada series “O” preferreds that at current levels offer a 6% dividend, a rate that towers over the mere 1.1% yield available on that issuer’s 5-year notes. Even assuming the reset in 2022 is done against the current 5-yr Canada rate of 0.43%, the dividend rate is still over four times the company’s bond yield, a ratio that improves to six times when one considers the favourable tax treatment of preferred dividends. We appreciate that the risk off market in March caused some investors to banish resets from their reindeer games. But at these prices, we couldn’t imagine a better asset class than Canadian rate resets to lead our investing sleigh. On Fairfax! On Husky! On Brookfield and Thomson!”
A Seasonal Cream Puff
Castle said: “In a world of 1% paper, the 5 7/8% 2026 notes of Open Text Corp stand out to us. Priced to yield 4.9% to maturity and only slightly lower to its most realistic call dates, Open Text remains in the cream puff category of relatively high yield in comparison to rather low credit risk. The company’s group of mostly corporate clients are very sticky users of its core search and portal software applications. Cash flow is strong and consistent, while $4.7B total debt is underpinned by over $15B of market cap. We estimate 1-year default probability at less than 0.1% for this note yielding 4.9% to 2026.”
A Golden Convertible
“We like the convertible bond space generally, and particularly when one combines a reasonably attractive cash yield with realistic convertibility upside,” Castle said. “In this area we point to Osisko’s 4% notes of December 2022. At last price, the Quebec-based precious metals royalty player’s notes yielded 3% to maturity, but provide equity optionality at common stock prices above $22.89. We don’t know what is going to happen over the next couple of years in the precious metals space, but given a default probability that we view as being less than 0.2%, we believe we aren’t paying anything for the call option value against Osisko common shares.”
